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


                                   FORM 10-QSB


[X]  Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act
     of 1934
     For the quarterly period ended June 30, 2006

[ ]  Transition Report under Section 13 or 15(d) of the Securities Exchange Act
     of 1934
     For the transition period ____________ to ____________


                        Commission File Number 000-49735



                           INTRAOP MEDICAL CORPORATION

        (Exact name of small business issuer as specified in its charter)


              Nevada                                    87-0642947
 (State or other jurisdiction of            (I.R.S. Employer Identification No.)
  incorporation or organization)

                               570 Del Rey Avenue
                           Sunnyvale, California 94085
                    (Address of principal executive offices)

          Issuer's telephone number, including area code: 408-636-1020



              (Former name, former address and former fiscal year,
                          if changed since last report)

Check whether the issuer (1) 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 issuer was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days [X] Yes [ ] No

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

State the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: 26,027,172 shares of $0.001 par value
Common Stock outstanding as of the date of this filing.

Transitional Small Business Disclosure Format (Check one):   Yes [ ]    No [X]



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<PAGE>



                           INTRAOP MEDICAL CORPORATION

                                   FORM 10-QSB

                                TABLE OF CONTENTS



PART 1 - FINANCIAL INFORMATION.................................................3
   Item 1.  Financial Statements...............................................3
   Item 2.  Management's Discussion and Analysis or Plan of Operation..........3
   Item 3.  Controls And Procedures...........................................29

PART II - OTHER INFORMATION...................................................30

   Item 1.  Legal Proceedings.................................................30
   Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.......30
   Item 3.  Defaults upon Senior Securities...................................31
   Item 4.  Submission of Matters to a Vote of Security Holders...............31
   Item 5.  Other Information.................................................31
   Item 6.  Exhibits..........................................................31

SIGNATURES....................................................................32

INDEX TO FINANCIAL STATEMENTS ...............................................Q-1



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<PAGE>



                         PART 1 - FINANCIAL INFORMATION

Item 1.  Financial Statements

         The accompanying unaudited financial statements, listed on the index to
financial statements on page Q-1 and filed as part of this Form 10-QSB, have
been prepared in accordance with the instructions to Form 10-QSB and, therefore,
do not include all information and footnotes necessary for a complete
presentation of financial position, results of operations, cash flows, and
stockholders' deficit in conformity with generally accepted accounting
principles. In the opinion of management, all adjustments considered necessary
for a fair presentation of the results of operations and financial position have
been included and all such adjustments are of a normal recurring nature.
Operating results for the three and nine months ended June 30, 2006 are not
necessarily indicative of the results that can be expected for the year ending
September 30, 2006.


Item 2.  Management's Discussion and Analysis or Plan of Operation

         This discussion and analysis should be read in conjunction with our
audited financial statements and accompanying footnotes included in our Form
10-KSB in which we disclosed our financial results for the years ended September
30, 2005 and 2004 and such other reports as we file from time to time with the
SEC.

         This section contains forward-looking statements. These forward-looking
statements involve a number of risks and uncertainties, including those
identified in the section of this Form 10-QSB titled " Risk Factors" that may
cause actual results to differ materially from those discussed in, or implied
by, such forward-looking statements. Forward-looking statements within this Form
10-QSB are identified by words such as "believes," "anticipates," "expects,"
"intends," "may," and other similar expressions. However, these words are not
the only means of identifying such statements. In addition, any statements that
refer to expectations, projections or other characterizations of future events
or circumstances are forward-looking statements. We are not obligated and
expressly disclaim any obligation to publicly release any update to any
forward-looking statement. Actual results could differ materially from those
anticipated in, or implied by, forward-looking statements as a result of various
factors, including the risks outlined elsewhere in this report.


Business Overview

         Intraop Medical Corporation or IntraOp, formerly Digitalpreviews.com,
Inc., was organized under the laws of the State of Nevada on November 5, 1999.
IntraOp's initial purpose was to engage in a consulting and seminar business. In
September 2003, in anticipation of negotiating a potential merger with Intraop
Medical, Inc., a privately-held Delaware corporation, we formally abandoned our
consulting and seminar business operations, which from inception through March
9, 2005, generated no revenue and during which time we were considered to be a
development stage company. On March 9, 2005, we completed the merger with
Intraop Medical, Inc. pursuant to the terms of an Agreement and Plan of
Reorganization dated February 24, 2004, or the Merger Agreement, by and between
IntraOp and Intraop Medical, Inc., pursuant to which Intraop Medical, Inc. was
merged with and into IntraOp, and IntraOp remained as the surviving corporation.
As result of the merger, we acquired all of the assets and assumed all of the
obligations of Intraop Medical, Inc. Such assets consist, without limitation, of
all of Intraop Medical, Inc.'s cash and cash equivalents, accounts receivables,
inventory, prepaid expenses, property and equipment, leased equipment,
intangible assets (including patents, certain installment payments for license
rights to acquire certain technology, amounts paid to third parties for
manufacturing and design rights as well as design rights and manufacturing/
design instructions in connection with the Mobetron, Intraop Medical, Inc.'s
product, and a certain medical device approval license).

         In connection with the consummation of the merger and pursuant to the
merger agreement, each of the issued and outstanding shares of Intraop Medical,
Inc.'s preferred stock and common stock was cancelled and extinguished and
automatically converted into the right to receive one (1) corresponding share of
our common stock. As a result of the merger, 14,175,028 shares of our common
stock were issued to stockholders of Intraop Medical, Inc. in exchange for their
shares of preferred stock and common stock. Additionally, as of March 9, 2005 we
assumed (i) 1,023,611 options reserved under Intraop Medical, Inc.'s stock


                                       3
<PAGE>


option plan which were exercisable within 60 days of the closing date for the
merger; (ii) warrants exercisable for 926,291 shares of our common stock; and
(iii) convertible promissory notes convertible into 1,540,795 shares of our
common stock. Additionally, we sold 795,000 shares of our common stock to
certain consultants in consideration for services provided in connection with
the consummation of the Merger. All of these securities were issued in reliance
upon the exemption from securities registration afforded by the provisions of
Regulation D, as promulgated by the Securities and Exchange Commission under the
Securities Act of 1933, as amended.

         As a result of the merger with Intraop Medical, Inc., we now
manufacture, market and distribute the Mobetron, a proprietary mobile electron
beam cancer treatment system designed for use in IORT. The IORT procedure
involves the direct application of radiation to a tumor and/or tumor bed while a
patient is undergoing surgery for cancer. The Mobetron is designed to be used
without requiring additional shielding in the operating room, unlike
conventional equipment adapted for the IORT procedure. The Mobetron system can
be moved from operating room to operating room, thereby increasing its
utilization and cost effectiveness. In addition to IORT, the Mobetron system
also can be used as a conventional radiotherapy electron beam accelerator.

         Our strategy is to expand our customer base both in the United States
and internationally through direct and distributor sales channels and joint
ventures with health care providers. We also intend to continue our research and
development efforts for additional Mobetron applications.

         We derive revenues from Mobetron product and accessory sales, service
and support, and leases. Product sales revenue is recognized upon installation
provided that any remaining obligations are inconsequential or perfunctory and
collection of the receivable is deemed probable. Revenues from accessory sales
are recognized upon shipment. Revenue from lease activities is recognized as
income over the lease term as it becomes receivable according to the provisions
of the lease. Revenue from maintenance is recognized as services are completed
or over the term of the service agreements as more fully disclosed in our
financial statements.

         Cost of revenues consists primarily of amounts paid to contract
manufacturers and, salary and benefit costs for employees performing customer
support and installation, lease related interest expense and depreciation
related to leased assets. General and administrative expenses include the
salaries and benefits of executive and administrative personnel, communications,
facilities, insurance, professional services and other administrative expenses.
Sales and marketing costs include salaries, benefits and the related expenses of
the sales staff including travel expenses, promotion materials, conferences and
seminars. Research and development expenses consist primarily of compensation
and related direct costs for employees and an allocation of research and
development-related overhead expenses. Since inception, we have invested
approximately $7 million in research and development. These amounts have been
primarily invested in development of the Mobetron product and have been expensed
as they have been incurred.

         As the Mobetron, our primary product, sells for in excess of $1,000,000
depending on configuration, and because we are just beginning to move into full
commercial sale and production of this product, our historical results may vary
significantly from period to period. For example, the sale of only one Mobetron
in any given quarter may substantially alter the sales and cost numbers for that
quarter, and the timing of such a sale often cannot be predicted with any
accuracy. While we expect that our financial results may ultimately become more
predictable as sales increase and costs stabilize, our financial results for the
foreseeable future are likely to continue to vary widely from period to period.

Critical Accounting Policies

         This discussion and analysis of financial condition and results of
operation is based on our financial statements which were prepared in conformity
with accounting principles generally accepted in the United States of America.
The preparation of these financial statements requires our management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. These estimates and assumptions are based on
historical experience and on various other factors that they believe are
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. These estimates and assumptions also
require the application of certain accounting policies, many of which require
estimates and assumptions about future events and their effect on amounts
reported in the financial statements and related notes. We periodically review


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<PAGE>


our accounting policies and estimates and make adjustments when facts and
circumstances dictate. Actual results may differ from these estimates under
different assumptions or conditions. Any differences may have a material impact
on our financial condition and results of operations.

         We believe that the following accounting policies fit the definition of
critical accounting policies. We use the specific identification method to set
reserves for both doubtful accounts receivable and the valuation of our
inventory, and use historical cost information to determine our warranty
reserves. Further, in assessing the fair value of option and warrant grants, we
have valued these instruments based on the Black-Scholes model which requires
estimates of the volatility of our stock and the market price of our shares,
which in the absence of a market for shares, was based on estimates of fair
value made by our Board of Directors.

         Additionally, we entered into registration rights agreements pursuant
to our issuance of our senior and convertible debentures and warrants on August
31, 2005 and October 25, 2005. Pursuant to the registration rights agreements,
we agreed to file a resale registration statement covering the resale of the
shares issuable to the investors upon the exercise of their warrants and
conversion of their debentures by September 30, 2005 and November 24, 2005,
respectively. At inception, the registration rights agreements required us to
pay monthly liquidated damages if:

     o    a registration statement was not filed on or prior to September 30,
          2005 and November 24, 2005, respectively, or

     o    we failed to file with the Securities and Exchange Commission a
          request for acceleration in accordance with Rule 461 promulgated under
          the Securities Act, within five trading days of the date that we are
          notified by the Commission that a registration statement will not be
          "reviewed," or not subject to further review, or

     o    prior to its effectiveness date, we failed to file a pre-effective
          amendment and otherwise respond in writing to comments made by the
          Commission in respect of such registration statement within 10
          calendar days after the receipt of comments by or notice from the
          Commission that such amendment is required for a registration
          statement to be declared effective, or

     o    a registration statement filed or required to be filed hereunder was
          not declared effective by the Commission by December 29, 2005 and
          February 22, 2006, respectively, or

     o    after December 29, 2005 and February 22, 2006, respectively, a
          registration statement ceases for any reason to remain continuously
          effective as to all registrable securities for which it is required to
          be effective, or the investors are not permitted to utilize the
          prospectus therein to resell such registrable securities for 10
          consecutive calendar days but no more than an aggregate of 15 calendar
          days during any 12-month period.

         The amount of monthly liquidated damages equals 2.0% of the aggregate
purchase price paid by the investors for any registrable securities held by the
investors. Late payment beyond seven days is subject to interest at an annual
rate of 18%.

         We evaluated the liquidated damages feature of the registration rights
agreements in accordance with Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended
("SFAS 133"). The liquidated damages qualify as embedded derivative instruments
at issuance and, because they do not qualify for any scope exception within SFAS
133, they were required by SFAS 133 to be recorded as derivative financial
instruments. Further, in accordance with EITF 05-04, "The Effect of a Liquidated
Damages Clause on a Freestanding Financial Instrument Subject to EITF Issue No.
00-19, Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock", we also evaluated whether the
registration rights agreements, the senior and convertible debentures, and
associated warrants should be combined into and accounted for as a single unit
or accounted for as separate financial agreements. In considering the
appropriate treatment of these instruments, we observed that:

     o    Although entered into contemporaneously, the debentures, warrants and
          registration rights agreements are nevertheless separate legal
          agreements.

     o    Payment of the liquidated damages penalties under the registration
          rights agreements does not alter the investors' rights under either
          the warrant or debenture agreements. The debentures and warrants have


                                       5
<PAGE>


          values which are based on their interest rate and the relation between
          their conversion price or exercise price and the value of our common
          stock. This value is independent of any payment for liquidated damages
          under the registration rights agreements, which is based on how long
          the shares remain unregistered.

     o    The various agreements do not relate to the same risk. The risk
          inherent in the debentures relates to our ability to repay these
          instruments as and when they come due or to the extent converted into
          common stock, to the price of our common stock. The warrants similarly
          bear risk related to the value of our common stock. The liquidated
          damages penalty under the registration rights agreements relates to
          the risk of Intraop filing a registration statement and having it
          declared effective.

         Thus, in light of the above facts and circumstances and in accordance
with guidance in EITF 05-4, View C, we evaluated and treated the registration
rights agreements, senior and convertible debentures and associated warrants as
separate free standing agreements.

         Upon execution, the registration rights agreements had no initial fair
value. In subsequent periods, the carrying value of the derivative financial
instrument related to the registration rights agreements will be adjusted to its
fair value at each balance sheet date and any change since the prior balance
sheet date will be recognized as a component of other income/(expense).

         The estimated fair value of the registration rights agreements was
determined using the discounted value of the expected future cash flows. At
September 30, 2005 and November 24, 2005, we were not able to file a
registration statement with the SEC or have it declared effective as required by
the dates specified in the registration rights agreements. However, in January
2006, we obtained an amendment to the registration rights agreements to extend
the required filing date of our initial registration statement to January 27,
2006, a deadline that we met, and to extend the required effectiveness date of
that same initial registration statement to March 31, 2006, a deadline we did
not meet, and to waive all amounts potentially due under the liquidated damages
clause which would have been due but for the waiver. On April 18, 2006 we
obtained a further amendment to the registration rights agreements to further
extend the required effectiveness date of our initial registration statement to
May 15, 2006 for investors subject to the August 31, 2005 registration rights
agreements and extend to May 30, 2006 the date on which we must have an
effective registration statement for 50% of the registrable shares for investors
who were signatory to the October 25, 2005 registration rights agreements, both
deadlines we met. On June 19, 2006, we met the requirements to have an effective
registration statement for all shares required to be registered pursuant to the
registrations right agreements. We believe that, in the future, we will be able
to meet the registration requirements of the registration rights agreements and
that in the event we cannot, and assuming we are making reasonable efforts to
file and have a registration statement declared effective, the holders of the
debentures will waive the liquidated damages required under the registration
rights agreements. As a result, at September 30, 2005 and June 30, 2006, we
assigned no value to the potential liquidated damages under the registration
rights agreements.

         EITF 05-04 offers multiple views on the question of whether a
registration rights agreement should be combined as a unit with the underlying
financial instruments and be evaluated as a single instrument. EITF 05-04 does
not reach a consensus on this question and allows for treatment as a combined
unit (Views A and B) as well as separate freestanding financial instruments
(View C). On September 15, 2005, the FASB staff postponed further discussion of
EITF 05-04. As of June 30, 2006, the FASB has still not rescheduled EITF 05-04
for discussion.

         In conjunction with our issuance of senior and convertible debentures
and the related warrants and registration rights, we adopted View C of EITF
05-04. Accordingly, the registration rights agreements, the warrants associated
with the senior and convertible debentures, the debentures themselves, as well
as certain features of the debentures were evaluated as stand alone financial
instruments. This treatment resulted in classification of the warrants and
certain features of the debentures as equity while the registration rights
agreements and other features of the debentures were treated as derivative
liabilities. Derivative liability treatment requires adjusting the carrying
value of the instrument to its fair value at each balance sheet date and
recognizes any change since the prior balance sheet date as a component of other
income/(expense). The recorded value of such derivative liabilities can
fluctuate significantly based on fluctuations of the market value of our
underlying securities, as well as on the volatility of our stock price during
the term used for observation and the term remaining for the underlying
financial instruments. We believe that should the FASB staff reach a consensus
on EITF 05-04 and select combined unit treatment (View A or B), the debt


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<PAGE>


features of the debentures and associated warrants previously classified as
equity will have to be evaluated as a combined unit with the registration rights
agreements. This combination will result in these instruments being treated as
derivative liabilities requiring periodic reevaluation of fair value with
potentially significant fluctuation in fair value from period to period.
Accordingly, this consensus could have a significant effect on our financial
statements.

Share-based Compensation Expense

         Effective January 1, 2006, we adopted on a modified prospective
transition method Statement of Financial Accounting Standards No. 123 (revised
2004), Share-Based Payment, or SFAS 123(R), which requires the measurement and
recognition of compensation expense for all share-based payment awards made to
employees and directors, including stock options issued under the New Plan. Our
financial statements as of June 30, 2006 and for the three and nine months ended
June 30, 2006, reflect the effect of SFAS 123(R). In accordance with the
modified prospective transition method, our financial statements for prior
periods have not been restated to reflect, and do not include, the impact of
SFAS 123(R). Share-based compensation expense recognized is based on the value
of the portion of share-based payment awards that is ultimately expected to
vest. Share-based compensation expense recognized in our Unaudited Condensed
Consolidated Statements of Operations during the three and nine months ended
June 30, 2006, included compensation expense for share-based payment awards
granted prior to, but not yet vested as of, December 31, 2005 based on the grant
date fair value estimated in accordance with the pro forma provisions of SFAS
123 and compensation expense for the share-based payment awards granted
subsequent to January 1, 2006 based on the grant date fair value estimated in
accordance with the provisions of SFAS 123(R). In conjunction with the adoption
of SFAS 123(R), we elected to attribute the value of share-based compensation to
expense using the straight-line attribution method. Share-based compensation
expense related to stock options was $53,162 and $125,557, before taxes on
earnings for the three and nine months ended June 30, 2006, respectively. During
the three and nine months ended June 30, 2005, there was no share-based
compensation expense related to stock options recognized under the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, or APB 25. See Note 7 to the Condensed
Consolidated Financial Statements for additional information.

         Upon adoption of SFAS 123(R), we elected to value our share-based
payment awards granted after January 1, 2006 using the Black-Scholes
option-pricing model, or the Black-Scholes model, which we previously used for
the pro forma information required under SFAS 123. For additional information,
see Note 7 to the Condensed Consolidated Financial Statements.

         The Black-Scholes model was developed for use in estimating the fair
value of traded options that have no vesting restrictions and are fully
transferable. The Black-Scholes model requires the input of certain assumptions.
Our options have characteristics significantly different from those of traded
options, and changes in the assumptions can materially affect the fair value
estimates. The determination of fair value of share-based payment awards on the
date of grant using the Black-Scholes model is affected by our stock price as
well as the input of other subjective assumptions. These assumptions include,
but are not limited to the expected term of stock options and our expected stock
price volatility over the term of the awards.

         The expected term of stock options represents the weighted-average
period the stock options are expected to remain outstanding. The expected term
is based on the observed and expected time to post-vesting exercise and
forfeitures of option by our employees. Upon the adoption of SFAS 123(R), we
determined the expected term of stock options using the simplified method as
allowed under SAB107. Prior to January 1, 2006, we determined the expected term
of stock options based on the option vesting period. Upon adoption of SFAS
123(R), we used historical volatility measured over a period equal to the option
expected terms in deriving its expected volatility assumption as allowed under
SFAS 123(R) and SAB 107. Prior to January 1, 2006, we had also used our
historical stock price volatility in accordance with SFAS 123 for purposes of
our pro forma information. The risk-free interest rate assumption is based upon
observed interest rates appropriate for the term of our stock options. The
dividend yield assumption is based on our history and expectation of dividend
payouts.




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<PAGE>



         As share-based compensation expense recognized in the Unaudited
Condensed Consolidated Statements of Operations for the three and nine months
ended June 30, 2006, is based on awards ultimately expected to vest, it has been
reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods
if actual forfeitures differ from those estimates. Forfeitures were estimated
based on our historical experience. In our pro-forma information required under
SFAS 123 for the periods prior to January 1, 2006, we accounted for forfeitures
as they occurred. If factors change and we employ different assumptions in the
application of SFAS 123(R) in future periods, the compensation expense that we
record under SFAS 123(R) may differ significantly from what we have recorded in
the current period.

         As of June 30, 2006, there was $87,097 of total unrecognized
compensation expense related to stock options granted under the New Plan. This
unrecognized compensation expense is expected to be recognized over a weighted
average period of 1.22 years.


                  (Remainder of page intentionally left blank)











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Results of Operation for the three months ended June 30, 2006 compared to the
three months ended June 30, 2005.

Revenue, Costs of Revenue and Gross Margins

<TABLE>
<CAPTION>

                                                                Quarter Ended June 30,
        Revenue                                        2006            2005         Change            Percent
        ------------------------------------------------------------------------------------------------------
            <S>                                        <C>             <C>            <C>               <C>
          Product sales                             $25,100         $42,714       $(17,614)           -41.24%
          Leasing                                         -          62,168        (62,168)          -100.00%
          Service                                    60,319          56,912          3,407              5.99%
        ------------------------------------------------------------------------------------------------------
        Total Revenue                                85,419         161,794        (76,375)           -47.21%
        ------------------------------------------------------------------------------------------------------

        Costs of Revenue
        ------------------------------------------------------------------------------------------------------
          Product sales                              69,797         111,623        (41,826)           -37.47%
          Leasing                                         -          92,498        (92,498)          -100.00%
          Service                                    27,314          71,338        (44,024)           -61.71%
        ------------------------------------------------------------------------------------------------------
        Total Costs of Revenue                       97,111         275,459       (178,348)           -64.75%
        ------------------------------------------------------------------------------------------------------

                                                                Quarter Ended June 30,
        Gross Margin                                   2006            2005         Change            Percent
        ------------------------------------------------------------------------------------------------------
          Product sales                             (44,697)        (68,909)        24,212            -35.14%
                                                   -178.08%        -161.33%

          Leasing                                         -         (30,330)        30,330           -100.00%
                                                          -         -48.79%

          Service                                    33,005         (14,426)        47,431           -328.79%
                                                     54.72%         -25.35%
        ------------------------------------------------------------------------------------------------------
        Total Gross Margin                         $(11,692)      $(113,665)      $101,973            -89.71%
                                                    -13.69%         -70.25%
        ======================================================================================================

</TABLE>

Product Sales

         Product sales revenue, which includes systems and accessories sales but
excludes parts sold as part of our service business, were minimal in both the
quarter ended June 30, 2005 and June 30, 2006. Product sale costs of revenue
include ongoing warranty expenses related to our installed base which led to
negative margins for this revenue segment in the quarters ended June 30, 2005
and 2006. Although we were unable to record a Mobetron sale in the quarter ended
June 30, 2006, we were able to announce two new orders in Japan and another in
Belgium received during the quarter ended June 30, 2006 and subsequent to the
end of the quarter, two more orders, one each in Netherlands and China. We
currently have six Mobetrons in inventory, which will allow us to satisfy these
orders as well as support future expected demand.





                                       9
<PAGE>



Leasing

         Leasing revenue in the quarter ended June 30, 2005 is comprised of
revenue recognized on a Mobetron system delivered to our customer in Eindhoven,
Holland in November 2003 and which lease ended on January 1, 2006. At inception,
as an equipment supplier, we received proceeds in the amount of $1,230,685 as
sale price of the equipment from a third party leasing company, who in turn
leased the equipment to the hospital pursuant to a seventy month lease. We had
no material obligations under the lease and the lease remained an unconditional
obligation of the hospital as the lessee to make payments to the leasing company
as lessor for the leasing company's own account.

         However, as an inducement to the hospital to enter into the lease, we
agreed in a contract with the hospital that, should the hospital decide, upon
sixty days prior notice to us, that at end of month eighteen of its lease on May
31, 2005 that the hospital wishes to prepay the lease with the leasing company
(a one-time option), that we would reimburse the hospital for the cost of the
hospital's exercise of the prepayment option to the leasing company. Following
the reimbursement by us to the hospital for the prepayment amount, title to the
equipment would revert to us.

         Because of the potential reimbursement to the hospital at the end of
month eighteen of the lease, we retained substantial risk of ownership in the
leased property, and the transaction has therefore been accounted for in
accordance with SFAS 13, "Accounting for Leases", specifically paragraphs 19,
21, and 22. Accordingly, we recorded the entire $1,230,685 of proceeds received
from the leasing company as obligation for leased equipment, a liability on our
balance sheet and accounted for the item as borrowing. In accordance with APB
Opinion 21, "Interest on Receivables and Payables" paragraphs 13 and 14, we
determined an interest rate for the obligation of 14.5% based on other debt
arrangements entered into by us at dates closest to the inception of the
obligation for leased equipment.

         During the quarter ended June 30, 2005, we recognized $62,168 of
leasing revenue from this transaction. Further, prior to the lease expiration on
January 1, 2006, a portion of each month's rental revenue was recorded as
interest expense and included in cost of revenue with the remainder recorded as
a reduction in obligation for leased equipment. Further, as the lease ended on
January 1, 2006, we recognized no leasing revenue in the quarter ended June 30,
2006.

         Further, at inception of the lease, we recorded $1,016,238, the amount
that would otherwise have been our cost of revenue for the transaction, as
leased equipment, an asset on our balance sheet. The asset was depreciated on a
straight line basis over the period of our reimbursement obligation to the
hospital down to a value equal to the estimated residual value of the equipment
at the end of the obligation of approximately $631,114. The depreciation expense
is included in cost of revenue.

         Prior to May 31, 2005 the hospital notified us that it intended to
exercise its prepayment option, however not until January 1, 2006. We agreed to
extend our reimbursement option from May 31, 2005 until January 1, 2006, and
agreed to a new reimbursement amount. Although satisfied with the performance of
the Mobetron, the hospital completed the build out of certain shielded
facilities and found the Mobetron surplus to its use. As a result, at lease
termination, we reclassified our remaining obligation for leased equipment in
the amount of $1,013,022 to accounts payable and further reclassified the leased
asset to inventory.

         In the quarter ended June 30, 2005 we incurred interest and
depreciation on the leased Mobetron of $92,498, exceeding the revenue recognized
on this transaction during that same period. Beginning October 1, 2005, we
stopped depreciating this asset as we believed that the residual value of the
equipment at lease termination January 1, 2006 would exceed the assets book
value. Further, as the lease ended on January 1, 2006, we recognized no cost of
leasing revenue in the quarter ended June 30, 2006.




                                       10
<PAGE>



Service

         The majority of service revenue for the quarter ended June 30, 2006
came from five service contracts with U.S. hospitals, with the balance from
as-requested service calls and parts sales to customers. In the quarter ended
June 30, 2005, we recognized revenue on two service contracts with U.S.
customers and on a single, significant, non-recurring repair order which
accounted for the majority of the difference in service cost of revenue for the
quarters ended June 30, 2006 and June 30, 2005. We expect service revenue to
grow in relative proportion to U.S. based sales. Overseas distributors are
generally responsible for servicing their own customers with parts supplied by
us, though the company also recently obtained direct service contracts with a
few of its customers in Europe, which revenue is included in the quarter ended
June 30, 2006.

Operating Expenses

         A comparison of our operating expenses for the quarters ended June 30,
2006 and June 30, 2005 are as follows:

<TABLE>
<CAPTION>

                                                            Quarter Ended
                                                               June 30,
                                                      2006               2005         Change          Percent
        ------------------------------------------------------------------------------------------------------
               <S>                                   <C>                <C>            <C>              <C>
        Research and Development                  $164,073           $142,295        $21,778           15.30%
        General & Administrative                   784,474            391,465        393,009          100.39%
        Sales and Marketing                        171,085            159,886         11,199            7.00%
        ------------------------------------------------------------------------------------------------------
        Total Operating Expenses                $1,119,632           $693,646       $425,986           61.41%
        ======================================================================================================

</TABLE>


         Research and development expenses increased by approximately 15.3% in
the quarter ended June 30, 2006 in comparison to the quarter ended June 30, 2005
as we added staff and continued work on various cost reduction and enhancement
projects for the Mobetron. During the quarter ended June 30, 2006, two
significant on-going research and development projects began to yield results.
In June 2006, we completed a prototype, cost-reduced modulator for the Mobetron
which we expect to yield a production cost savings of approximately $34,000 per
machine, and also in June 2006 we continued testing a prototype, motorized
transport which will allow our customers to more easily move the Mobetron within
the hospital.

         General and administrative expenses increased by approximately 100% in
the quarter ended June 30, 2006 in comparison to the quarter ended June 30,
2005. The largest components of this change were related to our increased
investor relations activities and to increases in compensation and related
charges paid to employees and directors as we added staff in this area, began to
provide cash compensation to our outside directors, and recognized share-based
compensation expense related to our adoption of FAS 123R. We also incurred
higher rental and office expenses due to our move to new, larger facilities in
October 2005.

         Sales and marketing expenses rose by $11,199 in the quarter ended June
30, 2006 in comparison to the quarter ended June 30, 2005 due to an expansion of
our sales force, including the recognition of share-based compensation expense
related to our adoption of FAS 123R. We expect expenses in this area to continue
to rise as we further our sales efforts by hiring staff and increasing our
marketing and advertising efforts.




                                       11
<PAGE>



         Interest Expense. We completed post-merger restructuring of our debt in
August through November 2005 through the sale of our senior and convertible
debentures, the addition of our Revolving Line (see Note 4 to our financial
statements included in this filing) and the repayment of certain pre-merger
borrowings. That restructuring resulted in an increase in the amounts borrowed,
a shift from shorter term to longer term maturities and a decrease in our
overall borrowing cost. As a result, although our interest expense increased by
$1,158,855 in the quarter ended June 30, 2006 in comparison to the quarter ended
June 30, 2005, after subtracting amortization of debt issuance costs, debt
discounts due to warrants and beneficial conversions features (all non-cash
components of interest), adjusted interest expense increased only by $1,659
while the amount of interest bearing obligations at June 30, 2006 was $3,271,331
greater than at June 30, 2005. Further, as a percentage of our interest bearing
obligations in quarter ended June 30, 2006, our adjusted interest expense, an
approximation of our borrowing rate during that quarter, decreased to 9.34%,
which compares favorably to an approximate annual borrowing rate of 12.37% for
the three months ended June 30, 2005, the quarter in which we completed our
merger.


<TABLE>
<CAPTION>


                                                            Quarter Ended June 30,
        Interest Bearing Obligations                                2006            2005          Change
        -------------------------------------------------------------------------------------------------
                <S>                                                <C>              <C>            <C>
        Capital lease obligations                                 $2,063          $    -

        Notes payable, related parties                           709,169       1,032,425

        Notes payable other, current portion                   4,281,462       7,732,306

        Obligation for leased equipment                                -       1,088,081
        Addback debt discounts and beneficial
        conversion features                                            -               -
        -------------------------------------------------------------------------------------------------
        Interest bearing obligations, current                  4,992,694       9,852,812     $(4,860,118)

        Capital lease obligations, non-current                     8,499               -
        Notes payable, related parties, non-current                    -               -
        Notes payable, other, non-current                      2,944,339               -
        Addback debt discounts and beneficial
        conversion features                                    5,188,641          10,030
        -------------------------------------------------------------------------------------------------
        Interest bearing obligations, non-current              8,141,479          10,030       8,131,449
        -------------------------------------------------------------------------------------------------
        Total interest bearing obligations                   $13,134,173      $9,862,842      $3,271,331
        =================================================================================================

        Interest Expense                                            2006            2005          Change
        -------------------------------------------------------------------------------------------------
        Interest Expense                                      $1,528,124        $369,269      $1,158,855

        Amortization of debt issuance costs, debt
        discounts due to warrants and beneficial
        conversion features                                    1,221,444          64,248       1,157,196
        -------------------------------------------------------------------------------------------------
        Adjusted interest expense                               $306,680        $305,021          $1,659

        Annualized adjusted interest expense                   1,226,720       1,220,083
        Interest bearing obligations                         $13,134,173      $9,862,842
                                                                   9.34%          12.37%         (3.03)%
        =================================================================================================

</TABLE>



                                       12
<PAGE>



Results of Operation for the nine months ended June 30, 2006 compared to the
nine months ended June 30, 2005.

Revenue, Costs of Revenue and Gross Margins

<TABLE>
<CAPTION>

                                                              Nine Months Ended June 30,
        Revenue                                      2006              2005          Change         Percent
        ----------------------------------------------------------------------------------------------------
             <S>                                    <C>               <C>            <C>              <C>
          Product sales                        $1,948,556        $2,427,339       $(478,783)        -19.72%
          Leasing                                 134,127           186,503         (52,376)        -28.08%
          Service                                 238,058           105,347         132,711         125.98%
        ----------------------------------------------------------------------------------------------------
        Total Revenue                           2,320,741         2,719,189        (398,448)        -14.65%
        ----------------------------------------------------------------------------------------------------

        Costs of Revenue
        ----------------------------------------------------------------------------------------------------
          Product sales                         1,748,476         1,952,510        (204,034)        -10.45%
          Leasing                                  38,323           279,822        (241,499)        -86.30%
          Service                                 201,682           128,418          73,264          57.05%
        ----------------------------------------------------------------------------------------------------
        Total Costs of Revenue                  1,988,481         2,360,750        (372,269)        -15.77%
        ----------------------------------------------------------------------------------------------------

                                                              Nine months Ended June 30,
        Gross Margin                                 2006             2005           Change         Percent
        ----------------------------------------------------------------------------------------------------
          Product sales                           200,080           474,829        (274,749)        -57.86%
                                                   10.27%            19.56%

          Leasing                                  95,804           (93,319)        189,123        -202.66%
                                                   71.43%           -50.04%

          Service                                  36,376           (23,071)         59,447        -257.67%
                                                   15.28%           -21.90%
        ----------------------------------------------------------------------------------------------------
        Total Gross Margin                       $332,260          $358,439        $(26,179)         -7.30%
                                                   14.32%            13.18%
        ====================================================================================================

</TABLE>


Product Sales

During the nine months ended June 30, 2006, we sold our sixth and seventh
systems in Europe bringing the total installed Mobetron base worldwide to
fifteen systems. Product sales revenue, which includes systems and accessories
sales but excludes parts sold as part of our service business, decreased however
due to the higher margins earned on a direct-to-the-customer, domestic sale made
during the nine months ended June 30, 2005 in comparison to the two overseas
sales made by distributors in the nine months ended June 30, 2006. We expect
overseas sales to continue to outnumber U.S. sales over the next few years.




                                       13
<PAGE>


<TABLE>
<CAPTION>


                                                             Nine Months Ended June 30,
Product Sales Analysis                                     2006               2005          Change         Percent
-------------------------------------------------------------------------------------------------------------------
     <S>                                                  <C>                <C>               <C>           <C>
Systems sold                                                  2                  2               -

  Product sales                                      $1,948,556         $2,427,339
  Non-recurring items                                    92,500           (133,630)
-------------------------------------------------------------------------------------------------------------------
  Adjusted product sales                              2,041,056          2,293,709
  Adjusted revenue per system sold                    1,020,528          1,146,855      $(126,327)         -11.02%

  Materials cost                                      1,521,856          1,756,099
  Non-recurring items                                    67,117            (67,117)
-------------------------------------------------------------------------------------------------------------------
  Adjusted material cost                              1,588,973          1,688,982
  Materials cost per system sold                        794,487            844,491        (50,005)          -5.92%
-------------------------------------------------------------------------------------------------------------------
  Adjusted materials margin                             452,083            604,727
  Adjusted materials margin per system sold             226,042            302,364        (76,322)         -25.24%
                                                         22.15%             26.36%

  Labor, and overhead                                   124,917            126,208

  Warranty                                              101,703             70,203
-------------------------------------------------------------------------------------------------------------------
Adjusted margin after warranty, labor and
overhead                                               $225,463           $408,316       (182,853)         -44.78%
                                                         11.05%             17.80%
===================================================================================================================

</TABLE>


         Per systems sales revenues were higher in the nine months ended June
30, 2005 in comparison to the nine months ended June 30, 2006 due to a better
mix of direct-to-customer versus distributor based sales in the nine months
ended June 30, 2005. Additionally, included in revenue for the nine months ended
June 30, 2005 were certain non-recurring, one-time foreign exchange gains on a
system sold prior to the nine months ended June 30, 2005, but for which
receivables were collected in the period. In the nine months ended June 30, 2006
we also experienced a large, one-time return of certain spare parts,
representing $92,500 of product revenue and $67,117 of cost of product revenue,
from one of our distributors. These spare parts were originally sold to the
distributor in the nine months ended June 30, 2005. The return occurred based on
a change in our agreement with that distributor over servicing responsibility
for that country. These transactions have been backed out of the table above to
facilitate a better period-to-period comparison.

         Because of our continued efforts to bring down materials costs, average
materials costs per system decreased by $50,005 in the nine months ended June
30, 2006 versus the nine months ended June 30, 2005, a 5.92% improvement. The
labor and overhead expenses remained constant for the nine months ended June 30,
2006 over the nine months ended June 30, 2005 as increased personnel related
expenses, including $21,705 of share based compensation related to our adoption
of FAS 123R, were offset by increased overhead absorption into our inventory. We
continue to seek improvement in our margins through various engineering cost
reduction efforts for the Mobetron.




                                       14
<PAGE>



Leasing

         Leasing revenue in the nine months ended June 30, 2006 and 2005 is
comprised of revenue recognized on a Mobetron system delivered to our customer
in Eindhoven, Holland in November 2003 and which lease ended on January 1, 2006.
At inception, as an equipment supplier, we received proceeds in the amount of
$1,230,685 as sale price of the equipment from a third party leasing company,
who in turn leased the equipment to the hospital pursuant to a seventy month
lease. We had no material obligations under the lease and the lease remained an
unconditional obligation of the hospital as the lessee to make payments to the
leasing company as lessor for the leasing company's own account.

         However, as an inducement to the hospital to enter into the lease, we
agreed in a contract with the hospital that, should the hospital decide, upon
sixty days prior notice to us, that at end of month eighteen of its lease on May
31, 2005 that the hospital wishes to prepay the lease with the leasing company
(a one-time option), that we would reimburse the hospital for the cost of the
hospital's exercise of the prepayment option to the leasing company. Following
the reimbursement by us to the hospital for the prepayment amount, title to the
equipment would revert to us.

         Because of the potential reimbursement to the hospital at the end of
month eighteen of the lease, we retained substantial risk of ownership in the
leased property, and the transaction has therefore been accounted for in
accordance with SFAS 13, "Accounting for Leases", specifically paragraphs 19,
21, and 22. Accordingly, we recorded the entire $1,230,685 of proceeds received
from the leasing company as obligation for leased equipment, a liability on its
balance sheet and accounted for the item as borrowing. In accordance with APB
Opinion 21, "Interest on Receivables and Payables" paragraphs 13 and 14, we
determined an interest rate for the obligation of 14.5% based on other debt
arrangements entered into by us at dates closest to the inception of the
obligation for leased equipment.

         During the nine months ended June 30, 2005, we recognized $186,503 of
leasing revenue from this transaction. Further, prior to the lease expiration on
January 1, 2006, a portion of each month's rental revenue was recorded as
interest expense and included in cost of revenue with the remainder recorded as
a reduction in obligation for leased equipment. As the lease terminated on
January 1, 2006, in the nine months ended June 30, 2006, in addition to monthly
rental earned during the three months ended December 31, 2005, we realized as
leasing revenue a final, one-time payment from the third party leasing company
due to the early termination of the lease by the hospital in the amount of
$71,959.

         Further, at inception of the lease, we recorded $1,016,238, the amount
that would otherwise have been our cost of revenue for the transaction, as
leased equipment, an asset on our balance sheet. The asset was depreciated on a
straight line basis over the period of our reimbursement obligation to the
hospital down to a value equal to the estimated residual value of the equipment
at the end of the obligation of approximately $631,114. The depreciation expense
is included in cost of revenue.

         Prior to May 31, 2005 the hospital notified us that it intended to
exercise its prepayment option, however not until January 1, 2006. We agreed to
extend our reimbursement option from May 31, 2005 until January 1, 2006, and
agreed to a new reimbursement amount. Although satisfied with the performance of
the Mobetron, the hospital completed the build out of certain shielded
facilities and found the Mobetron surplus to its use. As a result, at lease
termination, we reclassified our remaining obligation for leased equipment in
the amount of $1,013,022 to accounts payable and further reclassified the leased
asset to inventory.

         In the nine months ended June 30, 2005 we incurred interest and
depreciation on the leased Mobetron in Eindhoven, Holland of $279,822, exceeding
the revenue recognized on this transaction during that same period. Beginning
October 1, 2005, we stopped depreciating this asset as we believed that the
residual value of the equipment at lease termination January 1, 2006 would
exceed the assets book value. Further, as no interest expense was recognized
with respect to the early termination payment we received from the third party
leasing company, leasing revenue exceeded leasing cost of revenue for the nine
months ended June 30, 2006.




                                       15
<PAGE>



Service

         The majority of service revenue for the nine months ended June 30, 2005
came from two service contracts with U.S. hospitals, with the balance from
as-requested service calls and parts sales to customers. In the nine months
ended June 30, 2006 we recognized revenue on five service contracts with U.S.
customers, however the majority of the difference in service revenue and service
cost of revenue for the nine months ended June 30, 2006 and June 30, 2005
resulted from a single, large, non-recurring repair order. We expect service
revenue to grow in relative proportion to U.S. based sales. Overseas
distributors are generally responsible for servicing their own customers with
parts supplied by us, though the company also recently obtained direct contracts
with a few of its customers in Europe, which revenue is included in the nine
months ended June 30, 2006.

Operating Expenses

         A comparison of our operating expenses for the nine months ended June
30, 2006 and June 30, 2005 are as follows:

<TABLE>
<CAPTION>
                                                             Nine Months Ended June 30,
                                                     2006             2005           Change       Percent
        ----------------------------------------------------------------------------------------------------
                 <S>                                <C>                <C>             <C>           <C>
        Research and Development                 $459,553         $378,443          $81,110        21.43%
        General & Administrative                1,756,896        2,698,976         (942,080)      -34.91%
        Sales and Marketing                       545,236          449,477           95,759        21.30%
        ----------------------------------------------------------------------------------------------------
        Total Operating Expenses               $2,761,685       $3,526,896        $(765,211)      -21.70%
        ====================================================================================================

</TABLE>


         Research and development expenses, primarily personnel related,
increased by approximately 21.43% in the nine months ended June 30, 2006 in
comparison to the nine months ended June 30, 2005 as we as we added staff and
continue work on various cost reduction and enhancement projects for the
Mobetron.

         General and administrative expenses decreased by $942,080 in the nine
months ended June 30, 2006 in comparison to the nine months ended June 30, 2005.
Of this difference, $1,709,292 were costs related to our merger completed in
March 2005, including $1,591,470 of non-cash charges for stock issued to service
providers and preferred shareholders under anti-dilutive agreements upon their
conversion to common stock. Without the merger related charges, general and
administrative expenses in the nine months ended June 30, 2006 would have shown
an increase of $767,212 over the nine months ended June 30, 2005. The largest
components of this change were increased investor relations activities and
increases in compensation and related charges paid to employees and directors as
we added staff in this area and began to provide cash compensation to our
outside directors and recognized share-based compensation expense related to our
adoption of FAS 123R. We also incurred higher rental and office expenses due to
our move to new, larger facilities in October 2005.

         Sales and marketing expenses rose by $95,759 in nine months ended June
30, 2006 in comparison to the nine months ended June 30, 2005 due to an
expansion of our sales force, including the recognition of share-based
compensation expense related to our adoption of FAS 123R, and increased
expenditures for marketing and promotion. We expect expenses in this area to
continue to rise as we further our sales efforts by hiring staff and increasing
our marketing and advertising efforts.

         Interest Expense. We completed post-merger restructuring of our debt in
August through November 2005 through the sale of our senior and convertible
debentures, the addition of our Revolving Line (see Note 4 to our financial
statements included in this filing) and the repayment of certain pre-merger
borrowings. That restructuring resulted in an increase in the amounts borrowed,
a shift from shorter term to longer term maturities and a decrease in our
overall borrowing cost. As a result, although our interest expense increased by
$2,268,886 in the nine months ended June 30, 2006 in comparison to the nine
months ended June 30, 2005, after subtracting amortization of debt issuance
costs, debt discounts due to warrants and beneficial conversions features (all
non-cash components of interest), adjusted interest expense decreased by $58,053
while the amount of interest bearing obligations at June 30, 2006 was $3,271,331
greater than at June 30, 2005.




                                       16
<PAGE>


<TABLE>
<CAPTION>


        Interest Expense                             2006             2005           Change
        ------------------------------------------------------------------------------------
             <S>                                    <C>             <C>               <C>
        Interest Expense                       $3,580,134       $1,311,248       $2,268,886

        Amortization of debt issuance
        costs, debt discounts due to
        warrants. and beneficial
        conversion features                     2,708,842          381,903        2,326,939
        ------------------------------------------------------------------------------------
        Adjusted interest expense                $871,292         $929,345        $(58,053)
        ====================================================================================

</TABLE>


Liquidity and Capital Resources

         We experienced net losses of $6,019,773 and $4,375,060 for the nine
months ended June 30, 2006 and 2005, respectively. In addition, we have incurred
substantial monetary liabilities in excess of monetary assets over the past
several years and, as of June 30, 2006, had an accumulated deficit of
$26,874,590. These matters, among others, raise substantial doubt about our
ability to continue as a going concern. In view of the matters described above,
recoverability of a major portion of the recorded asset amounts shown on our
consolidated balance sheet is dependent upon our ability to generate sufficient
sales volume to cover our operating expenses and/or to raise sufficient capital
to meet our payment obligations. Management is taking action to address these
matters, which include:

     o    Retaining experienced management personnel with particular skills in
          the development and sale of our products and services.

     o    Developing new markets (primarily Europe) and expanding our sales
          efforts.

     o    Evaluating funding strategies in the public and private markets.

         Historically, management has been able to raise additional capital.
During the nine months ended June 30, 2006, we obtained an additional $4.5
million through the sale of convertible debentures and $880,716 through the
exercise of warrants related to these debentures. The proceeds will be used for
working capital. The successful outcome of future activities cannot be
determined at this time and there is no assurance that if achieved, we will have
sufficient funds to execute our business plan or generate positive operating
results.

         Our primary cash inflows and outflows for the nine months ended June
30, 2006 and 2005 are as follows:

<TABLE>
<CAPTION>

                                             Nine Months Ended June 30,
        Cash Flows                                 2006           2005             Change
        ------------------------------------------------------------------------------------
        Provided by (Used in):
               <S>                                  <C>             <C>             <C>
          Operating Activities                 $(4,532,662)   $(1,096,072)     $(3,436,590)
          Investing Activities                    (193,237)       (58,298)        (134,939)
          Financing Activities                    4,899,410      1,057,616        3,841,794
        ------------------------------------------------------------------------------------
        Net Increase/(Decrease)                    $173,511      $(96,754)         $270,265
        ====================================================================================

</TABLE>





                                       17
<PAGE>


Operating Activities

         Net cash used for operating activities increased by $3,436,590 in the
nine months ended June 30, 2006 in comparison to the same period in the prior
fiscal year. Significantly offsetting our net loss of $6,019,773 for the nine
months ended June 30, 2006 were $3,055,389 of non-cash charges, primarily for
amortization of debt discounts, beneficial conversion features and issuance
costs related to our new senior and convertible debentures. During the nine
months ended June 30, 2005, our net loss of $4,375,060 was similarly offset by
non-cash charges of $2,290,788 of which $1,709,292 were merger related non-cash
charges for stock issued to service providers and preferred shareholders under
anti-dilutive agreements upon their conversion to common stock. Additionally,
large combined differences in other asset and liability accounts of
approximately $2.5 million between nine months ended June 30, 2006 and June 30,
2005 significantly affected operating cash flow during those two years. These
accounts, which include inventories, account receivable, accounts payable,
customer deposits, and deposits with vendors, are currently highly subject to
short term fluctuations and will continue to be volatile because of our low
volume of Mobetron sales and large per system cost of the Mobetron.

Investing Activities

         Investing activities in the nine months ended June 30, 2006 consisted
primarily of the acquisition of fixed assets related to our move and expansion
into our new headquarters, manufacturing, and test facilities in October 2005.

Financing Activities

         In October and November 2005, we completed the sale of our convertible
debentures with the issuance of an additional $4.5 million of debentures. The
addition of these debentures to our existing convertible and senior debentures
completes a significant change and improvement to our capital structure. Prior
to the sale of the senior and convertible debentures, all of our notes payable
were due within one year. However, because no scheduled principal amortization
is required on the convertible debentures until their maturity three years from
date of issuance, and because only $333,333 of scheduled principal amortization
per annum is required on the senior debentures, our capital structure is much
more stable.

         During the nine months ended June 30, 2006 we repaid $341,789 of
outstanding notes to related parties and $2,768,145 of other notes payable, the
majority of which were repayments under our Product Financing Arrangement and
which we substantially re-borrowed during the period. We plan to fully repay our
related party debt over the next few years. Additionally, during the nine months
ended June 30, 2006, the following amounts were converted to shares of our
common stock: $183,967 of principal and $66,033 of interest by a related party
and $600,000 of principal and $14,660 of interest by holders of our convertible
debentures.





                  (Remainder of page intentionally left blank)






                                       18
<PAGE>



Debt and Lease Obligations

         At June 30, 2006, we had notes payable and capital leases from various
sources as shown below. Interest rates on such debt range from 5% to 24%. We
also lease office space and equipment under non-cancelable operating and capital
leases with various expiration dates through 2011. Also, during the nine months
ended June 30, 2006, we entered into a $312,500 payment agreement with a vendor
related to certain Mobetron manufacturing and design rights which is included in
Other Notes below.

<TABLE>
<CAPTION>



                                                                                  June 30, 2006
                                                                                ------------------
                        <S>                                                               <C>
        Notes payable, related parties, current                                        $  709,169
                                                                                ==================


        Convertible debentures                                                       $  6,400,000
        Product financing arrangement                                                   3,946,798
        Senior secured debentures                                                       1,750,000
        Other notes                                                                       317,644
                                                                                ------------------

        Less debt discounts due to warrants                                            (2,492,383)
        Less beneficial conversion features                                            (2,696,258)
                                                                                ------------------

        Notes payable, net of debt discounts and beneficial conversion
        features                                                                        7,225,801

        Less current portion                                                           (4,281,462)
                                                                                ------------------

           Notes payable, other, net of current portion, unamortized
             debt discounts and beneficial conversion features                        $ 2,944,339
                                                                                ==================



        Capital lease for equipment                                                    $   10,562

        Less current portion                                                               (2,063)
                                                                                ------------------

        Capital lease obligations, net of current portion                              $    8,499
                                                                                ==================
</TABLE>





                                       19
<PAGE>



         As of June 30, 2006, future minimum lease payments that come due in the
current and following fiscal years ending September 30:

<TABLE>
<CAPTION>

                                                                             Capital      Operating
                           Year Ended September 30,                          Leases        Leases
        -------------------------------------------------------------    ----------------------------
                                    <S>                                         <C>            <C>
                                    2006                                       $  645       $ 57,277
                                    2007                                        2,579        233,796
                                    2008                                        2,579        237,625
                                    2009                                        2,579        244,754
                                    2010                                        2,579        233,838
                                    2011                                          431              -
                                                                         ----------------------------

        Total minimum lease payments                                           11,392     $1,007,290
                                                                                       ==============

        Less: Amount representing interest                                       (830)
                                                                         -------------

        Present value of minimum lease payments                                10,562
        Less: Current portion                                                  (2,063)
                                                                         -------------

        Obligations under capital lease, net of current portion                $8,499
                                                                         =============

</TABLE>


Deferred Revenue:

         Revenue under service agreements is deferred and recognized over the
term of the agreement, typically one year, over a straight line basis. As of
June 30, 2006 and June 30, 2005 deferred revenue was $93,224 and $34,920
respectively, which is included under accrued liabilities.



Off-Balance Sheet Arrangements

         We had no off-balance sheet arrangements to report for the three months
ended June 30, 2006 or June 30, 2005.



                  (Remainder of page intentionally left blank)




                                       20
<PAGE>



                                  RISK FACTORS

         Stockholders should carefully consider the following risk factors,
together with the other information included and incorporated by reference in
this Form 10-QSB.

                         RISKS RELATING TO OUR BUSINESS

We have been in operation for over 10 years and have never been profitable.

         IntraOp is a medical device company that has experienced significant
operating losses in each year since incorporation on March 9, 1993, primarily
due to the cost of substantial research and development of its sole product, the
Mobetron. We have generated about $14.9 million in revenues through June 30,
2006, however we expect to continue to incur operating losses as well as
negative cash flows from operations in future periods. Our ability to achieve
profitability will depend upon our successful commercial marketing of the
Mobetron and effectively making the transition to a manufacturing and marketing
company. It is possible that the Mobetron and any other products of Intraop will
never gain full commercial acceptance, and as a result we may never generate
significant revenues or achieve or maintain profitability. As a consequence of
these uncertainties, our independent public accountants have expressed a "going
concern" qualification in their audit reports.

We have pledged all of our assets and issued a significant amount of our capital
stock as security for a loan.

         In August 2005, we entered into a revolving, $3,000,000, combined
inventory and international factoring agreement, or Revolving Line, under which
we pledged as collateral certain of our inventory and receivables. On June 1,
2006 we entered into an amendment to the Revolving Line, or Product Financing
Arrangement to increase the line to $4,000,000. Also in August 2005, we borrowed
$2,000,000 pursuant to 10% senior secured debentures issued to two private
lenders which are due at maturity in August 2008. Among other terms, the loan is
secured by a lien on all of our assets not otherwise pledged under our Revolving
Line. In addition we issued 1,600,000 shares of our common stock to the holders
of the 10% senior secured debentures, the Collateral Shares. So long as an event
of default under the secured debentures has not occurred, we retain voting
rights over the Collateral Shares and the lenders are not permitted to sell the
Collateral Shares.

         Should a default occur under the Revolving Line or the secured
debentures, the lenders under those agreements would be entitled to exercise
their rights as secured creditors under the Uniform Commercial Code, including
the right to take possession of the pledged collateral, which in the case of the
10% senior secured debentures would include all of our assets, and to sell those
assets at a public or private sale and also to sell the Collateral Shares. In
the event the lenders exercise those rights, we would have a very short period
of time in which to obtain adequate capital to satisfy the amount of the
obligations to the lenders to prevent the sale of our assets. For us to obtain
such capital in such a short period would result in very significant dilution to
the stockholders and if we are unable to obtain those funds, we could be unable
thereafter to operate, possibly resulting in a total loss of the investment made
by our stockholders.

We have significant additional capital needs.

         We have expended, and will continue to expend, substantial funds on
development, marketing, research, and commercialization related to the Mobetron.
In the past we received liquidity from payments by distributors and customers,
proceeds from the sale of equity securities and debt instruments, and government
grants. Any additional secured indebtedness would require the consent of our
senior lenders. Equity or debt financing may not be available on terms favorable
to us or at all, in which case we may be unable to meet our expenses.




                                       21
<PAGE>



Our single product is subject to uncertain market acceptance.

         We have not yet manufactured, marketed, or sold the Mobetron in full
commercial quantities. We cannot assure that the Mobetron will gain broad
commercial acceptance or that commercial viability will be achieved; that future
research and development related to the Mobetron system will be successful or
produce commercially salable products; that other products under development by
us will be completed or commercially viable; or that hospitals or other
potential customers will be willing to make the investment necessary to purchase
the Mobetron or other products under development by us, or be willing to comply
with applicable government regulations regarding their use.

We are dependent on key suppliers and have limited manufacturing experience.

         We have entered into an agreement with CDS Engineering LLC, or CDS, for
the manufacture of the majority of the Mobetron system, while the accelerator
guide, a key component of the Mobetron, is manufactured by Accuray Incorporated
of Sunnyvale, California and the modulator another key component of the Mobetron
is manufactured by TPI systems. One of the founders of Accuray Incorporated,
Donald A. Goer, is our President and CEO.

         Though members of management have extensive experience in
manufacturing, to date we have not manufactured the Mobetron system ourselves.
We do not have experience manufacturing our products in the volumes that will be
necessary for us to achieve significant commercial sales. Any significant
interruption in our relationship with Accuray, CDS, TPI systems or any other key
suppliers, including subcontractors, would have a material adverse effect on our
ability to manufacture the Mobetron and, therefore, on our business, financial
condition, and results of operation.

         We expect to retain the rights to manufacture certain Mobetron
accessories, options, and disposable medical devices. We may encounter
difficulties in scaling up the production of the Mobetron or in hiring and
training additional personnel to manufacture the Mobetron in commercial
quantities.

         We intend to continue to do our own final testing of the Mobetron. This
testing requires a specialized test facility. In September, 2005 we entered into
a lease for combined office, manufacturing, research and test facilities which
we believe are adequate for testing Mobetrons through August 2010. Should our
business grow more quickly than anticipated, our inability to locate additional
test facilities or expand test facilities at our current location would likely
have a material adverse effect on our ability to manufacture the Mobetron and,
therefore, on our business, financial condition, and results of operation.

We may be unable to protect our patents and proprietary technology.

         Our ability to compete effectively in the marketplace will depend, in
part, on our ability to protect our intellectual property rights. We rely on
patents, trade secrets, and know-how to establish and maintain a competitive
position in the marketplace. The enforceability of medical device or other
patents, however, can be uncertain. Any limitation or reduction in our rights to
obtain or enforce our patents could have a material adverse effect on our
ability to maintain or protect our intellectual property rights.

         NRT, an Italian company, is offering a modified, non-shielded IORT unit
called the Novac 7. This linear accelerator system was developed, in part, with
funding from the Italian government. The Novac 7 has lower energy than the
Mobetron and requires mobile shielding to be positioned around the surgical
table prior to treatment. A spin-off of NRT, called Info & Tech, which
manufactures a system called the Liac, is attempting to replace NRT in the
market. Info & Tech has delivered a small number of pre-commercial units to its
customers. The features and technology of the Liac system are very similar to
that of the NRT system.

         The Liac system has been offered to at least one customer in Germany
and we have notified Info & Tech and its German distributor that the Liac system
infringes on our intellectual property and demanded that Liac desist from this
infringement. In June, 2006, we brought suit at Dusseldorf, Germany against Info
& Tech for infringement of our German Patent 700578, seeking damages and an
injunction against further infringement. Although it is


                                       22
<PAGE>


understood that Info & Tech has accepted an order for equipment in Germany as of
this date, no infringing equipment is known to have been delivered into Germany
by them.

We may unknowingly infringe the intellectual property rights of third parties
and thereby be exposed to lawsuit(s).

         We attempt to avoid infringing known proprietary rights of third
parties in our product development efforts. However, we have not conducted and
do not conduct comprehensive patent searches to determine whether the technology
used in our products infringes patents held by third parties. In addition, it is
difficult to proceed with certainty in a rapidly evolving technological
environment in which there may be numerous patent applications pending, many of
which are confidential when filed, with regard to similar technologies. If we
discover that our products violate third-party proprietary rights, we cannot
assure that we would be able to obtain licenses to continue offering such
products without substantial reengineering or that any effort to undertake such
reengineering would be successful, that any such licenses would be available on
commercially reasonable terms, if at all, or that litigation regarding alleged
infringement could be avoided or settled without substantial expense and damage
awards. Any claims against us relating to the infringement of third-party
proprietary rights, even if not meritorious, could result in the expenditure of
significant financial and managerial resources and in injunctions preventing us
from distributing certain products. Such claims could materially adversely
affect our business, financial condition, and results of operations.

We could be subject to product liability claims for which we have no insurance
coverage.

         The manufacture and sale of our products entails the risk of product
liability claims. Although we obtained product liability insurance prior to
commercially marketing our products, product liability insurance is expensive
and may not be available to us in the future on acceptable terms or at all. To
date, we have not experienced any product liability claims. A successful product
liability claim against us in excess of our insurance coverage could have a
material adverse affect on our business, financial condition, and results of
operations.

We are substantially dependent on certain key employees.

         We believe that our success will depend to a significant extent upon
the efforts and abilities of a relatively small group of management personnel,
particularly Donald A. Goer, PhD, our Chief Executive Officer. The loss of the
services of one or more of these key people could have a material adverse effect
on us. We have employment agreements with Mr. Goer and one other employee and
have purchased "key person" life insurance for Mr. Goer in the amount of
$5,000,000, of which $3,000,000 has been pledged to holders of our 10% senior
secured debentures as security for their debentures.

         Our future success will also depend upon our ability to continue to
attract and retain qualified personnel to design, test, market, and service our
products and manage our business. Competition for these technical and management
employees is significant. We cannot assure that we will be successful in
attracting and retaining such personnel.

Our limited resources may prevent us from developing additional products or
services.

         We have limited financial, management, research, and development
resources. Plans by us to develop additional products and services may require
additional management or capital which may not be available at the appropriate
time or at a reasonable cost. In addition, these products and services may
divert our resources from the development and marketing of the Mobetron system
which could decrease our revenue and potential earnings.

The preparation of our financial statements requires us to make estimates and
assumptions and apply certain critical accounting policies that could materially
affect the reported amounts of our assets, liabilities, revenues and expenses.

         Estimates and assumptions used in our financial statements are based on
historical experience and on various other factors that we believe are
reasonable under the circumstances, the results of which form the basis for


                                       23
<PAGE>


making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. These estimates and assumptions also
require the application of certain accounting policies, many of which require
estimates and assumptions about future events and their effect on amounts
reported in the financial statements and related notes. We periodically review
our accounting policies and estimates and make adjustments when facts and
circumstances dictate. Actual results may differ from these estimates under
different assumptions or conditions. Any differences may have a material impact
on our financial condition and results of operations.

         In June 2005, the Financial Accounting Standards Board Emerging Issues
Task Force issued EITF 05-04, "The Effect of a Liquidated Damages Clause on a
Freestanding Financial Instrument Subject to EITF Issue No. 00-19, Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock". Under EITF 05-04, liquidated damages clauses may qualify
as freestanding financial instruments for treatment as a derivative liability.
Furthermore, EITF 05-04 addresses the question of whether a registration rights
agreement should be combined as a unit with the underlying financial instruments
and be evaluated as a single instrument. EITF 05-04 does not reach a consensus
on this question and allows for treatment as a combined unit (Views A and B) as
well as separate freestanding financial instruments (View C). On September 15,
2005, the FASB staff postponed further discussion of EITF 05-04. As of June 30,
2006, the FASB has still not rescheduled EITF 05-04 for discussion.

         In conjunction with our issuance of senior and convertible debentures
and the related warrants and registration rights, we adopted View C of EITF
05-04. Accordingly, the registration rights agreements, the warrants associated
with the senior and convertible debentures, the debentures themselves, as well
as certain features of the debentures were evaluated as stand alone financial
instruments. This treatment resulted in classification of the warrants and
certain features of the debentures as equity while the registration rights
agreements and other features of the debentures were treated as derivative
liabilities. Derivative liability treatment requires adjusting the carrying
value of the instrument to its fair value at each balance sheet date and
recognizes any change since the prior balance sheet date as a component of other
income/(expense). The recorded value of such derivative liabilities can
fluctuate significantly based on fluctuations of the market value of our
underlying securities, as well as on the volatility of our stock price during
the term used for observation and the term remaining for the underlying
financial instruments. We believe that should the FASB staff reach a consensus
on EITF 05-04 and select combined unit treatment (View A or B), the debt
features of the debentures and associated warrants previously classified as
equity will have to be evaluated as a combined unit with the registration rights
agreements. This combination will result in these instruments being treated as
derivative liabilities requiring periodic reevaluation of fair value with
potentially significant fluctuation in fair value from period to period.
Accordingly, this consensus could have a significant effect on our financial
statements.

         We believe that the following accounting policies also fit the
definition of critical accounting policies. We use the specific identification
method to set reserves for both doubtful accounts receivable and the valuation
of our inventory, and use historical cost information to determine our warranty
reserves. Further, in assessing the fair value of certain option and warrant
grants, we have valued these instruments based on the Black-Scholes model which
requires estimates of the volatility of our stock and the market price of our
shares, which in the absence of a market for shares, was based on estimates of
fair value made by our Board of Directors.

We are required to recognize expense for share-based compensation related to
stock, and there can be no assurance that the expense that we are required to
recognize accurately measures the value of our share-based payment awards and
the recognition of this expense could cause the trading price of our common
stock to decline

         On January 1, 2006, we adopted SFAS 123(R) using the modified
prospective transition method, which requires the measurement and recognition of
compensation expense for all share-based payment awards made to our employees
and directors including stock options and restricted stock based on their fair
values. As a result, our operating results contain, and our operating results
for future periods will contain, a charge for share-based compensation related
to stock. This charge is in addition to other share-based compensation expense
we have recognized in prior periods.




                                       24
<PAGE>


         The application of SFAS 123(R) requires the use of an option-pricing
model, such as the Black-Scholes option-pricing model, to determine the fair
value of share-based payment awards. Option-pricing models were developed for
use in estimating the value of traded options that have no vesting restrictions
and are fully transferable. Our stock options have characteristics significantly
different from those of traded options, and changes in the assumptions (such as
expected term, stock price volatility and other variables) can materially affect
the fair value estimates. Therefore, although we determine the fair value of
stock options in accordance with SFAS 123(R) and SAB 107, the existing valuation
models may not provide an accurate measure of such fair value, and there can be
no assurance that the resulting expense that we are required to recognize
accurately measures that value.

         As a result of the adoption of SFAS 123(R), our earnings the periods
subsequent to our adoption of SFAS 123(R) were lower than they would have been
had we not been required to adopt SFAS 123(R). This will continue to be the case
for future periods. We cannot predict the effect that this decrease in earnings
will have on the trading price of our common stock.



                         RISKS RELATING TO OUR INDUSTRY

We are subject to intense competition.

         Conventional medical linear accelerator manufacturers have more
substantial histories, backgrounds, experience, and records of successful
operations; possess greater financial, technical, marketing, and other
resources; and have more employees and more extensive facilities than we now
have, or will have in the foreseeable future. These companies have sold one or
two modified conventional accelerators and could continue to offer essentially
the same type of conventional unshielded system. Additionally, two other
manufacturers, NRT and Info & Tech, are known to us to have developed systems
that are light enough for operating room use.

         NRT, an Italian company, is offering a modified, non-shielded IORT unit
called the Novac 7. This linear accelerator system was developed, in part, with
funding from the Italian government. The Novac 7 has lower energy than the
Mobetron and requires mobile shielding to be positioned around the surgical
table prior to treatment. A spin-off of NRT, called Info & Tech, which
manufactures a system called the Liac, is attempting to replace NRT in the
market. Info & Tech has delivered a small number of pre-commercial units to its
customers. The features and technology of the Liac system are very similar to
that of the NRT system.

         The Liac system has been offered to at least one customer in Germany
and we have notified Info & Tech and its German distributor that the Liac system
infringes on our intellectual property and demanded that Liac desist from this
infringement. In June 2006, we brought suit at Dusseldorf, Germany against Info
& Tech for infringement of our German Patent 700578, seeking damages and an
injunction against further infringement. Although it is understood that Info &
Tech has accepted an order for equipment in Germany as of this date, no
infringing equipment is known to have been delivered into Germany by them.

         The possibility of significant competition from other companies with
substantial resources also exists. The cancer treatment market is subject to
intense research and development efforts all over the world, and we can face
competition from competing technologies that treat cancer in a different manner.
It is also likely that other competitors will emerge in the markets that we
intend to commercialize. We cannot assure that our competitors will not develop
technologies or obtain regulatory approval for products that may be more
effective than our products, and that our technologies and products would not be
rendered less competitive or obsolete by such developments.

Our industry is subject to rapid, unpredictable, and significant technological
change.

         The medical device industry is subject to rapid, unpredictable, and
significant technological change. Our business is subject to competition in the
U.S. and abroad from a variety of sources, including universities, research
institutions, and medical device and other companies. Many of these potential
competitors have substantially greater technical, financial, and regulatory
resources than we do and are accordingly better equipped to develop,
manufacture, and market their products. If these companies develop and introduce
products and processes competitive with or superior to our products, we may not
be able to compete successfully against them.


                                       25
<PAGE>


We are subject to extensive government regulation.

         The development, testing, manufacturing, and marketing of the Mobetron
are regulated by the United States Food and Drug Administration, or FDA, which
requires government clearance of such products before they are marketed. We
filed and received 510(k) pre-market notification clearance from the FDA in July
1998. We received clearance for sales in Japan, or JIS, in May 2000, and
received European EC Certificate approval, or CE Mark, on October 12, 2001.
However, we may need to obtain additional approvals from the FDA or other
governmental authorities if we decide to change or modify the Mobetron. In that
case, the FDA or other authorities may not grant any new approvals. In addition,
if we fail to comply with FDA or other regulatory standards, we could be forced
to withdraw our products from the market or be sanctioned or fined.

         We are also subject to federal, state, and local regulations governing
the use, generation, manufacture, and testing of radiation equipment, including
periodic FDA inspections of manufacturing facilities to determine compliance
with FDA regulations. In addition, we must comply with federal, state, and local
regulations regarding the manufacture of healthcare products and radiotherapy
accelerators, including Good Manufacturing Practice, or GMP, regulations,
Suggested State Regulations for the Control of Radiation, or SSRCR, and
International Electrotechnical Committee, or IEC, requirements, and similar
foreign regulations and state and local health, safety, and environmental
regulations. Although we believe that we have complied in all material respects
with applicable laws and regulations, we cannot assure that we will not be
required to incur significant costs in the future in complying with
manufacturing and environmental regulations. Any problems with our, or our
manufacturers' ability to meet regulatory standards could prevent us from
marketing the Mobetron or other products.

We expect to be highly dependent on overseas sales.

         We believe that the majority of our sales over at least the next few
years will be made to overseas customers. Our business, financial condition, and
results of operations could be materially adversely affected by changes or
uncertainties in the political or economic climates, laws, regulations, tariffs,
duties, import quotas, or other trade, intellectual property or tax policies in
the United States or foreign countries. We may also be subject to adverse
exchange rate fluctuations between local currencies and the U.S. dollar should
revenue be collectable or expenses paid in local currencies.

         Additionally, we have limited experience in many of the foreign markets
in which we plan to sell our goods and services. To succeed, we will have to
overcome cultural and language issues and expand our presence overseas by hiring
and managing additional staff and opening overseas offices to meet our sales,
manufacturing, and customer support goals. No assurance can be given that we can
meet these goals. We may also be subject to taxation in foreign jurisdictions,
and transactions between any of our foreign subsidiaries and us may be subject
to U.S. and foreign withholding or other taxes. We also may encounter
difficulties due to longer customer payment cycles and encounter greater
difficulties in collecting accounts receivable from our overseas customers.
Further, should we discontinue any of our international operations, we may incur
material costs to cease those operations. An inability to expand our overseas
presence or manage the risks inherent in that expansion could have a material
adverse affect on our business, financial condition, and results of operations.

IORT treatment may not become a "standard of care" for cancer treatment.

         Despite the fact that more than 20,000 patients have received IORT
treatment, and despite the promising results in selected clinical studies, IORT
is not yet considered by the majority of cancer practitioners to be a "standard
of care". In fact, IORT may never develop into a "standard of care" for the
treatment of cancer, in which case the market potential for the Mobetron and
other IORT techniques will remain limited. If the market remains limited, the
Company may not be able to achieve sustained profitability, or profitability at
all.

Our success in selling our Mobetron systems in the U.S. may depend on increasing
reimbursement for IORT services.

         Hospitals in the U.S. pay increasing attention to treatment costs,
return on assets and time to investment recovery when making capital purchase
decisions. While IORT is generally reimbursable, its rate of return on capital


                                       26
<PAGE>


invested compared to the return for external beam and other radiotherapy
delivery systems is currently unfavorable. While the Company intends to make an
effort to increase the rate of reimbursement to improve the rate of return on
the capital investment in the Mobetron for hospitals in the U.S., there is no
assurance that such an effort will be ultimately successful. Therefore,
regardless of positive clinical outcomes, the current U.S. reimbursement
environment may slow the widespread acceptance of IORT and the Mobetron in the
U.S. market.

If our revenue stream were to become more dependent upon third party payors such
as insurance companies, our revenues could decrease and our business could
suffer.

         The system of health care reimbursement in the United States is being
intensively studied at the federal and state level. There is a significant
probability that federal and state legislation will be enacted that may have a
material impact on the present health care reimbursement system. If, because of
a change in the law or other unanticipated factors, certain third party payors
(primarily insurance companies) were to become a more substantial source of
payment for our products in the future, our revenues may be adversely affected.
This is because such providers commonly negotiate or legislate cost structures
below the prevailing market rate and typically negotiate payment arrangements
which are less advantageous than those available from private payors. Payment by
third party payors could also be subject to substantial delays and other
problems related to receipt of payment. The health care industry, and
particularly the operation of reimbursement procedures, has been characterized
by a great deal of uncertainty, and accordingly no assurance can be given that
third party payors will not become a significant source of payment for our
products, or that such a change in payment policies will not occur. Any of these
factors could have a material adverse effect on our business and financial
condition and affect our ability to make interest and principal payments under
our notes. We cannot assure that such legislation will not restrict hospitals'
ability to purchase equipment such as the Mobetron or that such legislation will
not have a material adverse affect on our ability to sell the Mobetron and our
business prospects and financial condition.

                        RISKS RELATED TO OUR COMMON STOCK

The trading market for our common stock is limited.

         Our common stock is quoted on the OTC Bulletin Board under the symbol
"IOPM.OB." The trading market for our common stock is limited. Accordingly, we
cannot assure the liquidity of any markets that may develop for our common
stock, the ability of holders of our common stock to sell our common stock, or
the prices at which holders may be able to sell our common stock.

Our stock price may be volatile.

         The market price of our common stock is likely to be highly volatile
and could fluctuate widely in price in response to various factors, many of
which are beyond our control, including:

     o   technological innovations;
     o   introductions or withdrawals of new products and services by us or
         our competitors;
     o   additions or departures of key personnel;
     o   sales of our common stock;
     o   our ability to integrate operations, technology, products and services;
     o   our ability to execute our business plan;
     o   operating results below expectations;
     o   loss of any strategic relationship;
     o   industry developments;
     o   changes in the regulatory environment;
     o   economic and other external factors; and
     o   period-to-period fluctuations in our financial results.

         Because we have a limited operating history with little revenues to
date, any one of these factors may be considered material. Our stock price may
fluctuate widely as a result of any of the above.


                                       27
<PAGE>


         In addition, the securities markets have from time to time experienced
significant price and volume fluctuations that are unrelated to the operating
performance of particular companies. These market fluctuations may also
materially and adversely affect the market price of our common stock.

We have not paid dividends in the past and do not expect to pay dividends in the
future. Any return on investment may be limited to the value of our common
stock.

         We have never paid cash dividends on our common stock and do not
anticipate paying cash dividends in the foreseeable future. The payment of
dividends on our common stock will depend on earnings, financial condition and
other business and economic factors affecting it at such time as the board of
directors may consider relevant. If we do not pay dividends, our common stock
may be less valuable because a return on your investment will only occur if its
stock price appreciates.

Our common stock may be deemed penny stock with a limited trading market.

         Our common stock is currently listed for trading on the OTC Bulletin
Board which is generally considered to be a less efficient market than markets
such as NASDAQ or other national exchanges, and which may cause difficulty in
conducting trades and difficulty in obtaining future financing. Further, our
securities are subject to the "penny stock rules" adopted pursuant to Section 15
(g) of the Securities Exchange Act of 1934, as amended, or Exchange Act. The
penny stock rules apply to non-NASDAQ companies whose common stock trades at
less than $4.00 per share or which have tangible net worth of less than
$5,000,000 ($2,000,000 if the company has been operating for three or more
years). Such rules require, among other things, that brokers who trade "penny
stock" to persons other than "established customers" complete certain
documentation, make suitability inquiries of investors and provide investors
with certain information concerning trading in the security, including a risk
disclosure document and quote information under certain circumstances. Many
brokers have decided not to trade "penny stock" because of the requirements of
the penny stock rules and, as a result, the number of broker-dealers willing to
act as market makers in such securities is limited. If we remain subject to the
"penny stock rules" for any significant period, the market, if any, for our
securities may suffer. Because our securities are subject to the "penny stock
rules," investors will find it more difficult to dispose of our securities.
Further, for companies whose securities are traded in the OTC Bulletin Board, it
is more difficult: (i) to obtain accurate quotations, (ii) to obtain coverage
for significant news events because major wire services, such as the Dow Jones
News Service, generally do not publish press releases about such companies, and
(iii) to obtain needed capital.

A sale of a substantial number of shares of our common stock may cause the price
of our common stock to decline.

         If our stockholders sell substantial amounts of our common stock in the
public market, including shares issued upon the exercise of outstanding options
or warrants, the market price of our common stock could fall. These sales also
may make it more difficult for us to sell equity or equity-related securities in
the future at a time and price that we deem reasonable or appropriate. We
recently completed four registration statements resulting in a total of
68,378,224 shares of our common stock registered, including shares resulting
from the conversion of convertible securities and the exercise of warrants and
options, and we expect, within the next twelve months, to register a minimum of
up to an additional 3,597,000 shares of our common stock resulting from the
exercise of options, which upon registration with the SEC will also be freely
tradable.



                                       28
<PAGE>





Item 3.  Controls And Procedures.

         As of the end of the period covered by the Quarterly Report on
Form 10-QSB, we evaluated, under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial
Officer, the effectiveness of our disclosure controls and procedures, as such
term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the
Securities Exchange Act of 1934, as amended. Based upon that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures are effective to insure that information we
are required to disclose in reports that we file or submit under the Securities
Exchange Act of 1934 is properly recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms.

         There has been no change in our internal control over financial
reporting during the quarter ended June 30, 2006 that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.









                                       29
<PAGE>



                           PART II - OTHER INFORMATION

Item 1.  Legal Proceedings

         On April 21, 2006, DLA Piper Gray Cary US LLP, or DLA Piper, notified
us that it had filed an arbitration proceeding against us with the American
Arbitration Association, claiming that we owe it legal fees and costs in the
amount of $445,909 for services rendered. We claim that no amounts are due DLA
Piper and that DLA Piper overcharged us for the services it provided to us.
Arbitration of this case is stayed by agreement of the parties, and the parties
have agreed to mediation. The mediation is set to take place August 10, 2006.
Management intends to contest this case vigorously. Regardless, we continue to
carry an account payable to DLA Piper on our balance sheet in an amount
satisfactory to meet DLA Piper's claim.

         In June 2006, we brought suit at Dusseldorf, Germany against Info &
Tech S.p.A, an Italian company which manufactures an IORT system marketed as the
Liac, for infringement of our German Patent 700578, seeking damages and an
injunction against further infringement. Although it is understood that Info &
Tech has accepted an order for equipment in Germany as of this date, no
infringing equipment is known to have been delivered into Germany by them.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

         During the three months ended June 30, 2006, we issued and sold the
following securities:

         On April 7, 2006, we entered into an agreement with Emerging Markets
Consulting, LLC, or EMC. Pursuant to the Agreement, we issued to EMC 100,000
shares of common stock and a five-year warrant to purchase 100,000 shares of
common stock at an exercise price of $1.00 per share. Upon the first day of the
second six-month term of the Agreement, we will issue to EMC an additional
100,000 shares of common stock and an additional five-year warrant to purchase
100,000 shares of stock.

         On June 1, 2006, we entered into an amendment to the Product Financing
Arrangement, increasing the debt facility available under the Product Financing
Arrangement to $4,000,000. Under the terms of the amendment, we granted warrants
to purchase 192,307 shares of our common stock at an exercise price of $0.52 per
share with an expiration date of May 31, 2008 to the financial institution.
Additionally, we agreed to extend by one year to August 15, 2008, the expiration
date of 576,923 warrants previously issued to the financial institution.

         In May 2006, we issued options to purchase an aggregate of 50,500
shares of common stock under our 2005 Equity Incentive Plan to certain officers,
directors and employees. All options have a term of 10 years and were issued
with an exercise price of $0.54 per share.

         On June 13, 2006, we issued 100,000 shares of common stock to The
Investor Relations Group Inc pursuant to an agreement entered into on August 15,
2005.

         The issuances of the securities described above were deemed to be
exempt from registration under the Act in reliance on Section 4(2) of the Act as
transactions by an issuer not involving any public offering. In addition, the
recipients of securities in each such transaction represented their intentions
to acquire the securities for investment only and not with a view to or for sale
in connection with any distribution thereof and appropriate legends were affixed
to the share certificates issued in such transactions. All recipients had
adequate access, through their relationships with Intraop, to information about
Intraop. No underwriters were used in connection with these sales and issuances.




                                       30
<PAGE>



Item 3.  Defaults upon Senior Securities

         None.

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

         None.

Item 5.  Other Information

         None.

Item 6.  Exhibits

Exhibit
Number                             Description
-------   ----------------------------------------------------------------------
31.1      Certification of Chief Executive Officer pursuant to Section 302 of
          the Sarbanes-Oxley Act of 2002.
31.2      Certification of Chief Financial Officer pursuant to Section 302 of
          the Sarbanes-Oxley Act of 2002.
32.1      Certification of Chief Executive Officer pursuant to Section 906 of
          the Sarbanes-Oxley Act of 2002.
32.2      Certification of Chief Financial Officer pursuant to Section 906 of
          the Sarbanes-Oxley Act of 2002.












                                       31
<PAGE>



                                   SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

                                INTRAOP MEDICAL CORPORATION


Date:  August 4, 2006          By: /s/  Donald A. Goer
                                  ----------------------------------------------
                                       Donald A. Goer, Chief  Executive Officer
                                       and President
                                       (Principal Executive Officer)

Date:  August 4, 2006
                               By: /s/  Howard Solovei
                                  ----------------------------------------------
                                       Howard Solovei, Chief Financial Officer
                                       (Principal Financial Officer)

Date:  August 4, 2006
                               By: /s/  Regis Bescond
                                  ----------------------------------------------
                                       Regis Bescond, Corporate Controller
                                       (Principal Accounting Officer)







                                       32
<PAGE>



                           Intraop Medical Corporation
        Index to Condensed Consolidated Financial Statements (Unaudited)
                       For the Three and Nine Months Ended
                             June 30, 2006 and 2005

                                                                          Pages
                                                                          -----
Condensed Consolidated Financial Statements:
  Condensed Consolidated Balance Sheet (Unaudited)                          Q-2
  Condensed Consolidated Statements of Operations (Unaudited)               Q-3
  Condensed Consolidated Statements of Cash Flows (Unaudited)               Q-5
  Notes to Condensed Consolidated Financial Statements (Unaudited)          Q-7











                                       Q-1


<PAGE>


<TABLE>
<CAPTION>



Intraop Medical Corporation
Condensed Consolidated Balance Sheet (Unaudited)
--------------------------------------------------------------------------------------------------
                                                                                      June 30,
                                                                                        2006
                                                                                   ---------------
ASSETS
Current assets:
        <S>                                                                               <C>
  Cash and cash equivalents                                                           $   216,952
  Accounts receivable                                                                     189,231
  Inventories, net                                                                      1,151,891
  Inventories, under product financing arrangement                                      3,617,186
  Prepaid expenses and other current assets                                               123,680
                                                                                   ---------------

         Total current assets                                                           5,298,940

Property and equipment, net                                                               251,454
Intangible assets, net                                                                    344,205
Deferred financing cost                                                                   949,440
Deposits                                                                                  412,244
                                                                                   ---------------

        Total Assets                                                                  $ 7,256,283
                                                                                   ===============

LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
   Accounts payable                                                                   $ 2,619,834
   Accrued liabilities                                                                    806,461
   Capital lease obligations, current portion                                               2,063
   Notes payable, related parties, current portion                                        709,169
   Notes payable, other, current portion, net of unamortized debt discounts             4,281,462
                                                                                   ---------------

         Total current liabilities                                                      8,418,989

   Capital lease obligations, net of current portion                                        8,499
   Notes payable, other, net of current portion, unamortized debt discounts
       and beneficial conversion features                                               2,944,339
                                                                                   ---------------

         Total liabilities                                                             11,371,827
                                                                                   ---------------

Commitments and contingencies (see note 9)

Stockholders' deficit:
  Common stock, $0.001 par value: 100,000,000 shares authorized;
     23,091,452 shares issued and outstanding                                              23,091
  Additional paid-in capital                                                           22,885,955
  Treasury stock, at cost, 600,000 shares at $.25 per share                             (150,000)
  Accumulated deficit                                                                (26,874,590)
                                                                                   ---------------

          Total stockholders' deficit                                                 (4,115,544)
                                                                                   ---------------

             Total liabilities and stockholders' deficit                               $7,256,283
                                                                                   ===============

</TABLE>

See accompanying notes to these condensed consolidated financial statements.


                                      Q-2

<PAGE>

<TABLE>
<CAPTION>

Intraop Medical Corporation
Condensed Consolidated Statements of Operations (Unaudited)
---------------------------------------------------------------------------------------------------------------------------------
                                                     Three months ended June 30,                Nine months ended June 30,

                                                --------------------------------------     --------------------------------------
                                                      2006                 2005                  2006                 2005
                                                ------------------    ----------------     -----------------    -----------------

Revenues:
    <S>                                                     <C>                 <C>                  <C>                   <C>
  Product sales                                    $       25,100       $      42,714          $  1,948,556        $   2,427,339
  Leasing                                                       -              62,168               134,127              186,503
  Service                                                  60,319              56,912               238,058              105,347
                                                ------------------    ----------------     -----------------    -----------------

  Total revenues                                           85,419             161,794             2,320,741            2,719,189
                                                ------------------    ----------------     -----------------    -----------------

Cost of revenues:
  Product sales (1)                                        69,797             111,623             1,748,476            1,952,510
  Leasing                                                       -              92,498                38,323              279,822
  Service (1)                                              27,314              71,338               201,682              128,418
                                                ------------------    ----------------     -----------------    -----------------

  Total cost of revenues                                   97,111             275,459             1,988,481            2,360,750
                                                ------------------    ----------------     -----------------    -----------------

Gross margin                                              (11,692)           (113,665)              332,260              358,439

Operating expenses:
  Research and development (1)                            164,073             142,295               459,553              378,443
  General and administrative (1)                          784,474             391,465             1,756,896            2,698,976
  Sales and marketing (1)                                 171,085             159,886               545,236              449,477
                                                ------------------    ----------------     -----------------    -----------------

          Total operating expenses                      1,119,632             693,646             2,761,685            3,526,896
                                                ------------------    ----------------     -----------------    -----------------

Loss from operations                                   (1,131,324)           (807,311)           (2,429,425)          (3,168,457)

Other income                                              (42,375)                  -               (45,627)                   -
Gain on extinguishment of debt                                  -                   -                28,214              104,645
Interest income                                             1,646                   -                 7,199                    -
Interest expense                                       (1,528,124)           (369,269)           (3,580,134)          (1,311,248)
                                                ------------------    ----------------     -----------------    -----------------

Loss before taxes                                      (2,700,177)         (1,176,580)           (6,019,773)          (4,375,060)

Provision for income taxes (1)                                  -                   -                     -                    -
                                                ------------------    ----------------     -----------------    -----------------

Net loss                                           $   (2,700,177)       $ (1,176,580)        $  (6,019,773)       $  (4,375,060)
                                                ==================    ================     =================    =================

Basic and diluted net loss per share
   available to common shareholders                $        (0.13)       $      (0.07)        $       (0.29)       $       (0.29)
                                                ==================    ================     =================    =================
Weighted average number of shares in
   calculating net loss per share:
   Basic and diluted                                   21,048,860          16,970,983            20,602,552           15,194,890
                                                ==================    ================     =================    =================

</TABLE>

See accompanying notes to these condensed consolidated financial statements.

                                      Q-3

<PAGE>

<TABLE>
<CAPTION>

Intraop Medical Corporation
Condensed Consolidated Statements of Operations (Unaudited) (Continued)
---------------------------------------------------------------------------------------------------------------------------------
                                                     Three months ended June 30,                  Nine months ended June 30,
                                                --------------------------------------    ---------------------------------------
                                                      2006                 2005                 2006                  2005
                                                ------------------    ----------------    ------------------    -----------------
(1) Includes the following amounts related to share-based compensation expense of stock options:

    <S>                                                    <C>                  <C>                 <C>                 <C>
Cost of revenues - Product sales                        $       -             $     -            $        -           $        -
Cost of revenues - Service                                  1,826                   -                 4,430                    -
Research and development                                   15,705                   -                38,716                    -
General and administrative                                 20,623                   -                46,291                    -
Sales and marketing                                        15,008                   -                36,120                    -
Provision for income taxes                                      -                   -                     -                    -
                                                ------------------    ----------------    ------------------    -----------------
Total                                                   $  53,162             $     -            $  125,557           $        -
                                                ==================    ================    ==================    =================

</TABLE>

See accompanying notes to these condensed consolidated financial statements.

                  (Remainder of page intentionally left blank)













                                      Q-4

<PAGE>


<TABLE>
<CAPTION>


Intraop Medical Corporation
Consolidated Statements of Cash Flows (Unaudited)
---------------------------------------------------------------------------------------------------
                                                                     Nine months ended June 30,
                                                                -----------------------------------
                                                                      2006               2005
                                                                ----------------   ----------------
Cash flows from operating activities:
      <S>                                                                 <C>                 <C>
   Net loss                                                        $ (6,019,773)      $ (4,375,060)
   Adjustments to reconcile net loss to net cash
     used for operating activities:
     Depreciation of property and equipment                              56,489            174,131
     Amortization of intangible assets                                    9,352            170,410
     Amortization of beneficial conversion rights                     1,169,255                  -
     Amortization of debt discount                                    1,095,513             16,904
     Amortization of debt issuance costs                                181,207            365,000
     Non-cash compensation  for options issued                          127,538             20,649
     Non-cash compensation for warrants issued                          223,878             16,155
     Non-cash compensation for common stock issued                      216,001          1,216,349
     Non-cash expense related to issuance
       of anti-dilutive shares of common stock                                -            375,421
     Non-cash revenue received on leased equipment                      (62,168)          (186,504)
     Non-cash gain on extinguishment of debt                                  -                  -
     Non-cash interest expense                                           38,324            122,273
   Changes in assets and liabilities:
        Accounts receivable                                             740,072          1,016,096
        Inventories                                                  (1,854,297)           100,987
        Prepaid expenses and other current assets                       (16,294)           (27,940)
        Other assets                                                   (224,133)          (608,042)
        Accounts payable                                                 (9,689)           310,092
        Accrued liabilities                                            (269,008)           197,007
        Foreign exchange translation                                     65,071                  -
                                                                ----------------   ----------------

        Net cash used for operating activities                       (4,532,662)        (1,096,072)
                                                                ----------------   ----------------

Cash flows used for investing activities:
   Acquisition of fixed assets                                         (193,237)            (8,298)
   Acquisition of intangible assets                                           -            (50,000)
                                                                ----------------   ----------------

        Net cash used for investing activities                         (193,237)           (58,298)
                                                                ----------------   ----------------

Cash flows provided by financing activities:
     Proceeds from note payable, related party                           50,000            273,000
     Proceeds from note payable, other                                8,057,092          4,247,000
     Payments on note payable, related party                           (341,789)          (198,000)
     Payments on note payable, other                                 (2,819,325)        (3,054,384)
     Debt issuance costs                                               (339,568)          (210,000)
     Proceeds from issuance of common stock                             293,000                  -
                                                                ----------------   ----------------

            Net cash provided by financing activities                 4,899,410          1,057,616
                                                                ----------------   ----------------

Net increase (decrease) in cash and cash equivalents                    173,511            (96,754)
Cash and cash equivalents, at beginning of period                        43,441            119,475
                                                                ----------------   ----------------

Cash and cash equivalents, at end of period                       $     216,952      $      22,721
                                                                ================   ================

</TABLE>

See accompanying notes to these condensed consolidated financial statements.

                                      Q-5

<PAGE>


<TABLE>
<CAPTION>

Intraop Medical Corporation
Consolidated Statements of Cash Flows (Unaudited) (Continued)
-------------------------------------------------------------------------------------------------------
                                                                          Nine months ended June 30,
                                                                       --------------------------------
                                                                            2006              2005
                                                                       --------------    --------------

Supplemental disclosure of cash flow information:
       <S>                                                                    <C>               <C>
   Cash paid for interest                                                 $  777,509        $  618,552
   Income taxes paid                                                               -                 -

Supplemental disclosure of non-cash investing
  and financing activities:
  Inventory reclassified to leased equipment                              $        -        $    1,137
  Leased equipment reclassifed to inventory                                  631,114                 -
  Property and equipment, at book value, converted to inventory                    -             6,616
  Purchase of intangible under vendor payment agreement                      312,500                 -
  Proceeds of notes payable deposited with vendors                                 -         1,065,000
  Accounts payable, interest payable and royalty payable converted
     to notes payable                                                              -           308,022
  Conversion of promissory notes and interest payable
     to common stock                                                         864,660           395,000
  Adjustment to common stock and additional paid in capital
    due to anti-dilutive issuance of 300,336 shares of common stock                -           375,421

</TABLE>

See accompanying notes to these condensed consolidated financial statements.

                  (Remainder of page intentionally left blank)

















                                      Q-6


<PAGE>


                    INTRAOP MEDICAL CORPORATION NOTES TO THE
             CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES

Basis of Presentation:

The condensed consolidated financial statements have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC"). Certain information and note disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These condensed consolidated financial statements and the
accompanying notes are unaudited and should be read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-KSB for the year ended September 30, 2005. In
the opinion of management, the condensed consolidated financial statements
herein include adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the Company's financial position as of June
30, 2006, results of operations for the three and nine months ended June 30,
2006 and June 30, 2005, and cash flows for the nine months ended June, 2006 and
June 30, 2005. The results of operations for the three and nine months ended
June 30, 2006 are not necessarily indicative of the operating results to be
expected for the full fiscal year or any future periods.

Formation and Business of the Company:

Intraop Medical Corporation (the "Company") was organized under the laws of the
State of Nevada on November 5, 1999 under the name DigitalPreviews.com. On
January 21, 2004, the Company filed a Certificate of Amendment with the
Secretary of State of Nevada to change the name of the Company from
DigitalPreviews.com, Inc. to Intraop Medical Corporation. On March 9, 2005,
Intraop Medical Corporation merged with Intraop Medical, Inc. Until this date,
Intraop Medical Corporation had been seeking viable business opportunities but
had not commenced operations and was considered a development stage company as
defined in Statement of Financial Accounting Standards No. 7.

Intraop Medical, Inc., was incorporated in Delaware in March 1993 to develop,
manufacture, market, and service mobile electron beam treatment systems designed
for intraoperative radiotherapy (IORT). IORT is the application of radiation
directly to a cancerous tumor and/or tumor bed during surgery. In July 1998, the
Company obtained FDA 510(k) clearance on its initial product, the "Mobetron".
The business of Intraop Medical, Inc, is now the sole business of the Company.

History:

On March 9, 2005, the Company acquired all the outstanding shares of Intraop
Medical, Inc., a privately-held Delaware Corporation (incorporated on March,
1993) in exchange for an aggregate of 14,175,028 restricted shares of its common
stock. The merger transaction was a tax-free exchange of stock. All of the
outstanding common and preferred stock of Intraop Medical, Inc. was exchanged on
a one-for-one basis with the Company's common stock, and the Company assumed all
obligations under outstanding options, warrants and convertible securities of
Intraop Medical, Inc. The acquisition has been accounted for as a reverse merger
(recapitalization) with Intraop Medical, Inc., deemed to be the accounting
acquirer. Accordingly, the historical financial statements presented herein are
those of Intraop Medical, Inc., as adjusted to give effect to any difference in
the par value of the issuer's and the accounting acquirer's stock with an offset
to capital in excess of par value, and those of Intraop Medical Corporation (the
legal acquirer) since the merger. The retained earnings of the accounting

                                      Q-7

<PAGE>


NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)

acquirer have been carried forward after the acquisition and Intraop Medical,
Inc.'s basis of assets and liabilities were carried over in the
recapitalization. Operations prior to the business combination are those of the
accounting acquirer. Further pursuant to the Merger, certain holders of
convertible notes representing $295,000 of principal and $100,000 of principal
due related parties under Intraop Medical Inc.'s Promissory Note program,
converted their notes to common stock upon completion of the Merger at a price
of $1.25 per share.

Further pursuant to the Merger, the Company had agreed upon the close of the
Merger to issue 795,000 shares of common stock to certain service providers in
exchange for services related to the Merger. These shares were valued at $1.53
per share, the price of the Company's common stock on March 9, 2005, the date of
the Merger and were recorded as an expense on the Company's books.

In April 2005, the Company received notices from stockholders representing an
aggregate of 97,000 shares of common stock who had previously voted against the
Merger that they wished to redeem their shares in accordance with certain
dissenter's rights provisions. An accrual for the estimated redemption value of
$121,250 and a corresponding offset to common stock and additional paid in
capital was recorded and subsequently paid to the dissenting stockholders.

Basis of Consolidation:

The unaudited condensed consolidated financial statements include the accounts
of Intraop Medical Corporation and its wholly owned subsidiaries, Intraop
Medical Services, Inc. and IMS Louisville, LLC. All significant intercompany
balances and transactions have been eliminated in preparation of the unaudited
condensed consolidated financial statements.

Going Concern:

The accompanying unaudited condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles in the
United States, which contemplate continuation of the Company as a going concern.
However, the Company has experienced net losses of $2,700,177 and $1,176,580 for
the three months ended June 30, 2006 and 2005, respectively, and $6,019,773 and
$4,375,060 for the nine months ended June 30, 2006 and 2005, respectively. In
addition, the Company has incurred substantial monetary liabilities in excess of
monetary assets over the past several years and, as of June 30, 2006, has an
accumulated deficit of $26,874,590. These matters, among others, raise
substantial doubt about the Company's ability to continue as a going concern. In
view of the matters described above, recoverability of a major portion of the
recorded asset amounts shown in the accompanying unaudited condensed
consolidated balance sheet is dependent upon the Company's ability to generate
sufficient sales volume to cover its operating expenses and to raise sufficient
capital to meet its payment obligations. Management is taking action to address
these matters, which include:

     o    Retaining experienced management personnel with particular skills in
          the development and sale of its products and services.

     o    Developing new markets (primarily Europe) and expanding its sales
          efforts.

     o    Evaluating funding strategies in the public and private markets.



                                      Q-8

<PAGE>


NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)

Historically, management has been able to raise additional capital. During the
nine months ended June 30, 2006, the Company obtained capital through the
issuance of convertible debentures. The unaudited condensed consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts, or amounts and
classification of liabilities that might be necessary should the Company be
unable to continue in existence. The successful outcome of future activities
cannot be determined at this time and there is no assurance that if achieved,
the Company will have sufficient funds to execute its intended business plan or
generate positive operating results.

Concentration of Credit Risk:

The Company maintains its cash in bank accounts, which at times may exceed
federally insured limits. The Company has not experienced any losses on such
accounts.

Credit risk with respect to account receivables is concentrated due to the
limited number of transactions recorded in any particular period. One customer
represents 93.3% of accounts receivable at June 30, 2006. The Company reviews
the credit quality of its customers but does not require collateral or other
security to support customer receivables. Five customers accounted for 23.4%,
22.8%, 21.5%, 11.7% and 10.1% of net revenue for the three months ended June 30,
2006. Three customers accounted for 38.4%, 29.6% and 22.9% of net revenue for
the three months ended June 30, 2005. Two customers accounted for 44.4% and
37.8% of net revenue for the nine months ended June 30, 2006 and for 47.6% and
38.2% of net revenue for the nine months ended June 30, 2005.

Use of Estimates:

The preparation of consolidated financial statements, in conformity with
accounting principles generally accepted in the United States of America,
requires management to make estimates and assumptions that affect the amounts in
the financial statements and accompanying notes. Actual results could differ
from those estimates.

Management makes estimates that affect reserves for allowance for doubtful
accounts, deferred income tax assets, estimated useful lives of property and
equipment, accrued expenses, fair value of equity instruments and reserves for
any other commitments or contingencies. Any adjustments applied to estimates are
recognized in the period in which such adjustments are determined.

Revenue Recognition:

Revenue is recognized when earned in accordance with applicable accounting
standards, including Staff Accounting Bulletins 104, "Revenue Recognition in
Financial Statements" ("SAB 104"), and the interpretive guidance issued by the
Securities and Exchange Commission and EITF issue number 00-21, "Accounting for
Revenue Arrangements with Multiple Elements", of the FASB's Emerging Task Force.
Revenue is generated from machine sales, leasing of machines, installations, and
maintenance. Machine sales and installation revenue are recognized upon
shipment, installation, or final customer acceptance, depending on specific
contract terms, provided any remaining obligations are inconsequential or
perfunctory and collection of resulting receivable is deemed probable. Revenue
from maintenance is recognized as services are completed or over the term of the
maintenance agreements. Revenue from the leasing of machines is recognized over
the term of the lease agreements.




                                      Q-9

<PAGE>


NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)


The Company recognized revenue on service contracts with five and two
institutions for the service of Mobetrons at the customer site during the three
months ended June 30, 2006 and June 30, 2005, respectively. During the nine
months ended June 30, 2006 and June 30, 2005, the Company recognized revenue on
service contracts with five and two institutions respectively, for the service
of Mobetrons at the customer site. The customers paid for a one-year service
contract for which they receive warranty-level labor and a credit for a certain
contracted dollar amount of service-related parts. On each contract, the Company
recorded a liability for parts equal to the amount of the parts credit
contracted for by the customer with the remainder of the contract price recorded
as labor related service contract liability.


Lease Revenue and Leasing Transactions:

Revenue for the three months ended June 30, 2005 and nine months ended June 30,
2006 and June 30, 2005 is partly comprised of revenue recognized on a Mobetron
system delivered to our customer in Eindhoven, Holland in November 2003. At
inception, as an equipment supplier, we received proceeds in the amount of
$1,230,685 as the sale price of the equipment from a third party leasing
company, who in turn leased the equipment to the hospital pursuant to a seventy
month lease. The Company has no material obligations under the lease and the
lease remains an unconditional obligation of the hospital, as lessee, to make
payments to the leasing company, as lessor, for the leasing company's own
account.

However, as an inducement to the hospital to enter into the lease, the Company
agreed in a contract with the hospital that, should the hospital decide, upon
sixty days prior notice to the Company, to prepay the lease with the leasing
company (a one-time option), at the end of the 18th month of its lease on May
31, 2005, the Company would reimburse the hospital for the cost of the
hospital's exercise of the prepayment option to the leasing company. Following
the reimbursement by the Company to the hospital for the prepayment amount,
title to the equipment would revert to the Company.

Because of the potential reimbursement to the hospital at the end of month
eighteen of the lease, the Company retains substantial risk of ownership in the
leased property, and the transaction has therefore been accounted for in
accordance with SFAS 13, "Accounting for Leases", specifically paragraphs 19,
21, and 22.

Accordingly, the Company recorded the entire $1,230,685 of proceeds received
from the leasing company as obligation for leased equipment, a liability on its
balance sheet and accounted for the item as borrowing. In accordance with APB
Opinion 21, "Interest on Receivables and Payables" paragraphs 13 and 14, the
Company determined an interest rate for the obligation of 14.5% based on other
debt arrangements entered into by the Company at dates closest to the inception
of the obligation for leased equipment. Further, although the Company is not
entitled to the cash rental payments, the Company recognized rental revenue
totaling zero and $62,168 for the three months ended June 30, 2006 and June 30,
2005 respectively and $134,127 and $186,503 for the nine months ended June 30,
2006 and June 30, 2005 respectively. A portion of each month's rental revenue
was recorded as interest and included in cost of revenue with the remainder
recorded as a reduction in obligation for leased equipment.

Accordingly, the Company recorded $1,016,238, the amount that the Company would
otherwise have been the Company's cost of revenue for the transaction, as leased
equipment, an asset on its balance sheet. The asset was depreciated on a
straight line basis over the period of the Company's reimbursement obligation to
the hospital down to a value equal to the estimated residual value of the
equipment at the end of the obligation. The depreciation expense is included in
cost of revenue.



                                      Q-10

<PAGE>


NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)

Prior to May 31, 2005, the hospital notified the Company that it intended to
exercise its prepayment option, however the Company agreed to extend its
reimbursement option from May 31, 2005 until January 1, 2006 and agreed to a new
reimbursement amount. Pursuant to the reimbursement option extension, the
Company continued to recognize revenue and expense on this transaction,
including continued straight line depreciation down to a new asset residual
value of $631,114 which was reached on September 30, 2005, based on extended
usage, as described above. In January 2006, the hospital exercised its
prepayment option by paying certain sums to the third party leasing company. As
per prior agreement, the Company is obligated to reimburse the hospital for
$1,013,022, the amount paid to the leasing company. The previously recorded
leased asset with residual value of $631,114 was reclassified and included in
inventory at June 30, 2006. The previously recorded lease obligation was
adjusted to $1,013,022 and reclassified to accounts payable and a gain on
extinguishment of debt for $28,214 was recognized on the transaction.

Intangible Assets:

Intangible assets consist primarily of amounts paid for manufacturing and design
rights related to the Mobetron and a medical device approval license. These
manufacturing and design rights related to the Mobetron are amortized on a
straight-line basis over their estimated useful lives of five years.

The medical device approval license has an indefinite life and therefore is not
subject to amortization.

The Company evaluates the carrying value of its intangible assets during the
fourth quarter of each year and between annual evaluations if events occur or
circumstances change that would more likely than not reduce the fair value of
the asset below its carrying amount. Such circumstances could include, but are
not limited to: (1) a significant adverse change in legal factors or in business
climate, (2) unanticipated competition, or (3) an adverse action or assessment
by a regulator.

The Company's evaluation of intangible assets completed during the fourth
quarter of the fiscal year ended September 30, 2005 resulted in no impairment
losses.

Income Taxes:

The Company accounts for its income taxes using the Financial Accounting
Standards Board Statements of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," which requires the establishment of a deferred
tax asset or liability for the recognition of future deductible or taxable
amounts and operating loss and tax credit carryforwards. Deferred tax expense or
benefit is recognized as a result of timing differences between the recognition
of assets and liabilities for book and tax purposes during the year.

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. Deferred tax assets are
recognized for deductible temporary differences and operating loss, and tax
credit carryforwards. A valuation allowance is established to reduce that
deferred tax asset if it is "more likely than not" that the related tax benefits
will not be realized. The Company has recorded a full valuation allowance
against its deferred tax assets.


                                      Q-11

<PAGE>


NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)

Basic and Diluted Loss Per Share:

In accordance with SFAS No. 128, "Earnings Per Share," the basic loss per share
is computed by dividing the loss attributable to common stockholders by the
weighted average number of common shares outstanding during the period. Basic
net loss per share excludes the dilutive effect of stock options or warrants and
convertible notes. Basic net loss per share for the three and nine months ended
June 30, 2005, includes shares redeemable by stockholders in accordance with
certain dissenter's rights provisions as these shares were repurchased on
December 13, 2005. Diluted net loss per share was the same as basic net loss per
share for all periods presented, since the effect of any potentially dilutive
securities is excluded, as they are anti-dilutive due to the Company's net
losses.

The following table sets forth the computation of basic and diluted net loss per
common share:

<TABLE>
<CAPTION>

                                                        Three months ended                      Nine months ended
                                                ------------------------------------    -----------------------------------
                                                             June 30,                                June 30,
                                                ------------------------------------    -----------------------------------
                                                     2006                2005                2006                2005
                                                ----------------    ----------------    ---------------     ---------------

Numerator
    <S>                                               <C>                  <C>               <C>                  <C>
Net loss available to common
stockholders                                        $(2,700,177)        $(1,176,580)       $(6,019,773)        $(4,375,060)

Denominator
Weighted average common shares
outstanding                                          21,048,860          16,873,983         20,602,552          15,097,890
Dissenter shares pending redemption                           -              97,000                  -              97,000
                                                ----------------    ----------------    ---------------     ---------------
Total shares, basic                                  21,048,860          16,970,983         20,602,552          15,194,890
                                                ================    ================    ===============     ===============

Net loss per common share:
  Basic and diluted                                $      (0.13)       $      (0.07)       $     (0.29)        $     (0.29)
                                                ================    ================    ===============     ===============

</TABLE>


The potential shares, which are excluded from the determination of basic and
diluted net loss per share as their effect is anti-dilutive, are as follows:

<TABLE>
<CAPTION>

                                                                 Three months ended                Nine months ended
                                                            ------------------------------   ------------------------------
                                                                      June 30,                         June 30,
                                                            ------------------------------   ------------------------------
                                                                 2006             2005            2006             2005
                                                            -------------    -------------   --------------    ------------
       <S>                                                        <C>              <C>             <C>              <C>
Debentures convertible to common stock                        16,000,000                -       16,000,000               -
Bridge notes payable convertible to common stock                       -          920,128                          920,128
Promissory Notes convertible to common stock                           -          384,000                          384,000
Options to purchase common stock                               1,740,000        1,127,500        1,740,000       1,127,500
Warrants to purchase common stock                             22,390,481          871,251       22,390,481         871,251
                                                            -------------    -------------   --------------    ------------

Potential equivalent shares excluded                          40,130,481        3,302,879       40,130,481       3,302,879
                                                            =============    =============   ==============    ============

</TABLE>


                                      Q-12

<PAGE>


NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)

Stock-Based Compensation:

Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123 (revised 2004), Share-Based Payment ("SFAS 123(R)"),
which requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors, including stock
options and restricted stock based on their fair values. SFAS 123(R) supersedes
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees ("APB 25"), which the Company previously followed in accounting for
stock-based awards. In March 2005, the SEC issued Staff Accounting Bulletin No.
107 ("SAB 107") to provide guidance on SFAS 123(R). The Company has applied SAB
107 in its adoption of SFAS 123(R). See Note 7 for a detailed discussion of SFAS
123(R).

On November 10, 2005, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position No. FAS 123(R)-3 Transition Election Related to Accounting
for Tax Effects of Share-Based Payment Awards. The Company has elected to adopt
the "short-cut" method provided in the FASB Staff Position for calculating the
tax effects of share-based compensation pursuant to SFAS 123(R). The "short-cut"
method includes simplified methods to establish the beginning balance of the
additional paid-in capital pool ("APIC pool") related to the tax effects of
share-based compensation, and to determine the subsequent impact on the APIC
pool and the Condensed Consolidated Statements of Cash Flows of the tax effects
of share-based compensation awards that are outstanding upon adoption of SFAS
123(R).

Accounting for Convertible Debt Securities:

The Company has issued convertible debt securities with non-detachable
conversion features. The Company accounts for such securities in accordance with
Statement of Financial Accounting Standards No. 133 and 150 and Emerging Issues
Task Force Issue Nos. 98-5, 00-19, 00-27, 05-02, 05-08 and 05-04 View C. For a
contingent benefit conversion option, the Company records the intrinsic value,
which is to be measured using the commitment date fair value of the underlying
stock.

Comprehensive Loss:

Comprehensive loss consists of net loss and other gains and losses affecting
stockholders' equity that, under generally accepted accounting principles, are
excluded from net loss in accordance with Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income." The Company, however, does
not have any components of other comprehensive loss as defined by SFAS No. 130
and therefore, for the three and nine months ended June 30, 2006 and 2005,
comprehensive loss is equivalent to the Company's reported net loss.
Accordingly, a statement of comprehensive loss is not presented.

Segment:

The Company operates in a single business segment that includes the design,
development, and manufacture of the Mobetron. The Company does disclose
geographic area data, which is based on product shipment destination. The
geographic summary of long-lived assets is based on physical location.

Reclassification:

The Company made certain reclassifications to the condensed consolidated
financial statements for the nine months ended June 30, 2005 to conform to the
presentation of the condensed consolidated financial statements for the nine
months ended June 30, 2006.


                                      Q-13

<PAGE>


NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)

Recent Accounting Pronouncements:

In December 2004, the FASB issued SFAS No.123 (revised 2004), "Share-Based
Payment". Statement 123(R) will provide investors and other users of financial
statements with more complete and neutral financial information by requiring
that the compensation cost relating to share-based payment transactions be
recognized in financial statements. That cost will be measured based on the fair
value of the equity or liability instruments issued. Statement 123(R) covers a
wide range of share-based compensation arrangements including share options,
restricted share plans, performance-based awards, share appreciation rights, and
employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123,
Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. Statement 123, as originally issued in
1995, established as preferable a fair-value-based method of accounting for
share-based payment transactions with employees. However, that Statement
permitted entities the option of continuing to apply the guidance in Opinion 25,
as long as the footnotes to financial statements disclosed what net income would
have been had the preferable fair-value-based method been used. Public entities
(other than those filing as small business issuers) are required to apply
Statement 123(R) as of the first interim or annual reporting period that begins
after June 15, 2005. Effective January 1, 2006, the Company adopted SFAS 123(R),
and does not believe the impact to be significant to the Company's overall
results of operations or financial position. However, the Company will recognize
additional compensation expense related to stock options and warrants granted to
employees.

In March 2005, the FASB issued Staff Accounting Bulletin No. 107 ("SAB 107")
which provides additional guidance to the new stock option expensing provisions
under SFAS 123(R). SAB 107 acknowledges that fair value estimates cannot predict
actual future events and as long as the estimates are made in good faith, they
will not be subsequently questioned no matter what the actual outcome.
Historical volatility should be measured on an unweighted basis over a period
equal to or longer than the expected option term or contractual term, depending
on the option-pricing model that is used. Implied volatility is based on the
market prices of a company's traded options or other financial instruments with
option-like features, and is derived by entering the market price of the traded
option into a closed-form model and solving for the volatility input. SAB 107
provides additional guidance for companies when estimating an option's expected
term. In general, companies are not allowed to consider additional term
reduction and the option term cannot be shorter than the vesting period.
Companies are permitted to use historical stock option exercise experience to
estimate expected term if it represents the best estimate for future exercise
patterns. SAB 107 provides that companies should enhance MD&A disclosures
related to equity compensation subsequent to adoption of Statement 123(R). SAB
107 provided that companies should provide all disclosures required by Statement
123 (R) in the first 10-Q filed after adoption of the new rules.

In February 2006, the FASB issued FASB Staff Position No FAS 123(R)-4
Classification of Options and Similar Instruments Issued as Employee
Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent
Event. ("FSP FAS 123(R)-4"). FSP FAS 123(R)-4 addresses the classification of
options and similar instruments issued as employee compensation that allow for
cash settlement upon the occurrence of a contingent event and amends paragraphs
32 and A229 of FASB Statement No. 123 (R). Companies are required to apply FSP
FAS 123(R)-4 upon initial adoption of Statement 123(R). Effective January 1,
2006, the Company adopted FSP FAS 123(R)-4, and does not believe the impact to
be significant to the Company's overall results of operations or financial
position.


                                      Q-14

<PAGE>


NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)

In June 2005, the Financial Accounting Standards Board Emerging Issues Task
Force issued EITF 05-04, "The Effect of a Liquidated Damages Clause on a
Freestanding Financial Instrument Subject to EITF Issue No. 00-19, Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock". Under EITF 05-04, liquidated damages clauses may qualify
as freestanding financial instruments for treatment as a derivative liability.
Furthermore, EITF 05-04 addresses the question of whether a registration rights
agreement should be combined as a unit with the underlying financial instruments
and be evaluated as a single instrument. EITF 05-04 doesn't reach a consensus on
this question and allows for treatment as a combined unit (Views A and B) as
well as separate freestanding financial instruments (View C). On September 15,
2005, the FASB staff postponed further discussion of EITF 05-04. As of June 30,
2006, the FASB has still not rescheduled EITF 05-04 for discussion.

In conjunction with the issuance of the Company's senior and convertible
debentures and the related warrants and registration rights, the Company adopted
View C of EITF 05-04. Accordingly, the registration rights agreements, the
warrants associated with the senior and convertible debentures, the debentures
themselves, as well as certain features of the debentures were evaluated as
stand alone financial instruments. This treatment resulted in classification of
the warrants and certain features of the debentures as equity while the
registration rights agreements and other features of the debentures were


                                      Q-15

<PAGE>


NOTE 1- INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)

treated as derivative liabilities. Derivative liability treatment requires
adjusting the carrying value of the instrument to its fair value at each balance
sheet date and recognizes any change since the prior balance sheet date as a
component of other income/(expense). The recorded value of such derivative
liabilities can fluctuate significantly based on fluctuations of the market
value of the underlying securities of the Company, as well as on the volatility
of the Company's stock price during the term used for observation and the term
remaining for the underlying financial instruments. The Company believes that
should the FASB staff reach a consensus on EITF 05-04 and select combined unit
treatment (View A or B), the debt features of the debentures and associated
warrants previously classified as equity will have to be evaluated as a combined
unit with the registration rights agreements. This combination will result in
these instruments being treated as derivative liabilities requiring periodic
reevaluation of fair value with potentially significant fluctuation in fair
value from period to period. Accordingly, this consensus could have a
significant effect on the Company's financial statements.


In September 2005, the Financial Accounting Standards Board Emerging Issues Task
Force issued EITF 05-08, "Income Tax Consequences of Issuing Convertible Debt
with a Beneficial Conversion Feature." EITF 05-08 is effective for financial
statements beginning in the first interim or annual reporting period beginning
after December 15, 2005. We do not expect there to be a material impact from the
adoption of EITF 05-08 on our unaudited condensed consolidated financial
position, results of operations, or cash flows.

In September 2005, the Financial Accounting Standards Board Emerging Issues Task
Force issued EITF 05-02, "The Meaning of 'Conventional Convertible Debt
Instrument' in EITF Issue No. 00-19, 'Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock.'"
EITF 05-02 is effective for new instruments entered into and instruments
modified in reporting periods beginning after June 29, 2005. We do not expect
there to be a material impact from the adoption of EITF 05-02 on our unaudited
condensed consolidated financial position, results of operations, or cash flows.

In September 2005, the Financial Accounting Standards Board Emerging Issues Task
Force issued EITF 05-07, "Accounting for Modifications to Conversion Options
Embedded in Debt Instruments and Related Issues." EITF 05-7 is effective for
future modifications of debt instruments beginning in the first interim or
annual reporting period beginning after December 15, 2005. We do not expect
there to be a material impact from the adoption of EITF 05-07 on our unaudited
condensed consolidated financial position, results of operations, or cash flows.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments--an amendment of FASB Statements No. 133 and 140.
Companies are required to apply Statement 155 as of the first annual reporting
period that begins after September 15, 2006. The Company does not believe
adoption of SFAS No. 155 will have a material effect on its unaudited condensed
consolidated financial position, results of operations or cash flows.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of
Financial Assets--an amendment of FASB Statement No. 140. Companies are required
to apply Statement 156 as of the first annual reporting period that begins after
September 15, 2006. The Company does not believe adoption of SFAS No. 156 will
have a material effect on its unaudited condensed consolidated financial
position, results of operations or cash flows.


                                      Q-16

<PAGE>


NOTE 2 - MAJOR CUSTOMERS AND VENDORS

One customer represented 93.3% of accounts receivable at June 30, 2006. Five
customers accounted for 23.4%, 22.8%, 21.5%, 11.7% and 10.1% of net revenue for
the three months ended June 30, 2006 respectively. Three customers accounted for
38.4%, 29.6% and 22.9% of net revenue for the three months ended June 30, 2005
respectively. Two customers accounted for 44.4% and 37.8% of net revenue for the
nine months ended June 30, 2006 and for 47.6% and 38.2% of net revenue for the
nine months ended June 30, 2005.

Three suppliers represented 43.2%, 22.1% and 18.4% of accounts payable at June
30, 2006. Purchases from these suppliers during the three months ended June 30,
2006 totaled approximately zero, $1,042,971 and zero. Purchases from these
suppliers during the nine months ended June 30, 2006 totaled approximately zero,
$2,469,920 and zero respectively.


NOTE 3 - BALANCE SHEET COMPONENTS

<TABLE>
<CAPTION>

Inventory:

Inventory consists of the following:
                                                                                June 30,
                                                                                  2006
                                                                           -----------------
            <S>                                                                   <C>
       Finished goods                                                      $              -
       Work-in-progress                                                             664,657
       Purchased parts and raw material, net of reserves of $10,159                 487,234
                                                                           -----------------
                                                                           $      1,151,891
                                                                           =================
Inventories, under product financing arrangement:

Inventories under product financing arrangement consist of the following:
                                                                                June 30,
                                                                                  2006
                                                                           -----------------

       Finished goods                                                      $      1,323,840
       Work-in-progress                                                           1,923,862
       Purchased parts and raw material                                             369,484
                                                                           -----------------
                                                                           $      3,617,186
                                                                           =================

</TABLE>

On April 10, 2006, the Company entered into an amendment to the Revolving Line
(see Note 4) to clarify and amend certain terms and conditions pursuant to which
the Company can obtain financing under the Revolving Line. Under the amendment
to the Revolving Line (the "Product Financing Arrangement"), ownership of the
inventory financed is transferred to the lending financial institution. From
time to time, the Company may repurchase financed inventory from the lender at a
price equal to the original transfer price plus interest.






                                      Q-17

<PAGE>


NOTE 3 - BALANCE SHEET COMPONENTS (CONTINUED)

Property and Equipment and Leased Equipment:

 Property and Equipment and Leased Equipment consist of the following:

                                                                    June 30,
                                                                      2006
                                                               -----------------

   Equipment                                                      $     275,613
   Computer equipment                                                   115,000
   Furniture & fixtures                                                  64,306
   Lease hold improvements                                                5,707
                                                               -----------------
                                                                        460,626
   Less accumulated depreciation                                       (209,172)
                                                               -----------------
                                                                  $     251,454
                                                               =================

Included in property and equipment is an asset acquired under capital lease
obligations with an original cost of $11,742 as of June 30, 2006. Related
accumulated depreciation and amortization of this asset was $1,957 as of June
30, 2006.

Intangible Assets:

Intangible Assets consist of the following:

                                                                    June 30,
                                                                      2006
                                                              ------------------

  Mobetron related manufacturing and design rights                $     336,900
  Less accumulated amortization                                         (22,695)
                                                              ------------------
  Mobetron related manufacturing and design rights, net                 314,205
  Medical device approval license not subject to amortization            30,000
                                                              ------------------
  Intangible assets, net                                          $     344,205
                                                              ==================

The Company's historical and projected revenues are related to the sale and
servicing of the Company's sole product, the Mobetron. Should revenues of the
Mobetron product in future periods be significantly less than management's
expectation, the benefit from the Company's Mobetron related intangibles would
be limited and may result in an impairment of these assets.

Deferred financing cost:

Deferred financing cost consists of the following:

                                                   June 30,
                                                     2006
                                              ------------------

  Debt issuance cost                               $  1,286,906
  Less accumulated amortization                        (337,466)
                                              ------------------

  Deferred financing cost, net                     $    949,440
                                              ==================


                                      Q-18

<PAGE>


NOTE 3 - BALANCE SHEET COMPONENTS (CONTINUED)

Accrued Liabilities:

Accrued Liabilities consist of the following:


                                                         June 30,
                                                           2006
                                                    --------------------
            Accrued liabilities:
            Accrued interest payable                       $    172,711
            Contract advances                                   160,000
            Accrued warranty                                    149,788
            Accrued personal paid leave                         100,625
            Deferred revenue                                     93,224
            Accrued sales tax payable                            71,127
            Accrued royalty payable                              50,000
            Other accrued liabilities                             8,986
                                                    --------------------

                                                           $    806,461
                                                    ====================

Deferred Revenue:

Revenue under service agreements is deferred and recognized over the term of the
agreement, typically one year, over a straight line basis. As of June 30, 2006
and June 30, 2005 deferred revenue was $93,224 and $34,920 respectively, which
is included under accrued liabilities.

Warranty:

The warranty periods for the Company's products are generally one year from the
date of shipment. The Company is responsible for warranty obligations arising
from its sales and provides for an estimate of its warranty obligation at the
time of sale. The Company's contract manufacturers are responsible for the costs
of any manufacturing defects. Management estimates and provides a reserve for
warranty upon sale of a new machine based on historical warranty repair expenses
of the Company's installed base.

The following table summarizes the activity related to the product warranty
liability, which was included in accrued liabilities.



            Warranty accrual at September 30, 2005         $  168,555

            Accrual for warranties during the period          101,703
            Actual product warranty expenditures             (120,470)
                                                     -----------------

            Warranty accrual at June 30, 2006              $  149,788
                                                     =================


                                      Q-19

<PAGE>


NOTE 4 - BORROWINGS

Outstanding notes payable were as follows:

<TABLE>
<CAPTION>

                                                                                       June 30,
                                                                                         2006
                                                                                  -------------------
                         <S>                                                             <C>
        Notes payable, related parties, current                                        $     709,169
                                                                                  ===================


        Convertible debentures                                                         $   6,400,000
        Product financing arrangement                                                      3,946,798
        Senior secured debentures                                                          1,750,000
        Other notes                                                                          317,644

        Less debt discounts due to warrants                                               (2,492,383)
        Less beneficial conversion features                                               (2,696,258)
                                                                                  -------------------

        Notes payable, net of debt discounts and beneficial conversion
        features                                                                           7,225,801

        Less current portion                                                              (4,281,462)
                                                                                  -------------------

           Notes payable, other, net of current portion, unamortized debt
               discounts and beneficial conversion features                            $   2,944,339
                                                                                  ===================

</TABLE>


Notes payable, related parties:

Notes payable to related parties of $709,169 at June 30, 2006, include notes
issued to two officers of the Company. The notes are due on demand and bear
interest at 9% per annum. During the nine months ended June 30, 2006, $183,967
of principal of notes and $66,033 of interest were converted to 431,034 shares
of common stock at $0.58 per share. Additionally, during the nine months ended
June 30, 2006, the Company received note proceeds of $50,000 from related
parties and repaid $341,789 of principal to related parties.

Convertible debentures

In August 2005, the Company sold $2,500,000 of convertible debentures to certain
investors. The debentures are convertible into the Company's common stock at
$0.40 per share at the option of the debenture holders and bear interest at 7%
per annum, payable quarterly. The debentures have a term of three years with
principal due in full at maturity. As a further inducement, the Company granted
the holders of the debentures warrants to purchase 3.125 million shares of the
Company's common stock, expiring September 30, 2006, and warrants to purchase
3.125 million shares of the Company's common stock, expiring August 31, 2010.
Both sets of warrants are exercisable at $0.40 per share.

In October 2005, the Company sold an additional $2,500,000 of convertible
debentures to certain investors. The debentures are convertible into Company
common stock at $0.40 per share at the option of the note holders and bear
interest at 7% per annum, payable quarterly. The debentures have a term of three
years with principal due in full at maturity. As a further inducement, the
Company granted the holders of the convertible debentures short-term warrants to
purchase 3.125 million shares of its common stock, expiring November 2006, and
warrants to purchase 3.125 million shares of its common stock, expiring October
2010. Both sets of warrants are exercisable at $0.40 per share.


                                      Q-20

<PAGE>


NOTE 4 - BORROWINGS (CONTINUED)

In November 2005, the Company sold an additional $2,000,000 of convertible
debentures to certain investors. The debentures are convertible to Company
common stock at $0.40 per share at the option of the note holders and bear
interest at 7% per annum, payable quarterly. The debentures have a term of three
years with principal due in full at maturity. As a further inducement, the
Company granted the holders of the convertible debentures short-term warrants to
purchase 2.5 million shares of its common stock expiring December 4, 2006 and
warrants to purchase 2.5 million shares of its common stock expiring November 4,
2010. Both sets of warrants are exercisable at $0.40 per share.

The convertible debentures and associated warrants include a price reset
provision. Under this provision the conversion price of the debentures and the
exercise price of the warrants would be adjusted to take into account the effect
of certain dilutive events. The price reset provision of the convertible
debentures and associated warrants would be triggered if the following events
occur:

   o     the payment of a dividend in the form of common stock or other
         equivalent equity security, or the occurrence of a stock split, reverse
         stock split, or reclassification of common stock. Upon such event, the
         conversion price of the debentures and the exercise price of the
         warrants would be adjusted by a percentage equal to the percentage of
         the Company outstanding common shares prior to the event over the
         Company outstanding common shares and other equivalent equity
         securities after the event.
   o     the re-pricing, sale, or right to re-price or buy the Company's common
         stock or equivalent instrument at a price less than the conversion
         price. Upon such event, the conversion price of the debentures and the
         exercise price of the warrants would be adjusted to the price of the
         Company common stocks or other equivalent equity securities involved in
         the triggering event.
   o     the making of distribution of cash, evidence of indebtedness, cash
         other or other assets, or rights to any equity securities to the
         holders of the Company's common stock. Upon such event, the conversion
         price of the debentures and the exercise price of the warrants would be
         adjusted by a percentage equal to the percentage change in the Company
         common stock price resulting from this event.
   o     the occurrence of a transaction for the merger, sale, tender offer, or
         recapitalization of the Company. Upon such event, the conversion price
         of the debentures and the exercise price of the warrants would be
         adjusted to allow the holders of the convertible debentures to receive
         upon conversion, the same consideration received by the holder of the
         Company common stocks at the time of the triggering event.

Pursuant to the registration rights agreements with the holders of the
convertible debentures dated August 31, 2005 and October 25, 2005, the Company
agreed to file by September 30, 2005 and November 24, 2005 respectively, a
resale registration statement covering the resale of the shares issuable to the
investors upon the conversion of their debt and the exercise of their warrants.
At inception, the registration rights agreements required the Company to pay
monthly liquidated damages if:

   o     a registration  statement was not filed on or prior to September 30,
         2005 and November 24, 2005, respectively, or
   o     the Company fails to file with the Commission a request for
         acceleration in accordance with Rule 461 promulgated under the
         Securities Act, within five trading days of the date that the Company
         is notified by the Commission that a registration statement will not be
         "reviewed," or not subject to further review, or


                                      Q-21

<PAGE>


NOTE 4 - BORROWINGS (CONTINUED)

   o     prior to its effectiveness date, the Company fails to file a
         pre-effective amendment and otherwise respond in writing to comments
         made by the Commission in respect of such registration statement within
         10 calendar days after the receipt of comments by or notice from the
         Commission that such amendment is required in order for a registration
         statement to be declared effective, or
   o     a registration statement filed or required to be filed, is not declared
         effective by the Commission by December 29, 2005 and February 22, 2006,
         respectively, or
   o     after December 29, 2005 and February 22, 2006, respectively, a
         registration statement ceases for any reason to remain continuously
         effective as to all registrable securities for which it is required to
         be effective, or the investors are not permitted to utilize the
         prospectus therein to resell such registrable securities for 10
         consecutive calendar days but no more than an aggregate of 15 calendar
         days during any 12-month period.

The amount of monthly liquidated damages equals 2.0% of the aggregate purchase
price paid by the investors for any registrable securities held by the
investors. Seven day late payment of the damages is subject to interest at an
annual rate of 18%. At June 30, 2006 the Company determined the maximum
potential liquidated damages to be approximately, $2,273,720.

The Company evaluated the liquidated damages feature of the registration rights
agreements in accordance with Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended
("SFAS 133"). The liquidated damages provisions qualify as embedded derivative
instruments at issuance and, because they do not qualify for any scope exception
within SFAS 133, they were required by SFAS 133 to be recorded as derivative
financial instruments. Further, in accordance with EITF 05-04, "The Effect of a
Liquidated Damages Clause on a Freestanding Financial Instrument Subject to EITF
Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock", the Company also evaluated
whether the registration rights agreements, the convertible debentures, and
associated warrants should be combined into and accounted for as a single unit
or accounted for as separate financial agreements.

In considering the appropriate treatment of these instruments, the Company
observed that:

   o     Although entered into contemporaneously, the debentures, warrants and
         registration rights agreements are nevertheless separate legal
         agreements.
   o     Payment of liquidated damages penalties under the registration rights
         agreements does not alter the investors' rights under either the
         warrant or debenture agreements. The debentures and warrants have
         values which are based on their interest rate and the relation between
         their conversion price or exercise price and the value of the Company's
         common stock. This value is independent of any payment for liquidated
         damages under the registration rights agreements, which is based on how
         long the shares remain unregistered.
   o     The various agreements do not relate to the same risk. The risk
         inherent in the debentures relates to the Company ability to repay
         these instruments as and when they come due or to the extent converted
         into common stock, to the price of the Company's common stock. The
         warrants similarly bear risk related to the value of the Company common
         stock. The liquidated damages penalty under the registration rights
         agreements relates to the risk of the Company filing a registration
         statement and having it declared effective.

                                      Q-22

<PAGE>


NOTE 4 - BORROWINGS (CONTINUED)

Thus, in light of the above facts and circumstances and accordance with guidance
in EITF 05-4, View C, the Company evaluated and treated the registration rights
agreements, convertible debentures and associated warrants as separate free
standing agreements.

At issuance of the convertible debentures on August 31, 2005, October 31, 2005
and November 4, 2005, the Company assigned no initial fair value to the
registration rights agreements. In subsequent periods, the carrying value of the
derivative financial instrument related to the registration rights agreements
will be adjusted to its fair value at each balance sheet date and any change
since the prior balance sheet date will be recognized as a component of other
income/(expense).

The estimated fair value of the registration rights agreements was determined
using the discounted value of the expected future cash flows. At September 30,
2005 and November 24, 2005, the Company was not able to have a registration
statement declared effective by the SEC as required by the registration rights
agreements. However, in January 2006, the Company obtained an amendment to the
registration rights agreements to extend the required filing date of the
Company's initial registration statement to January 27, 2006, a deadline that
the Company met, and to extend the required effectiveness date of that same
initial registration statement to March 31, 2006, a deadline the Company did not
meet, and to waive all amounts potentially due under the liquidated damages
clause which would have been due but for the waiver. On April 18, 2006 the
Company obtained a further amendment to the registration rights agreements to
further extend the required effectiveness date of its initial registration
statement to May 15, 2006 for investors subject to the August 31, 2005
registration rights agreement and extend to May 30, 2006 the date on which the
Company must have an effective registration statement for 50% of the
registerable shares for investors who were signatory to the October 25, 2005
registration rights agreement, both deadlines the Company met. On June 19, 2006,
the Company met the requirements to have an effective registration statement for
all shares required to be registered pursuant to the registrations right
agreements. The Company believes that, in the future, it will be able to meet
the registration requirements of the registration rights agreements and that, in
the event it cannot, and assuming the Company is making reasonable efforts to
file and have a registration statement declared effective, the holders of the
debentures will waive the liquidated damages required under the registration
rights agreements. As a result, at June 30, 2006, the Company assigned no value
to the potential liquidated damages.

In accordance with Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended
("SFAS 133"), certain features of the convertible debentures are not clearly and
closely related to the characteristics of the convertible debentures. SFAS133
requires that, unless they qualify under a scope exemption, these features be
recorded as derivative financial instruments. In accordance with the guidelines
provided by SFAS133 and EITF 00-19, the following convertible debentures
features qualified for a scope exemption under SFAS133 and were recorded as
equity instruments:

   o     Beneficial conversion features: these debentures are convertible at the
         option of the holder with the following provisions:
          o    the conversion can be at anytime on or prior to maturity;
          o    holders of the convertible debentures are subject to certain
               conversion restrictions; and
          o    the conversion price is subject to a conversion price reset
               provision.

The value of the beneficial conversion features, $3,904,926, was limited to the
relative fair value of the debentures and will be amortized to interest over the
life of the debentures.


                                      Q-23

<PAGE>


NOTE 4 - BORROWINGS (CONTINUED)

Only the debt acceleration provision upon default features of the convertible
debentures did not qualify for a scope exception under SFAS133. Accordingly,
they were required by SFAS 133 to be accounted for separately from the debt
instrument and recorded as derivative financial instruments.

At issuance of the convertible debentures on August 31, 2005, October 31, 2005
and November 4, 2005, the derivative features of the convertible debentures had
no initial fair value as the Company estimated the probability of occurrence of
these features to be nil or extremely low. In subsequent periods, the carrying
value of the derivative financial instrument related to the derivative features
of the convertible debentures will be adjusted to its fair value at each balance
sheet date and any change since the prior balance sheet date will be recognized
as a component of other income/(expense).

As of June 30, 2006, the Company assigned no value to the derivative features of
the convertible debentures, as the Company believes the probability of
occurrence of a default under the debentures to be nil or extremely low.

The estimated fair value of the derivative features was determined using the
probability weighted averaged expected cash flows methodology. Accordingly, the
fair value of the derivative features can fluctuate significantly based on
changes in the Company estimates of the probability of occurrence of a default
on the debentures and their then outstanding balance.

The relative fair value of the warrants issued was determined using the
Black-Scholes option-pricing model.





                                      Q-24

<PAGE>


NOTE 4 - BORROWINGS (CONTINUED)

The relative fair value of the warrants, the debentures conversion feature and
the debentures derivative features were recorded as a note discount and will be
amortized to interest over the life of the debentures. During the nine ended
June 30, 2006, $600,000 of convertible debentures and $14,660 of related
interest were converted to 1,500,000 and 36,651 shares of common stock at $0.40
per share, respectively. At June 30, 2006 the outstanding principal balance of
the convertible debentures was $6,400,000 and the unamortized note discount was
as follows:

Relative fair value of warrants allocated to note discount
Convertible debentures - August 2005                               $ 1,081,138
Convertible debentures - October 2005                                  995,963
Convertible debentures - November 2005                                 748,267
                                                                 --------------

Total relative fair value of warrants allocated to note discount     2,825,368
Less accumulated amortization                                         (875,337)
                                                                 --------------

Note discount related to warrants, net                               1,950,031
                                                                 ==============

Relative fair value of beneficial conversion features
 allocated to note discount
Convertible debentures - August 2005                                 1,418,862
Convertible debentures - October 2005                                1,487,797
Convertible debentures - November 2005                                 998,267
                                                                 --------------

Total relative fair value of beneficial conversion features
 allocated to note discount                                          3,904,926

Less accumulated amortization                                       (1,208,668)
                                                                 --------------

Note discount related to beneficial conversion features, net         2,696,258
                                                                 ==============

Fair value of derivative feature allocated to note discount
Convertible debentures - August 2005                                         -
Convertible debentures - October 2005                                        -
Convertible debentures - November 2005                                       -
                                                                 --------------

Total derivative feature allocated to note discount                          -
Less accumulated amortization
                                                                 --------------

Note discount related to derivative feature, net                   $         -
                                                                 ==============



                                      Q-25

<PAGE>


NOTE 4 - BORROWINGS (CONTINUED)

Product financing arrangement:

In August 2005, the Company entered into a $3,000,000 revolving combined
inventory financing and international factoring agreement (the "Revolving Line")
with a financial institution. Under the terms of the agreement, the Company
agreed to pay interest at the rate of 12% per annum on inventory financings and
24% per annum on factoring related borrowings under the line. The loan is
secured by a lien on the financed inventory and receivables. As a further
inducement, the Company also agreed to grant the financial institution a
warrant, which included piggyback registration rights, for 576,923 shares of its
common stock at an exercise price of $0.52 per share. The warrant has a two year
term. The fair value attributable to the warrant of $120,608 was recorded as a
note discount and will be amortized to interest over a one year period. On April
10, 2006, the Company entered into an amendment to the Revolving Line to clarify
and amend certain terms and conditions pursuant to which the Company can obtain
financing under the Revolving Line. Under the amendment to the Revolving Line
(the "Product Financing Arrangement"), ownership of the inventory financed is
transferred to the lending financial institution. From time to time, the Company
may repurchase financed inventory from the lender at a price equal to the
original transfer price plus interest. On June 1, 2006, the Company entered into
an amendment to the Product Financing Arrangement, increasing the debt facility
available under the Product Financing Arrangement to $4,000,000. Under the terms
of the amendment, the Company granted warrants to purchase 192,307 shares of its
common stock at an exercise price of $0.52 per share with an expiration date of
May 31, 2008 and a fair value of $66,708 to the financial institution.
Additionally, the Company agreed to extend by one year to August 15, 2006, the
expiration date of 576,923 warrants previously issued to the financial
institution representing a fair value of $45,945. The fair value attributable to
the warrant and to the expiration date extension was recorded as a note discount
and will be amortized to interest over a one year period. At June 30, 2006 the
outstanding principal balance under this agreement was $3,946,799 and the
unamortized note discount was $123,366.

Senior secured debentures

In August 2005, the Company sold $2,000,000 of senior secured debentures to
certain investors. The debentures bear interest at 10% per annum, payable
monthly, and have a three year term. Principal in the amount of $27,778 is due
monthly, with the remaining balance due at maturity. The debentures are secured
by a security interest in substantially all of the Company's assets. In
addition, the Company issued 1,600,000 shares of its common stock to the holders
of the debentures as security for the debentures, which the Company estimated
had a fair market value of $0.55 per share. As a further inducement, the Company
granted the holders of the debentures warrants to purchase 2.5 million shares of
its common stock at an exercise price of $0.40 per share with an expiration date
of August 31, 2010.

The warrants associated with the senior debentures include a price reset
provision. Under this provision the exercise price of the warrants would be
adjusted to take into account the effect of certain dilutive events. The price
reset provision of the warrants associated with the senior debentures would be
triggered if the following events occur:

     o    the payment of a dividend in the form of common stock or other
          equivalent equity security, or the occurrence of a stock split,
          reverse stock split, or reclassification of common stock. Upon such
          event, the exercise price of the warrants would be adjusted by a
          percentage equal to the percentage of the Company outstanding common
          shares prior to the event over the Company outstanding common shares
          and other equivalent equity securities after the event.


                                      Q-26

<PAGE>


NOTE 4 - BORROWINGS (CONTINUED)

     o    the re-pricing, sale, or right to re-price or buy the Company's common
          stock or equivalent instrument at a price less than the conversion
          price. Upon such event, the exercise price of the warrants would be
          adjusted to the price of the Company common stocks or other equivalent
          equity securities involved in the triggering event.
     o    the making of distribution of cash, evidence of indebtedness, cash
          other or other assets, or rights to any equity securities to the
          holders of the Company's common stock. Upon such event, the exercise
          price of the warrants would be adjusted by a percentage equal to the
          percentage change in the Company common stock price resulting from
          this event.
     o    the occurrence of a defined event of default under the senior
          debentures, upon which event the exercise price of the warrants would
          be reduced to one cent per share.
     o    the occurrence of a transaction for the merger, sale, tender offer, or
          recapitalization of the Company. Upon such event, the exercise price
          of the warrants would be adjusted to allow the holders of the warrants
          to receive upon conversion, the same consideration received by the
          holder of the Company common stocks at the time of the triggering
          event.

Pursuant to the registration rights agreement with the holders of the senior
debentures dated August 31, 2005, the Company agreed to file by September 30,
2005, a resale registration statement covering the resale of the shares issuable
to the holders of the senior debentures upon the exercise of their warrants. At
inception, the registration rights agreement required the Company to pay monthly
liquidated damages if:

     o    a registration statement was not filed on or prior to September 30,
          2005, or
     o    the Company fails to file with the Commission a request for
          acceleration in accordance with Rule 461 promulgated under the
          Securities Act, within five trading days of the date that the Company
          is notified by the Commission that a registration statement will not
          be "reviewed," or not subject to further review, or
     o    prior to its effectiveness date, the Company fails to file a
          pre-effective amendment and otherwise respond in writing to comments
          made by the Commission in respect of such registration statement
          within 10 calendar days after the receipt of comments by or notice
          from the Commission that such amendment is required in order for a
          registration statement to be declared effective, or
     o    a registration statement filed or required to be filed is not declared
          effective by the Commission by December 29, 2005, or
     o    after December 29, 2005 a registration statement ceases for any reason
          to remain continuously effective as to all registrable securities for
          which it is required to be effective, or the investors are not
          permitted to utilize the prospectus therein to resell such registrable
          securities for 10 consecutive calendar days but no more than an
          aggregate of 15 calendar days during any 12-month period.

The amount of monthly liquidated damages equals 2.0% of the aggregate purchase
price paid by the investors for any registrable securities held by the
investors. Late payment beyond seven days is subject to interest at an annual
rate of 18%. At June 30, 2006, the Company determined the maximum potential
liquidated damages to be approximately, $638,734.


                                      Q-27

<PAGE>


NOTE 4 - BORROWINGS (CONTINUED)

The Company evaluated the liquidated damages feature of the registration rights
agreement in accordance with Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended
("SFAS 133"). The liquidated damages qualify as embedded derivative instruments
at issuance and, because they do not qualify for any scope exception within SFAS
133, they were required by SFAS 133 to be recorded as derivative financial
instruments. Further, in accordance with EITF 05-04, "The Effect of a Liquidated
Damages Clause on a Freestanding Financial Instrument Subject to EITF Issue No.
00-19, Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock", the Company also evaluated
whether the registration rights agreement, the senior debentures, and associated
warrants should be combined into and accounted for as a single unit or accounted
for as separate financial agreements. In considering the appropriate treatment
of these instruments, the Company observed that:

     o    Although entered into contemporaneously, the debentures, warrants and
          registration rights agreements are nevertheless separate legal
          agreements.
     o    Payment of the liquidated damages penalties under the registration
          rights agreement does not alter the investors' rights under either the
          warrant or debenture agreements. The debentures and warrants have
          values which are based on their interest rate and the relation between
          their conversion price or exercise price and the value of the
          Company's common stock. This value is independent of any payment for
          liquidated damages under the registration rights agreement, which is
          based on how long the shares remain unregistered.
     o    The two agreements do not relate to the same risk. The risk inherent
          in the debentures relates to the Company ability to repay these
          instruments as and when they come due or to the extent converted into
          common stock, to the price of the Company's common stock. The warrants
          similarly bear risk related to the value of the Company common stock.
          The liquidated damages penalty under the registration rights agreement
          relates to the risk of the Company filing a registration statement and
          having it declared effective.

Thus, in light of the above facts and circumstances and accordance with guidance
in EITF 05-4, View C, the Company evaluated and treated the registration rights
agreement, senior debentures and associated warrants as separate free standing
agreements.

At issuance of the senior debentures on August 31, 2005, the Company assigned no
initial fair value to the registration rights agreement. In subsequent periods,
the carrying value of the derivative financial instrument related to the
registration rights agreement will be adjusted to its fair value at each balance
sheet date and any change since the prior balance sheet date will be recognized
as a component of other income/(expense).



                                      Q-28

<PAGE>


NOTE 4 - BORROWINGS (CONTINUED)

The estimated fair value of the registration rights agreement was determined
using the discounted value of the expected future cash flows. At September 30,
2005, the Company was not able to have a registration statement declared
effective by the SEC as required by the registration rights agreement. However,
in January 2006, the Company obtained an amendment to the registration rights
agreement to extend the required filing date of the Company's initial
registration statement to January 27, 2006, a deadline that the Company met, and
to extend the required effectiveness date of that same initial registration
statement to March 31, 2006, a deadline the Company did not meet, and to waive
all amounts potentially due under the liquidated damages clause which would have
been due and payable but for the waiver. On April 18, 2006 the Company obtained
a further amendment to the registration rights agreement to further extend the
required effectiveness date of its initial registration statement to May 15,
2006, a deadline the Company met. On June 19, 2006, the Company met the
requirements to have an effective registration statement for all shares required
to be registered pursuant to the registrations right agreement. The Company
believes that, in the future, it will be able to meet the registration
requirements of the registration rights agreement and that in the event it
cannot, and assuming the Company is making reasonable efforts to file and have a
registration statement declared effective, the holders of the debentures will
waive the liquidated damages required under the registration rights agreement.
As a result, at June 30, 2006, the Company assigned no value to the potential
liquidated damages.

The relative fair value of the warrants was determined using the Black-Scholes
option-pricing model and was recorded as a note discount and will be amortized
to interest over the life of the debentures. At June 30, 2006 the outstanding
principal balance under the senior secured debentures was $1,750,000 and the
unamortized note discount was $418,986.

Other notes:

The Company converted an outstanding accounts payable balance into an unsecured
note during fiscal year 2003. This unsecured note accrues interest at 5%. At
June 30, 2006, the principal balance outstanding under this note was $5,144.

The Company has a twelve month payment arrangement with a vendor in the amount
of $312,500 related to the acquisition of certain Mobetron design rights. The
payment arrangement bears interest of 10% per annum. At June 30, 2006, the
principal balance outstanding under this payment arrangement was $312,500.


NOTE 5 - CAPITAL LEASE

Capital lease

Capital lease obligations were as follows:

                                                            Nine months
                                                               ended
                                                           June 30, 2006
                                                        --------------------

Capital lease for equipment                                      $   10,562

Less current portion                                                 (2,063)
                                                        --------------------

Capital lease obligations, net of current portion                $    8,499
                                                        ====================


                                      Q-29

<PAGE>


NOTE 5 - CAPITAL LEASE (CONTINUED)

During the year ended September 30, 2005, the Company acquired equipment from a
vendor, to be paid in monthly installments through November 2010. At June 30,
2006 the outstanding principal balance under the lease is $10,562 of which
$2,063 is classified as current and $8,499 as long term.

NOTE 6 - COMMON STOCK

Shares Reserved for Future Issuance:

The Company has reserved shares of common stock for future issuance as follows:

                                                              June 30,
                                                               2006
                                                       ---------------------

            2005 Equity Incentive Plan                            3,597,000
            Common stock warrants                                22,390,481
                                                       ---------------------

            Total                                                25,987,481
                                                       =====================

Conversion of notes payable, related parties into Common Stock:

During the nine months ended June 30, 2006, one holder of the Company's notes
payable to related parties elected to convert an aggregate of $183,967 of
principal amount of the notes and $66,033 of related interest into 317,185 and
113,849 shares of the Company's common stock, respectively.

Issuance of Common Stock as consideration for amending the registration rights
agreements:

On March 16, 2006, the Company issued an aggregate of 135,000 shares of its
common stock having a market value of $81,000, a component of non cash interest
expense, to the holders of the Company's convertible and senior debentures in
consideration for amending the registration rights agreements. The amendment to
the registration rights agreements waived all liquidated damages currently owed
by the Company to the holders of the Company's convertible and senior debentures
and extended the required effectiveness date of the initial registration
statement to March 31, 2006. (see Note 4).

Issuance of Common Stock as consideration for services:

On April 7, 2006, the Company entered into an agreement with Emerging Markets
Consulting, LLC ("EMC"). Pursuant to the agreement, the Company issued to EMC
100,000 shares of common stock having a market value of $70,000, a component of
general and administrative expense. Upon the first day of the second six-month
term of the agreement, should the Company not cancel the agreement, the Company
will issue to EMC an additional 100,000 shares of common stock.

On June 13, 2006, the Company issued 100,000 shares of common stock having a
market value of $65,000, a component of general and administrative expense, to
the Investor Relations Group Inc pursuant to an agreement entered into on August
15, 2005.

Conversion of convertible debentures into Common Stock:

During the nine months ended June 30, 2006, the holders of the Company's
convertible debentures elected to convert an aggregate of $600,000 of principal
amount of the debentures and $14,660 of related interest into 1,500,000 and
36,651 shares of the Company's common stock, respectively.


                                      Q-30

<PAGE>


NOTE 6 - COMMON STOCK (CONTINUED)

Issuance of Common Stock upon exercise of warrants:

During the nine months ended June 30, 2006, the Company received proceeds of
$290,000 upon the exercise by certain investors of warrants to purchase 725,000
shares of its common stock.

NOTE 7 - STOCK OPTIONS

In 1995, the Company adopted the 1995 Stock Option Plan (the "Plan") and
reserved 2,400,000 shares of common stock for issuance under the Plan. On
December 7, 2005, the Company's Board of Directors voted to amend and restate
the Company's 1995 Stock Option Plan to among other things, a) extend the
expiration date of the Plan to December 7, 2015; b) change the name of the plan
to the "Intraop Medical Corporation 2005 Equity Incentive Plan" (the "New Plan")
and c) increase the number of shares reserved under the New Plan from 2,400,000
shares to 4,000,000 shares.

Under the New Plan, incentive options to purchase the Company's common stock may
be granted to employees at prices not lower than fair market value at the date
of grant as determined by the Board of Directors. In addition, incentive or
non-statutory options may be granted to persons owning more than 10% of the
voting power of all classes of stock at prices no lower than 110% of the fair
market value at the date of grant as determined by options (no longer than ten
years from the date of grant, five years in certain instances). Options granted
generally vest at a rate of 33% per year and have 10-year contractual terms.

Effective January 1, 2006, the Company adopted SFAS 123(R) using the modified
prospective transition method, which requires the measurement and recognition of
compensation expense for all share-based payment awards made to the Company's
employees and directors including stock options under the New Plan. The
Company's financial statements as of June 30, 2006, and for the three months and
nine months ended June 30, 2006 reflect the effect of SFAS 123(R). In accordance
with the modified prospective transition method, the Company's financial
statements for prior periods have not been restated to reflect, and do not
include, the impact of SFAS 123(R). Share-based compensation expense recognized
is based on the value of the portion of share-based payment awards that is
ultimately expected to vest. Share-based compensation expense recognized in the
Company's Condensed Consolidated Statements of Operations during the three
months and nine months ended June 30, 2006 included compensation expense for
share-based payment awards granted prior to, but not yet vested, as of December
31, 2005 based on the grant date fair value estimated in accordance with the pro
forma provisions of SFAS 123 and compensation expense for the share-based
payment awards granted subsequent to December 31, 2005 based on the grant date
fair value estimated in accordance with the provisions of SFAS 123(R). In
conjunction with the adoption of SFAS 123(R), the Company elected to attribute
the value of share-based compensation to expense using the straight-line
attribution. Share-based compensation expense related to stock options was
$53,162 and $125,557 for the three and nine months ended June 30, 2006,
respectively. During the three months and nine months ended June 30, 2005, there
was no share-based compensation expense related to stock options recognized
under the intrinsic value method in accordance with APB 25.

Upon adoption of SFAS 123(R), the Company elected to value its share-based
payment awards granted after January 1, 2006 using the Black-Scholes
option-pricing model, which was previously used for its pro-forma information
required under SFAS 123. The Black-Scholes model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. The Black-Scholes model requires the input of
certain assumptions. The Company's options have characteristics significantly
different from those of traded options, and changes in the assumptions can
materially affect the fair value estimates.


                                      Q-31

<PAGE>


NOTE 7 - STOCK OPTIONS (CONTINUED)

The fair value of options granted under the Plan and the New Plan were estimated
at the date of grant using the Black-Scholes model with the following weighted
average assumptions:

<TABLE>
<CAPTION>

                                          Three months ended                           Nine months ended
                                               June 30,                                    June 30,
                                   ------------------------------------------------------------------------------------
                                          2006             2005                    2006                   2005
                                   ------------------------------------------------------------------------------------
      <S>                                 <C>               <C>                    <C>                     <C>
Expected term (in years)               5.1 to 6.5            -                   4 to 10                 4 to 10
Risk-free interest rate              4.99% to 5.11%          -                4.41% to 5.11%         3.11% to 4.16%
Expected volatility                     131.35%              -              103.37% to 131.35%           42.68%
Expected dividend yield                    0%                -                      0%                     0%
Weighted average fair
   value at grant date                   $0.45               -                    $0.57                   $0.59

</TABLE>

The expected term of stock options represents the weighted-average period the
stock options are expected to remain outstanding. The expected term is based on
the observed and expected time to post-vesting exercise and forfeitures of
options by employees. Upon the adoption of SFAS 123(R), the Company determined
the expected term of stock options using the simplified method as allowed under
SAB107. Prior to January 1, 2006, the Company determined the expected term of
stock options based on the option vesting period. Upon the adoption of SFAS
123(R), the Company used historical volatility measured over a period equal to
the option expected terms in deriving its expected volatility assumption as
allowed under SFAS 123(R) and SAB 107. Prior to January 1, 2006, the Company
also used its historical stock price volatility in accordance with SFAS 123 for
purposes of its pro-forma information. The risk-free interest rate assumption is
based upon observed interest rates appropriate for the term of the Company's
stock options. The expected dividend assumption is based on the Company's
history and expectation of dividend payouts.

As share-based compensation expense recognized in the Condensed Consolidated
Statements of Operations for the three months and nine months ended June 30,
2006 is based on awards ultimately expected to vest, it has been reduced for
estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the
time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. Forfeitures were estimated based on
historical experience. In the Company's pro forma information required under
SFAS 123 for the periods prior to January 1, 2006, the Company accounted for
forfeitures as they occurred.






                                      Q-32

<PAGE>



NOTE 7 - STOCK OPTIONS (CONTINUED)

The effect of recording share-based compensation expense for the three months
and nine months ended June 30, 2006 is as follows:

<TABLE>
<CAPTION>

                                                                       Three Months           Nine Months
                                                                           Ended                 Ended
                                                                         June 30,              June 30,
                                                                           2006                  2006
---------------------------------------------------------------------------------------     ----------------
      <S>                                                                    <C>                  <C>
Stock-based compensation expense related to employee
stock options and employee stock purchases                                   $  53,162            $ 125,557
Tax benefit                                                                          -                    -
                                                                     ------------------     ----------------
Net decrease in net earnings                                                 $  53,162            $ 125,557
                                                                     ==================     ================

Effect on:
Cash flows from operating activities                                                 -                    -
Cash flows from financing activities                                                 -                    -

Effect on:
Net earnings per share -- Basic                                              $       -            $    0.01
                                                                     ==================     ================
Net earnings per share -- Diluted                                            $       -            $    0.01
                                                                     ==================     ================

</TABLE>


For the three and nine months ended June 30, 2006, total share-based
compensation expense recognized in earnings before taxes was $53,162 and
$125,557, respectively and the total related recognized tax benefit was zero in
both periods. Total share-based compensation expense capitalized as part of
inventories for the three and nine months ended June 30, 2006 was $8,256 and
$21,705 respectively. Total share-based compensation expense applied to warranty
reserve for the three and nine months ended June 30, 2006 was $1,703 and $4,131,
respectively.




                   Remainder of page intentionally left blank.












                                      Q-33

<PAGE>



NOTE 7 - STOCK OPTIONS (CONTINUED)

Activity under the New Plan is presented below:

<TABLE>
<CAPTION>


                                                                                       Weighted
                                                                                        Average
                                                                        Weighted       Remaining        Aggregate
                                        Shares                          Average       Contractual       Intrinsic
                                      Available         Number of       Exercise          Term            Value
                                      for Grant          Shares          Price         (in years)          (1)
                                    ---------------  --------------  -------------  ---------------  ---------------
        <S>                                  <C>           <C>              <C>               <C>          <C>
Balance at September 30, 2005              899,500       1,127,500         $ 0.77             5.15
Granted                                   (656,000)        656,000           0.58             9.46
Authorized                               1,600,000               -
Cancelled or expired                        13,500         (13,500)          0.93
Exercised                                        -         (30,000)          0.10
                                    ---------------  --------------  -------------  ---------------  ---------------
Balance at June 30, 2006                 1,857,000       1,740,000         $ 0.71             6.38           $  970
                                    ---------------  --------------  -------------  ---------------  ---------------
Exercisable at June 30, 2006                             1,335,722         $ 0.73             5.49           $  970
                                    ===============  ==============  =============  ===============  ===============

</TABLE>

(1) The aggregate intrinsic value represents the total pre-tax intrinsic value,
based on the Company's closing stock price of $0.51 as of June 30, 2006, which
would have been received by the option holders had all option holders exercised
their options as of that date.

The total pre-tax intrinsic value of options exercised was zero and $12,000
during the three and nine months ended June 30, 2006, respectively.

Total options under the Plan at September 30, 2005, comprised the following:

<TABLE>
<CAPTION>


                                                            Weighted
                                     Options                 Average               Options
                                   Outstanding              Remaining            Exercisable
                Option                as of                Contractual              as of
               Exercise            September 30,           Life (Years)          September 30,
                Price                  2005                                          2005
            ---------------    ----------------------     -----------------    -------------------
                 <S>                      <C>                  <C>                      <C>
                $0.100                  30,000                 0.12                   30,000
                 0.500                  97,000                 2.87                   97,000
                 0.550                 300,000                 2.20                  300,000
                 0.800                 386,500                 6.53                  386,250
                 0.880                 120,000                 5.55                  120,000
                 1.250                 164,000                 8.63                   98,583
                 1.375                  30,000                 8.51                   15,000
                               ----------------------                          -------------------

                Total                1,127,500                                      1,046,833
                               ======================                          ===================

</TABLE>




                                      Q-34

<PAGE>



NOTE 7 - STOCK OPTIONS (CONTINUED)

Total options under the New Plan at June 30, 2006, comprised the following:

                          Options            Weighted              Options
                        Outstanding           Average            Exercisable
     Option                as of             Remaining              as of
    Exercise             June 30,           Contractual           June 30,
     Price                 2006             Life(Years)             2006
 ---------------    ----------------     ------------------   ----------------
     $0.500                97,000              2.12                  97,000
      0.540                50,500              9.61                       -
      0.550               300,000              1.45                 300,000
      0.580               602,000              9.44                 292,528
      0.700                 3,500              9.61                     486
      0.800               377,000              5.81                 377,000
      0.880               120,000              4.80                 120,000
      1.250               160,000              7.89                 126,208
      1.375                30,000              7.76                  22,500
                    ----------------                          ----------------

     Total              1,740,000                                 1,335,722
                    ================                          ================


SFAS 123(R) requires the Company to present pro forma information for the
comparative period prior to the adoption as if it had accounted for all of its
stock options under the fair value method of SFAS 123. The following table
illustrates the pro forma information regarding the effect on net earnings and
net earnings per share if the Company had accounted for the share-based employee
compensation under the fair value method of accounting:

<TABLE>
<CAPTION>

                                                            Three months ended                    Nine months ended
                                                                 June 30,                             June 30,
                                                          2006              2005               2006              2005
                                                    -----------------------------------   ----------------------------------

          <S>                                              <C>              <C>                 <C>               <C>
Net loss available to common stockholders,
  as reported                                        $ (2,700,177)     $ (1,176,580)         $(6,019,773)   $  (4,375,060)

Compensation recognized under APB 25                         -                 -                    -                -

Compensation recognized under SFAS 123                       -                 -                (347,029)         (47,637)
                                                    -----------------------------------   ----------------------------------

Pro-forma net loss available to common
  stockholders                                       $ (2,700,177)     $ (1,176,580)         $(6,366,802)   $  (4,422,697)
                                                    ===================================   ==================================

           Net loss per share:

             Basic and diluted - as reported                $ (0.13)         $  (0.07)          $  (0.29)       $    (0.29)
                                                    ===================================   ==================================

             Basic and diluted - pro-forma                 $  (0.13)         $  (0.07)         $  ( 0.31)       $    (0.29)
                                                    ===================================   ==================================

</TABLE>

As of June 30, 2006, there was $87,097 of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under the
New Plan. This unrecognized compensation expense is expected to be recognized
over a weighted-average period of 1.22 years.


                                      Q-35

<PAGE>



NOTE 8 - WARRANTS

The following warrants are each exercisable into one share of common stock:

<TABLE>
<CAPTION>

                                                                         Weighted
                                                 Number of               Average              Aggregate
                                                   Shares                 Price                 Price
                                             -------------------     -----------------     ----------------
          <S>                                        <C>                    <C>                   <C>
 Balance at September 30, 2004                          863,091            $     1.49          $ 1,287,500
 Warrants granted                                    10,222,583                  0.42            4,250,200
 Warrants exercised                                           -                     -                    -
 Warrants cancelled                                           -                     -                    -
 Warrants repriced                                     (119,100)                (1.25)            (148,875)
 Warrants repriced                                      119,100                  0.70               83,370
 Warrants expired                                      (100,000)                (2.00)            (200,000)
                                             -------------------     -----------------     ----------------

 Balance at September 30, 2005                       10,985,674                  0.48            5,272,195
 Warrants granted                                    12,329,807                  0.41            5,015,000
 Warrants exercised                                    (725,000)                 0.40             (290,000)
 Warrants cancelled                                           -                     -                    -
 Warrants expired                                      (200,000)                (1.88)            (375,000)
                                             -------------------     -----------------     ----------------

 Balance at June 30, 2006                            22,390,481            $     0.43          $ 9,622,195
                                             ===================     =================     ================

</TABLE>

The common stock warrants are comprised of the following:

                                  Warrants               Weighted
                                Outstanding              Average
                                   as of                Remaining
         Exercise               September 30,          Contractual
          Price                    2005                 Life (Years)
    --------------------    ---------------------    ------------------
          $0.400                  9,537,500                3.64

           0.520                    576,923                1.88

           0.700                    119,100                4.92

           1.250                    583,060                1.85

           1.375                     69,091                1.42

           2.500                    100,000                0.50

                            ---------------------
           Total                 10,985,674
                            =====================

                                  Warrants                Weighted
                                Outstanding               Average
                                   as of                 Remaining
        Exercise                  June 30,              Contractual
          Price                     2006                Life (Years)
    --------------------    ---------------------    ------------------
          $0.400                      20,850,000           2.74
           0.520                         769,230           2.08
           0.700                         119,100           4.17
           1.000                         100,000           4.77
           1.250                         483,060           1.40
           1.375                          69,091           0.67

                            ---------------------
           Total                      22,390,481
                            =====================


                                      Q-36

<PAGE>



NOTE 8 - WARRANTS (CONTINUED)

During the following fiscal years, the numbers of warrants to purchase common
stock which will expire in the next five years if unexercised are:

                    Fiscal Year
                       Ending
                    September 30,              Number
                 --------------------     ----------------
                        2006                    2,500,000
                        2007                    5,963,051
                        2008                      813,330
                        2009                      150,000
                        2010                    6,451,600

                                          ================
                                               15,877,981
                                          ================

During the nine months ended June 30, 2006, the Company issued to the holders of
its convertible debentures short-term warrants to purchase 5.625 million shares
of its common stock, with expiration dates between November 25, 2006 and
December 4, 2006 and warrants to purchase 5.625 million shares of its common
stock, with expiration dates between October 25, 2010 and November 4, 2010. Both
sets of warrants are exercisable at $0.40 per share. The Company determined that
the relative fair value of the warrants was $1,744,230. The relative fair value
of the warrants was recorded as a note discount and will be amortized to
interest over the life of the convertible debentures. At June 30, 2006 the
unamortized note discount was $1,262,907.

During the nine months ended June 30, 2006, the Company issued five year
warrants to purchase 787,500 shares of common stock at an exercise price of
$0.40 per share for services rendered by a financial advisor in connection with
sales of the 7% convertible debentures (see Note 4). The fair value of these
warrants of $255,085 was capitalized as debt issuance cost and amortized over
the term of the debentures. At June 30, 2006 the unamortized debt issuance cost
was $198,399.

On April 7, 2006, the Company entered into an agreement with Emerging Markets
Consulting, LLC. Pursuant to the agreement, the Company issued to EMC a
five-year warrant to purchase 100,000 shares of common stock at an exercise
price of $1.00 per share. Upon the first day of the second six-month term of the
agreement, should the Company not cancel the agreement, the Company will issue
to EMC an additional five-year warrant to purchase 100,000 shares of stock. The
fair value of these warrants of $42,011 was recorded as marketing expense in the
three months ended June 30, 2006.

On June 1, 2006, the Company entered into an amendment to the Product Financing
Arrangement, increasing the debt facility available under the Product Financing
Arrangement to $4,000,000. Under the terms of the amendment the Company granted
warrants to purchase 192,307 shares of its common stock at an exercise price of
$0.52 per share with an expiration date of May 31, 2008 and a fair value of
$66,708 to the financial institution. Additionally, the Company agreed to extend
by one year to August 15, 2008, the expiration date of 576,923 warrants
previously issued to the financial institution representing a fair value of
$45,945. The fair value attributable to the warrant and to the expiration date
extension was recorded as a note discount and will be amortized to interest over
a one year period. At June 30, 2006 the unamortized note discount was $103,265.


                                      Q-37

<PAGE>


NOTE 8 - WARRANTS (CONTINUED)

The values of the warrants issued were determined using the Black-Scholes
option-pricing model based on the following assumptions:

                                              Nine months ended
                                                  June 30,
                                                    2006
                                            -------------------------

Expected life (in years)                           1.08 to 5
Risk-free interest rate                          4.26% to 4.92%
Expected volatility                            77.39% to 134.40%
Expected dividend yield                                -

NOTE 9 - COMMITMENTS AND CONTENGENCIES

The Company leases offices and equipment under non-cancelable operating and
capital leases with various expiration dates through 2011. Rent expense for the
three months ended June 30, 2006 and 2005 was $64,994 and $21,174 respectively
and $155,719 and $66,854 for the nine months ended June 30, 2006 and 2005. The
terms of the facility lease provide for rental payments on a graduated scale.
The Company recognizes rent expense on a straight-line basis over the lease
period, and has accrued for rent expense incurred but not paid.

Future minimum lease payments under non-cancelable operating and capital leases
are as follows:

<TABLE>
<CAPTION>


                                                                 Capital            Operating
             Year Ended September 30,                            Leases              Leases
---------------------------------------------------------    -------------      ---------------
                      <S>                                           <C>                <C>
                       2006                                      $    645             $ 57,277
                       2007                                         2,579              233,796
                       2008                                         2,579              237,625
                       2009                                         2,579              244,754
                       2010                                         2,579              233,838
                       2011                                           431                    -
                                                             -------------      ---------------

Total minimum lease payments                                       11,392           $1,007,290
                                                                                ===============

Less: Amount representing interest                                   (830)
                                                             -------------

Present value of minimum lease payments                            10,562
Less: Current portion                                              (2,063)
                                                             -------------

Obligations under capital lease, net of current portion          $  8,499
                                                             =============

</TABLE>







                                      Q-38

<PAGE>



NOTE 10 - OPERATING SEGMENT AND GEOGRAPHIC INFORMATION


Net revenues by geographic area are presented based upon the region of
destination. No other foreign region represented 10% or more of net revenues for
any of the periods presented. Net revenues by geographic area were as follows:

<TABLE>
<CAPTION>

                                    Three months ended                      Nine months ended
                                         June 30,                               June 30,
                           -------------------------------------    ----------------------------------
                                 2006                2005                2006               2005
                           -----------------    ----------------    ---------------    ---------------
  <S>                              <C>                 <C>                <C>                <C>
Europe                          $    24,588         $    63,100         $2,040,066         $1,268,855
United States                        60,831              98,694            280,675          1,450,334
                           -----------------    ----------------    ---------------    ---------------

Total Revenue                   $    85,419         $   161,794         $2,320,741         $2,719,189
                           =================    ================    ===============    ===============

</TABLE>

Long lived assets includes property and equipment, intangible assets, and leased
equipment each net of applicable depreciation or amortization residing in the
following countries as of June 30, 2006.

            Netherlands                      $   593,481
            United States                          2,178
                                       ------------------

            Total                            $   595,659
                                       ==================


NOTE 11 - SUBSEQUENT EVENTS


The following subsequent events occurred between the end of the quarter ended
June 30, 2006 and August 2, 2006.

On July 17, 2006 the Company filed a Form SB-2 registration statement for 19.1
million shares of its common stock previously sold to investors in private
transactions. The Company will not receive any proceeds from this registration.
The registration was declared effective by the Securities Exchange Commission on
July 31, 2006.

In July 2006, the Company repaid the following amounts of principal: $51,541 due
under notes payable to related parties, $77,368 due under other notes payable,
$55,556 due under the 10% senior secured debentures and $185 due under capital
leases. Also, a $25,000 obligation under other notes payable was extinguished as
proceed for the exercise of 83,333 short term warrants by certain investors.
Additionally, the Company received the following proceeds: $43,750 for
borrowings under the Product Financing Arrangement, $50,000 from notes payable
to related parties and $25,000 from other notes payable.



                                      Q-39

<PAGE>


NOTE 11 - SUBSEQUENT EVENTS (CONTINUED)

In July 2006, for a limited time, the Company reduced the exercise price of
certain short term warrants to purchase its common stock held by the holders of
its convertible debentures from $0.40 per share to $0.30 per share. This
reduction was valid only for exercises during the period from July 21, 2006 to
July 26, 2006, up to an aggregate of 6,000,000 shares. All other terms of the
warrants remained unchanged. Holders of short-term warrants elected to exercise
such warrants to purchase an aggregate of 2,935,720 shares of common stock for
an aggregate purchase price of $880,716, of which, $25,000 was from the
cancellation and surrender of other notes payable and the balance was in cash.
The Company will use the proceeds from this warrant exercise for general working
capital purposes. Short-term warrants for an aggregate of 5,126,780 shares of
common stock remain unexercised and outstanding. After July 26, 2006, the
exercise price of the unexercised short-term warrants reverted to $0.40 per
share.



                                      Q-40