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

                                   FORM 10-KSB

               [X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                     For the fiscal year ended June 30, 2006

             [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

             For the transition period from __________ to __________

                         Commission File Number 0-21537

                            PACIFIC BIOMETRICS, INC.
                 (Name of small business issuer in its charter)

           DELAWARE                                      93-1211114
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
 incorporation or organization)

                            220 WEST HARRISON STREET
                            SEATTLE, WASHINGTON 98119
                    (Address of principal executive offices)

                                 (206) 298-0068
                           (Issuer's telephone number)

Securities registered under Section 12(b) of the Exchange Act: (none)

Securities registered under Section 12(g) of the Exchange Act: COMMON STOCK,
$0.01 PAR VALUE PER SHARE

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

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. [X] Yes [ ] No

Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]

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

Issuer's revenue for its most recent fiscal year: $10,750,023

As of September 29, 2006, there were 18,336,884 shares of the Company's common
stock issued and outstanding, and the aggregate market value of such common
stock held by non-affiliates was approximately $17,420,000, based on the closing
price of $0.95 of such stock on that date.

DOCUMENTS INCORPORATED BY REFERENCE: The Company's definitive proxy statement
for the annual meeting of stockholders, which will be filed with the Securities
and Exchange Commission within 120 days after the close of the fiscal year 2006,
is incorporated by reference in Part III hereof.

Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
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                            PACIFIC BIOMETRICS, INC.

                            Form 10-KSB Annual Report

                                Table of Contents

                                                                            Page
                                                                            ----
                                     PART I

Item 1.       Description of Business.........................................2

Item 2.       Description of Property........................................23

Item 3.       Legal Proceedings..............................................23

Item 4.       Submission of Matters to a Vote of Security Holders............24


                                     PART II

Item 5.       Market for Common Equity, Related Stockholder Matters and
              Small Business Issuer Purchases of Equity Securities...........24

Item 6.       Management's Discussion and Analysis or Plan of Operations.....25

Item 7.       Financial Statements...........................................32

Item 8.       Changes in and Disagreements with Accountants on Accounting
              and Financial Disclosure.......................................32

Item 8A.      Controls and Procedures........................................32

Item 8B.      Other Information..............................................33


                                    PART III

Item 9.**     Directors, Executive Officers, Promoters and Control
              Persons; Compliance with Section 16(a) of the Exchange Act.....33

Item 10.**    Executive Compensation.........................................33

Item 11.**    Security Ownership of Certain Beneficial Owners and
              Management, and Related Stockholder Matters....................33

Item 12.**    Certain Relationships and Related Transactions.................34

Item 13.      Exhibits.......................................................34

Item 14.**    Principal Accountant Fees and Services.........................36

SIGNATURES...................................................................37

**   Information  contained  in Items 9  through  12 and Item 14 of Part III are
     incorporated by reference from the definitive  proxy statement for our 2006
     annual meeting of stockholders, which will be filed with the Securities and
     Exchange  Commission  within  120 days  after the close of the 2006  fiscal
     year.

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             CAUTIONARY NOTICE REGARDING FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-KSB contains certain forward-looking statements,
including statements about

     o    our existing working capital and cash flows and whether and how long
          these funds will be sufficient to fund our operations,

     o    the success of our business development efforts and our ability to
          enter into work orders for laboratory services and generate revenue,

     o    the development of new services and products and the expansion of the
          market for our current services and products,

     o    implementing aspects of our business plan and strategies,

     o    financing goals and plans, and

     o    our raising of additional capital through future equity and debt
          financings.

The forward-looking statements in this Annual Report reflect management's
current views and expectations with respect to our business, strategies,
products, future results and events and financial performance. All statements
other than statements of historical fact, including future results of operations
or financial position, made in this Annual Report on Form 10-KSB are forward
looking. In particular, the words "believe," "expect," "intend," "anticipate,"
"estimate," "desire," "goal," "may," "will," variations of such words, and
similar expressions identify forward-looking statements, but are not the
exclusive means of identifying such statements and their absence does not mean
that the statement is not forward-looking. These forward-looking statements are
subject to certain risks and uncertainties, including those discussed below. Our
actual results, performance or achievements could differ materially from
historical results as well as those expressed in, anticipated or implied by
these forward-looking statements. We do not undertake any obligation to revise
these forward-looking statements to reflect any future events or circumstances.

For a discussion of some of the factors that may affect our business, results
and prospects, see "ITEM 1. - DESCRIPTION OF BUSINESS - Risk Factors Affecting
the Business of the Company" beginning on page 12. Readers are urged to
carefully review and consider the various disclosures made by us in this Report
and in our other reports previously filed with the Securities and Exchange
Commission, including our periodic reports on Forms 10-KSB and 10-QSB, and those
described from time to time in our press releases and other communications,
which attempt to advise interested parties of the risks and factors that may
affect our business, prospects and results of operations.

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                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS.

GENERAL

We provide specialty central laboratory services to support pharmaceutical and
laboratory diagnostic manufacturers in the conduct of human clinical research,
for use in their drug and diagnostic product development efforts. Our clients
include a number of the world's largest multi-national pharmaceutical,
biotechnology and diagnostic companies. Our well-recognized specialty areas
include cardiovascular disease (dyslipidemia, atherosclerosis, and coronary
heart disease), diabetes (and obesity), and bone and joint diseases
(osteoporosis as well as osteo and rheumatoid arthritis). Coupled with our
specialty testing, we also have central laboratory capability and provide
full-service central laboratory support for multi-center clinical trials,
including routine safety lab tests (general chemistry, hematology, and
urinalysis). Our company is a Delaware corporation, incorporated in May 1996,
and we conduct our operations primarily through our wholly-owned subsidiary,
Pacific Biometrics, Inc., a Washington corporation.

BUSINESS STRATEGY

Specialty reference and central laboratory service companies like ours typically
derive substantially all of their revenue from the research, development and
marketing expenditures of the pharmaceutical, biotechnology, and diagnostic
industries. Participants in the pharmaceutical, biotechnology, and diagnostic
industries typically outsource a significant quantity of these services to both
central labs and specialty reference labs. In addition, central laboratories
outsource to specialty reference labs some of the specialty testing where the
central laboratory lacks expertise. We believe that such outsourcing will
continue and may increase in the future because of many factors, including
continuing pressures on the pharmaceutical and biotechnology industries to
contain costs, limitations on pharmaceutical companies' internal capacity, a
need for faster development time for new drugs, research in multiple countries
simultaneously, stringent government regulation, and the difficulty in
developing expertise in specialty testing areas internally within pharmaceutical
companies or central labs. We believe the investment and amount of time required
to develop new drugs and diagnostic products has been increasing, and that these
trends create opportunities for companies like ours to provide our expertise and
services to help reduce the time in the drug development and laboratory
diagnostic product development processes and make the processes more efficient.

Our strategy is to meet the needs for outsourcing by pharmaceutical,
biotechnology, and diagnostic companies and other central laboratories, and to
assist in enhancing the drug and diagnostic development processes by developing
and delivering innovative services that apply science and technology in the
provision of high quality service within our areas of specialty.

Our primary business strategy is to continue our focus on providing high quality
specialty central laboratory services in our core areas, including
cardiovascular disease and bone and joint diseases because of active drug
development activities. In addition, we also intend to pursue other strategies
identified below to further our business. However, because of the significant
expense associated with some of these strategies, we may not pursue some of
these strategies unless our revenue increases significantly or we are able to
raise equity or debt financing to adequately fund these strategies. There can be
no assurance that we will pursue any or all of the strategies below or, if
pursued, that any of such strategies will be successful.

DIVERSIFY CLIENT BASE

We have a goal to continue to diversify our client base, both in terms of the
number of clients and the number of contracts within any particular client. In
fiscal 2005 we adopted a new corporate visual identity and are using this to
integrate all of our marketing efforts and advertising. We have also increased
our visibility at industry trade shows and in industry publications through
print advertisements and publicity campaigns. Historically, our largest two
clients in any individual fiscal year have represented in excess of 50% of our
revenue. This trend continues in the fiscal year ended June 30, 2006, in which
our top two clients represented 50% of our revenue compared to 40% during the
fiscal year ended June 30, 2005. However, as a result of ongoing business
development efforts, we have added 10 new clients to our client base during the
fiscal year ended June 30, 2006, compared to 5 new clients in

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fiscal 2005, and we continue to diversify the total number and types of study
contracts. During fiscal 2006, the Company held a total of 76 active contracts,
compared to 62 active contracts in fiscal 2005, a 22.6% increase. Management
believes, therefore, that as a result of these continuing business development
activities, we will incrementally diversify our client base and spread our
revenues across a larger number of clients and a larger number of individual
study contracts.

Nevertheless, despite these trends, our largest client in fiscal 2006
individually accounted for approximately 36% and 23% of our total revenue in
fiscal 2006 and 2005, respectively, while our largest client in fiscal 2005
accounted for approximately 23% and 36% of our total revenue in fiscal 2005 and
2004, respectively. Revenue from our five largest clients represented
approximately 74% and 67% of total revenue in fiscal 2006 and 2005,
respectively. Because our revenue has historically been concentrated in one or
two large clients, we can be materially adversely impacted by any delays in
undertaking clinical studies or submitting samples for testing services,
including any early termination or reductions in work orders or clinical
studies, or any decreases in the volume or timing of new work orders. In fiscal
2007 we will continue to actively pursue business development and marketing
activities to broaden our client and revenue base.

INCREASE SPECIALTY AREAS

In addition to our core specialties of cardiovascular disease and bone and joint
diseases, our goal is to further expand our specialty laboratory expertise
within related areas where we have a competitive advantage of existing in-depth
expertise. This includes diabetes, obesity, metabolic syndrome, rheumatoid and
osteo arthritis, and related inflammatory diseases.

ADD GLOBAL CENTRAL LABORATORY CAPABILITY

We believe that in the central laboratory services business it is important to
provide a broad geographic base as most clinical drug development programs are
global. Through partnering with a major central laboratory with a large
established client base and existing infrastructure for managing clinical
studies globally, we believe that we can compete with other central laboratories
that have offices, monitoring sites and laboratories in many countries around
the globe. In fiscal 2005, we entered into a joint marketing arrangement with
Quintiles Transnational Corp. We have continued to refine this relationship
through joint workshops held in fiscal 2006. In fiscal 2007 we expect to build
on this relationship by expanding joint business development efforts and
implementing operational integration in certain areas that will lead to
streamlined services. We believe that this joint marketing relationship can
provide a unique advantage of combining both scope and depth in quality
specialty testing service.

ACQUISITIONS AND STRATEGIC RELATIONSHIPS

Our clients and our competitors have experienced significant consolidation over
the last several years and we expect that trend to continue. The uncertainty
caused by the consolidation trend may result in other companies in the industry
seeking to form strategic relationships or joint ventures or to be acquired in
order to stay competitive. This may make it possible for us to make strategic
acquisitions that are complementary to our existing services and that expand our
ability to serve our clients. We are also exploring other strategic alternatives
for our business and operations, which may include joint ventures, co-marketing
relationships, or other strategic relationships especially with diagnostic
companies with emerging or proprietary technologies. Additionally, we will
evaluate, as appropriate, any potential business combinations involving our
company as a whole, or involving a portion of our assets.

UPGRADING INFORMATION TECHNOLOGY AND BACK-UP SYSTEMS

We are currently focusing a significant portion of our capital expenditures and
investments in carefully selected hardware and software products, information
technology systems and networks. During fiscal 2006, we invested in our
laboratory information system, including the initial phase implementation of the
ClinAxys II Laboratory Information System. The installation of this new system
should streamline and improve our project and data management capabilities. In
fiscal 2007, we expect to complete the ClinAxys II Laboratory Information System
implementation and will continue to invest in the improvement of our information
systems. We believe capital improvements in these areas are important to meet
the changing demands of drug development by improving and

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facilitating our data reporting, testing data capacity and efficiency and the
overall service to and communications with our clients.

In fiscal 2006, to provide our clients with the confidence that we can minimize
the impact of local power outages, we invested in redundant or back-up systems.
In fiscal 2005 we acquired and in fiscal 2006 have begun to use a back-up
electrical generator. In addition, we have added and anticipate completing
redundant or back-up CO2 systems for all of our individual freezers to protect
samples stored in those freezers.

SERVICES

SPECIALTY REFERENCE LABORATORY SERVICES

Our specialty reference laboratory in Seattle, Washington has established itself
as a technical leader due to our strong expertise in certain core areas. Our
three general areas of expertise include:

     o    cardiovascular disease (dyslipidemia, atherosclerosis, and coronary
          heart disease),
     o    diabetes, metabolic syndrome, and obesity, and
     o    bone and joint diseases (osteoporosis as well as osteo and rheumatoid
          arthritis).

Management believes that among prospective new drugs, these areas of expertise
represent three of the top ten areas of focus by the pharmaceutical industry.

With respect to cardiovascular disease, we are one of the leaders in lipid
services for clinical drug development in the U.S. Our expertise is concentrated
on the measurement of cardiovascular disease markers, especially cholesterol and
lipoproteins, including HDL, LDL, HDL and LDL subfractions, remnant cholesterol,
apolipoproteins, Lp(a), and lipoprotein fraction compositions. Furthermore, the
Pacific Biometrics Research Foundation, a non-profit organization affiliated and
co-located with PBI, is one of only three U.S. standardization centers in the
Cholesterol Reference Method Laboratory Network sponsored by the Centers for
Disease Control and the National Heart, Blood & Lung Institute. There are only
ten such laboratories worldwide.

We are enhancing our activities in the area of diabetes and related disorders,
notably obesity and metabolic syndrome. Metabolic syndrome is a collection of
abnormalities that include central obesity, dyslipidemia (low HDL cholesterol
and high triglycerides), insulin resistance, pre-diabetes and pre-hypertension.
In the U.S. the prevalence of metabolic syndrome is estimated at 47 million
individuals (Heart Disease and Stroke Statistics - 2006 Update, American Heart
Association). People with metabolic syndrome are at increased risk for
cardiovascular disease and associated morbidity and mortality and as a result,
this population is coming under increased scrutiny for pharmacological
intervention. Because of our established strengths in testing for lipids,
cardiovascular risk and diabetes, we believe we are well-positioned to take
advantage of this emerging area of pharmaceutical drug development. Moreover, we
are expanding our test menu in areas related to diabetes and metabolic syndrome,
notably in testing for markers of inflammation.

We are active in promoting the standardization of bone metabolism biomarkers,
and are involved in technologies for monitoring treatment response in diseases
such as osteoporosis. We have used our expertise in osteoporosis-indicating
bone-biomarker assays to manage the first proficiency-testing programs for
bone-resorption markers. In the areas of bone metabolism and women's health, we
also specialize in the measurement of hormones, and our menu of biochemical
markers includes pyridinolines, various C- and N- terminal telopeptides,
procollagens, osteocalcin and bone-specific alkaline phosphatase. Moreover, in
recent years we have actively expanded our test menu to include biochemical
markers of cartilage turnover as relating to drug development for arthritis, and
we have performed specialty testing to support clinical drug development of
drugs for rheumatoid arthritis and osteoarthritis.

In connection with these stated areas of expertise, we offer a variety of
services through our specialty reference laboratory, including

     o    clinical study testing services,
     o    development of laboratory reference methods,

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     o    development of clinical trial protocols, and
     o    contract research and development.

Our involvement with clients frequently begins at the protocol design stage.
Clinical trial support includes coordinating the collection and receipt of
specimens from investigative sites, processing the samples, generating test
databases and reporting the consolidated data to study sites and sponsors. The
extensive knowledge we have in test development and our close collaboration with
diagnostic manufacturers, frequently allow us to offer novel tests to our
clinical research clients before such tests are commercially available.

CENTRAL LABORATORY SERVICES

Coupled with our expertise in specialty testing we also provide central
laboratory services. The full-service central laboratory support for
multi-center clinical trials includes project management and routine safety lab
tests (general chemistry, hematology and urinalysis). Our operations support
clinical trials by producing study-specific specimen collection supplies,
coordinating collection and the receipt of specimens from clinical sites,
processing the samples, generating test databases, and reporting data to sites
and sponsors.

We generally provide full-service central laboratory services in support of
Phase I and Phase II FDA clinical trials. These trials are typically smaller and
more geographically focused than Phase III trials.

Through our joint marketing relationship with Quintiles Laboratories in
providing centralized specialty lab testing services, we intend to compete with
other central laboratories that have offices, monitoring sites and laboratories
in countries around the globe, both for Phase I and Phase II trials, as well as
Phase III and Phase IV trials. In fiscal 2007, we expect to build on this
relationship with Quintiles by expanding joint business development efforts and
implementing operational integration in certain areas that will lead to
streamlined services. In fiscal 2006, we did not realize significant financial
benefit from our relationship with Quintiles and there is no guarantee that the
relationship will successfully generate expected revenue.

TECHNOLOGIES AND PRODUCTS

During fiscal 2004, we formed a new wholly owned subsidiary, PBI Technology,
Inc., for the purpose of holding, developing and seeking commercialization of
certain of our technologies and intellectual property portfolio, including our
isothermal DNA amplification method (LIDA), our Cell Viability technology, and
our Osteopatch(TM) and Saliva Sac(R) diagnostic devices. These technologies are
described in more detail below.

MOLECULAR TECHNOLOGIES

PBI Technology owns DNA-based proprietary technologies, processes and equipment.
This novel intellectual property (patented and patent-pending) includes a
proprietary isothermal DNA amplification method (LIDA) and a genetic method for
distinguishing live from dead cells (Cell Viability).

As of June 30, 2006, these technology assets still require additional
development prior to commercialization and their future value, as well as timing
of their ongoing development, is dependent upon additional capital being
available to fund continuing research and development. We expect to need
additional capital to fund continuing research and development efforts related
to these technologies, and there are no assurances that such funds will be
available to us. We are actively seeking commercial partners interested in
co-development or licensing of our technologies. If we are unable to find
commercial partners or to obtain suitable financing to continue research and
development efforts, commence the regulatory approval process (where applicable)
and commercialization of the technologies, we are unlikely to continue pursuing
development efforts related to these technologies.

While we intend to continue to pursue development efforts, partnership,
licensing or other means to realize the value of these intangible assets, in
fiscal 2004 we determined that the value of these assets may not be recoverable
over their remaining useful lives, and thus the value of these assets should be
written off on our financial statements. Accordingly, we wrote off the entire
balance ($476,874) of technology assets as of June 30, 2004.

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Although we believe these technologies are valuable assets, we may not be able
to successfully develop these technologies and they may not generate revenue. In
addition, even if we are ultimately successful in developing products from these
technologies, some of those products would likely be subject to regulatory
approval, and could always be the subject of litigation or other claims from
competitors or others with respect to such products or the patents and
methodologies upon which they are based.

DIAGNOSTIC DEVICE TECHNOLOGIES

During the 1990's, we developed an intellectual property position in sweat and
saliva collection technologies. In 1998, due to lack of funding and our failure
to obtain FDA approval for resultant products, we suspended all further
development efforts relating to these technologies and products. We subsequently
wrote off the value of these assets on our balance sheet in 1999. We believe
there may be potential commercial application for some of these technologies,
and we have recently engaged outside consultants to resume business development
efforts related to the saliva and sweat collection technologies.

Set forth below is a brief description of some of these diagnostic device
technologies:

     SALIVASAC(R) - SALIVA COLLECTION & PROCESSING DEVICE. This proprietary
device, developed by us, collects a non-invasive saliva sample that may be able
to replace blood and urine testing in various applications. The SalivaSac(R), as
a sample collection device, can be combined with currently available testing
technologies to permit new, non-invasive diagnostic test applications. We
believe the SalivaSac(R) design has the potential to lend itself to
point-of-care diagnostic applications, including as a screening product to
detect diabetes in the general population.

     OSTEOPATCH(TM) SWEAT COLLECTION DEVICE FOR MONITORING MARKERS OF BONE
METABOLISM. This patented technology involves a method to measure the presence
or absence of markers, typically cross-linked amino acids such as pyridinoline,
from body fluids such as sweat. The presence of these markers can be considered
useful to support the diagnosis of certain bone disease states such as
osteoporosis, and as an adjunct to monitor response to treatment in such bone
diseases.

OTHER INTELLECTUAL PROPERTY

In addition to the patented technologies, we have developed certain computer
software and internal procedures and products intended to enhance the quality
and effectiveness of our services. Although our intellectual property rights are
important to our results of operations, we believe that such factors as the
technical expertise, knowledge, ability and experience of our laboratory
professionals are more important, and that, overall, these technological
capabilities provide significant benefits to our clients.

CLIENTS / MARKETING

We provide specialty reference and central laboratory services to, among others,
the pharmaceutical, biotechnology, and laboratory diagnostic industries. We also
act as a subcontractor for large central laboratories for our specialty
reference laboratory services. In fiscal years 2006 and 2005, our clients
included companies ranging from the world's largest pharmaceutical companies and
biotechnology companies to small and start-up organizations. Historically, our
largest two clients in any individual fiscal year have represented in excess of
50% of our revenue. During the fiscal year ended June 30, 2006, our top two
clients represented 50% of our revenue as compared to 40% during the fiscal year
ended June 30, 2005. Our largest client in fiscal 2006 individually accounted
for approximately 36% and 23% of our total revenue in fiscal 2006 and 2005,
respectively, while our largest client in fiscal 2005 accounted for
approximately 23% and 36% of our total revenue in fiscal 2005 and 2004,
respectively. Revenue from our five largest clients represented approximately
74% and 67% of total revenue in fiscal 2006 and 2005, respectively.

Our scientific expertise is an integral and interrelated part of our marketing
and sales process. Our Chief Scientific Officer and our Chief Medical Officer
are directly involved in sales and marketing through company capability and
scientific presentations as well as consultation with pharmaceutical clinical
teams beginning at the protocol design stage. Our extensive knowledge in test
development and our close collaboration with diagnostic manufacturers frequently
allow us to offer novel tests to our clinical research clients before such tests
are commercially available.

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Additionally, our affiliation with the Centers for Disease Control through
Pacific Biometrics Research Foundation, which allows us to participate in the
development of reference methods, creates further expertise that we can bring to
bear on our clients' testing needs. By marketing and selling our expertise, we
believe we have a competitive advantage over our competitors.

CONTRACTUAL ARRANGEMENTS

Our contracts with clients are, for the most part, either fixed price or
fee-for-service with a cap. To a lesser extent, contracts are fee-for-service
without a cap. In cases where the contracts are fixed price, we generally bear
the cost of overruns, but we benefit if the costs are lower than we anticipated.
In cases where our contracts are fee-for-service with a cap, the contracts
contain an overall budget for the trial based on time and cost estimates. If our
costs are lower than anticipated, the client generally benefits from the
savings. If our costs are higher than estimated, we bear the responsibility for
the overrun unless the increased cost is a result of a change requested by the
client, such as an increase in the number of patients to be enrolled or the type
or amount of data to be collected. Contracts may range from a few months to
several years depending on the nature of the work performed. For most contracts,
a portion of the contract fee is paid at the time the study or trial is started
with the balance of the contract fee payable in installments upon the progress
of the work completed or achievement of milestones over the study or trial
duration. We recognize revenue in the period that we perform the related
services.

As of June 30, 2006, we have master contract service agreements with nine of our
largest clients. Under these master service agreements, we perform laboratory
research services based on work orders submitted to us by the client. There is
no guaranteed minimum number of work orders or revenue to us under either
agreement. Each work order is separately negotiated with the client and is
usually limited to a specific project with limited duration.

Most of our contracts may be terminated at any time by the client either
immediately or upon notice. Our contracts typically entitle us to receive
payment for services performed by us up to the time of termination and
reimbursement for out-of-pocket costs incurred prior to termination. In certain
limited instances, our contracts also entitle us to a termination fee or payment
for the costs of winding down the terminated projects.

Most of our contracts also provide for the client to indemnify us for any third
party damages and claims arising from our providing services under the contract.
The typical exception to this is that no indemnification will be provided if the
damage or claim results from our negligence or intentional misconduct.

COMPETITION

The specialty reference and central laboratory services industries have many
participants ranging from small, limited-service providers to a limited number
of full-service laboratories with global capabilities.

For specialty reference laboratory services in our areas of expertise, we
primarily compete against other full-service and limited service specialty and
central laboratory services organizations and, to a lesser extent, laboratories
in academic centers. Many of these organizations have significantly greater
resources than we do with somewhat different focus and business targets. Our
significant competitors in specialty reference laboratory services include
Synarc, Inc., MRL/PPD, MedPace, NW Lipid Laboratory, Esoterix Inc., Linco
Diagnostics, Liposcience, Atherotech, ARUP, and the Mayo Clinic.

In the full-service central laboratory service area, we primarily compete with
much larger full-service central laboratories with significantly greater
resources than we do and many have international operations. Our significant
competitors in central laboratory services include Covance Central Laboratory
Services, Inc., ICON Laboratories, Quintiles Transnational Corp., CRL - Medinet,
MDS Inc. and Quest Diagnostics Incorporated, and Lab Corp among others. As
discussed above, in fiscal 2005 we entered into a joint marketing arrangement
with Quintiles Transnational and in fiscal 2007 we expect to build on this
relationship by expanding joint business development efforts and implementing
operational integration in certain areas that will lead to streamlined services.

There is significant competition for clients on the basis of many factors for
both specialty reference and full-service central laboratory services, including

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     o    technological expertise and efficient drug development processes,
     o    financial stability,
     o    reputation for on-time quality performance,
     o    strengths in various geographic markets and global reach,
     o    ability to manage large-scale clinical trials both domestically and
          internationally,
     o    expertise and experience in specific areas,
     o    scope of service offerings,
     o    price,
     o    ability to acquire, process, analyze and report data in a timely and
          accurate manner,
     o    size, and
     o    expertise and experience in health economics and outcomes services.

While size and global reach are more important competitive factors in the
central laboratory services business, we believe that technological expertise is
more important for specialty reference laboratory services. Except as to size
and international capacity, where we know certain other competitors have an
advantage, we believe we compete very favorably in a majority of these areas,
particularly with respect to our technical expertise in our three specialty
areas.

GOVERNMENT REGULATION

Our laboratory services are subject to various regulatory requirements designed
to ensure the quality and integrity of our laboratory testing in support of
clinical trials. The industry standards for conducting clinical laboratory
testing are embodied in the Clinical Laboratory Improvement Amendments of 1988
("CLIA"). As a medical test site in the State of placeStateWashington, we have
established quality assurance programs at our laboratory facilities which
monitor ongoing compliance with CLIA. In addition, we are a
placePlaceTypeCollege of PlaceNameAmerican Pathologists ("CAP") or CAP-certified
test site. This certification provides monitoring for CAP and CLIA compliance by
CAP on a yearly basis.

The industry standards for conducting preclinical laboratory testing are
embodied in the Good Laboratory Practices ("GLP") regulations as defined by the
FDA. Although we do not perform testing related to preclinical research, we do
comply with specific sections of the GLP regulations, at our discretion, when it
is either important to our clients or is determined by management as
advantageous to our quality assurance program.

Our clinical laboratory services are subject to industry standards for the
conduct of clinical research and development of studies that are embodied in the
regulations for Good Clinical Practice ("GCP"). The FDA requires that test
results submitted to such authorities be based on studies conducted in
accordance with GCP. Noncompliance with GCP can result in the disqualification
of some or all of the data collected during the clinical trial, as well as
precipitate a full investigation of all previous and current regulatory
submissions.

We are subject to licensing and regulation under federal, state and local laws
relating to workplace hazard communications and employee right-to-know
regulations, the handling and disposal of medical specimens and hazardous waste
and radioactive materials, as well as the safety and health of laboratory
employees. Our laboratory is subject to applicable federal, state and local laws
and regulations relating to the storage and disposal of all laboratory specimens
including, but not limited to, the regulations of the Environmental Protection
Agency, the Nuclear Regulatory Commission, the Department of Transportation, the
National Fire Protection Agency and the Resource Conservation and Recovery Act.
Although we believe that we are currently in compliance in all material respects
with such federal, state and local laws, failure to comply could subject us to
denial of the right to conduct business, fines, criminal penalties and other
enforcement actions.

In addition to its comprehensive regulation of safety in the workplace, the
Occupational Safety and Health Administration has established extensive
requirements relating to workplace safety for health care employers whose
workers may be exposed to blood borne pathogens such as HIV and the hepatitis B
virus, as well as radiation. Our employees receive initial and periodic training
focusing on compliance with applicable hazardous materials regulations and
health and safety guidelines.

                                       -8-
<PAGE>

In the past few years, both the placecountry-regionUnited States and foreign
governments have become more concerned about the disclosure of confidential
personal data. The European Union prohibits the disclosure of personal
confidential information, including medical information, to any entity that does
not comply with certain security safeguards. The U.S. Department of Health and
Human Services recently promulgated final regulations under the Health Insurance
Portability and Accountability Act of 1996 ("HIPAA") that will govern the
disclosure of confidential medical information in the United States. We do not
process IIHI (Individually Identifiable Health Information) during any phase of
our business practices related to clinical testing. We therefore are currently
exempt from HIPAA regulations.

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

LAURUS DEBT INVESTMENTS

In fiscal 2004 and 2005, we entered into two financing arrangements with Laurus
Master Fund, Ltd. ("Laurus"), a placeCityNew York City based investment fund,
for a total of $4 million of secured convertible debt financing. In fiscal 2005,
we amended the terms of these financing arrangements, to extend and defer
principal payments and to waive certain defaults, all as described below.

LAURUS DEBT INVESTMENT - MAY 2004 $2.5 MILLION SECURED CONVERTIBLE NOTE

Effective May 28, 2004, we entered into our first financing arrangement with
Laurus, consisting of a $2.5 million secured convertible note with a term of
three years (the "2004 Note"). In connection with the financing, we also issued
to Laurus a warrant to purchase up to 681,818 shares of common stock at an
exercise price of $1.25 exercisable at any time prior to May 28, 2011.

Under the terms of the 2004 Note, we started making monthly payments of accrued
interest only beginning on July 1, 2004. In addition, the 2004 Note provided for
monthly payments of principal in the amount of $83,333.33, plus accrued
interest, to commence December 1, 2004. The 2004 Note bears interest at an
initial rate equal to the prime rate plus two percent (2%). This is a variable
interest rate that was 8.25% and 10.25% for fiscal years ending June 30, 2006
and 2005, respectively. For any cash payments we are required to make on the
2004 Note (e.g., any amounts due that are not converted into common stock), we
are required to pay an amount equal to 102% of the principal amount due (i.e., a
payment of $85,000 reduces the principal balance by $83,333). In addition, we
can prepay the 2004 Note at any time upon payment of an amount equal to 130% of
the then-outstanding principal balance, plus accrued and unpaid interest.

Laurus has the option at any time to convert any or all of the outstanding
principal and accrued and unpaid interest on the 2004 Note into shares of our
common stock at an initial conversion price of $1.06 per share. The note
conversion price is subject to certain antidilution adjustments, including full
ratchet antidilution if we issue convertible or equity securities at a price per
share less than the conversion price. In addition, for each monthly payment
under the 2004 Note, Laurus will be obligated to convert a portion of the
monthly payment into common stock at the applicable conversion price, when
certain conditions are present.

As security for the obligation to Laurus, we and each of our subsidiaries
granted Laurus a blanket security interest in all of our assets, and we entered
into a stock pledge with Laurus for the capital stock in all of our
subsidiaries.

In conjunction with the financing, we paid fees and expenses of approximately
$193,500 in cash and reserved $100,000 for potential payments due to Source
Capital, our broker, upon the conversion of principal to common stock. The total
amount of $293,500 has been amortized to other expense at the rate of
approximately $8,153 per month over the 36-month life of the 2004 Note,
beginning June 2004. In addition, we issued to our broker a five-year warrant,
exercisable as and to the extent that amounts owing under the 2004 Note are
converted into common stock, for up to 181,818 shares of common stock at an
exercise price of $1.25 per share. See "Note 8 to Notes to Consolidated
Financial Statements."

                                       -9-
<PAGE>

Through June 30, 2006, Laurus has converted a total of $710,200 in principal on
the May 2004 Note, leaving a remaining principal balance on the note of
$1,789,800.

LAURUS WAIVER REGARDING 2004 NOTE

On December 1, 2004, we owed our first repayment of principal to Laurus on the
2004 Note. Prior to December 1, 2004, we initiated discussions with Laurus for a
six-month deferral on all principal payments and we did not make the principal
payments on either December 1, 2004 or January 1, 2005. On January 31, 2005
Laurus formally agreed to the six-month deferral and also waived all events of
default, including the failure by us to make our scheduled amortization payments
in December and January. Laurus agreed that we would not be required to pay the
principal portion of any monthly amount due for the six-month period from
December 2004 through May 2005, and instead such deferred principal amounts
would be due on May 1, 2007, the maturity date of the 2004 Note. There was no
change in the interest rate charged by Laurus on the unpaid principal.

In consideration for the principal payment deferral and the waiver on the 2004
Note, we issued an additional common stock purchase warrant to Laurus to
purchase up to 200,000 shares of common stock at an exercise price of $1.48. The
warrant expires on January 31, 2009. See "Note 12 to Notes to Consolidated
Financial Statements."

LAURUS DEBT INVESTMENT - JANUARY 2005 $1.5 MILLION SECURED CONVERTIBLE NOTE

Effective January 31, 2005, we entered into our second debt financing
arrangement with Laurus, consisting of $1.5 million secured convertible note
with a term of three years (the "2005 Note"). The terms of the 2005 Note are
similar to the terms of the 2004 Note. In connection with the financing, we also
issued to Laurus a warrant to purchase up to 326,087 shares of common stock at
an exercise price of $1.37 per share exercisable at any time prior to January
31, 2010.

Under the terms of the 2005 Note, we started making monthly payments of accrued
interest only beginning on March 1, 2006. In addition, the 2005 Note provides
for monthly payments of principal in the amount of $50,000, plus accrued
interest, commencing August 1, 2006. The 2005 Note bears interest at an initial
rate equal to the prime rate plus two percent (2%). This is a variable interest
rate that was 8.25% and 10.25% for fiscal years ending June 30, 2006 and 2005,
respectively. For any cash payments made on the 2005 Note (e.g., any amounts due
that are not converted into common stock), we are required to pay an amount
equal to 102% of the principal amount due (i.e., a payment of $51,000 reduces
the principal amount by $50,000). In addition, we can prepay the 2004 Note at
any time upon payment of an amount equal to 130% of the then-outstanding
principal balance, plus accrued and unpaid interest.

Laurus has the option to convert any or all of the outstanding principal and
accrued interest on the 2005 Note into shares of our common stock at an initial
conversion price of $1.17 per share. The note conversion price is subject to
certain antidilution adjustments, including full ratchet antidilution if we
issue convertible or equity securities at a price per share less than the
conversion price. In addition, for each monthly payment under the 2005 Note,
Laurus will be obligated to convert a portion of the monthly payment into common
stock at the applicable conversion price, when certain conditions are present.

As security for the obligation to Laurus, we and each of our subsidiaries
granted Laurus a blanket security interest in all of our assets, and we entered
into a stock pledge with Laurus for the capital stock in all of our
subsidiaries.

In conjunction with the financing, we paid fees and expenses of approximately
$108,000 in cash and reserved $60,000 for potential payments due to Source
Capital, our broker, upon the conversion of principal to common stock. The total
amount of $168,000 has been amortized to other expense at the rate of
approximately $3,167 per month over the 36-month life of the 2006 Note,
beginning February 2006. In addition, we issued to our broker a five-year
warrant, exercisable as and to the extent that amounts owing under the 2006 Note
are converted into common stock, for up to 105,263 shares of common stock at an
exercise price of $1.37 per share. See "Note 8 to Notes to Consolidated
Financial Statements."

                                      -10-
<PAGE>

LAURUS DEFERRAL AND EXTENSION - 2004 NOTE AND 2005 NOTE

On May 6, 2005, we and Laurus amended the terms of the 2004 Note and the 2005
Note, to provide for a twelve-month deferral and extension of both. With respect
to the 2004 Note, Laurus agreed to (a) extend the term for an additional year,
to be due in full on May 28, 2008, and (b) defer 12 months of principal payments
(originally due June 1, 2005 through May 1, 2006) to be paid monthly beginning
June 1, 2007 through May 1, 2008. With respect to the 2005 Note, Laurus agreed
to (a) extend the term for an additional year, to be due in full on January 31,
2009, and (b) defer 12 months of principal payments (originally due August 1,
2005 through July 1, 2006) to be paid monthly beginning February 1, 2008 through
January 1, 2009, with the balance on the 2005 Note to be paid in full on January
31, 2009.

As a result of these amendments, the first repayments of principal owed to
Laurus on the 2004 and 2005 Notes are now June 1, 2006 and August 1, 2006,
respectively and the maturity dates for the 2004 and 2005 Notes are now May 1,
2008 and January 1, 2009, respectively. There was no change in the interest rate
charged by Laurus on the unpaid principal. Furthermore, commencing as of May 31,
2005 we adjusted the amortization schedules for the 2004 Note and 2005 Note
related to the beneficial conversion feature, stock purchase warrants and
deferred finance costs. Deferred finance costs are now being amortized at $5,509
and $3,422 per month for the 2004 and 2005 Notes, respectively. The amortization
of the beneficial conversion feature and the warrants are now being amortized at
$47,912 and $22,846 per month for the 2004 and 2005 Notes, respectively.

In consideration for the principal payment deferral and the extension of the
2004 and 2005 Notes, we issued an additional common stock purchase warrant to
Laurus to purchase up to 1,000,000 shares of our common stock at an exercise
price of $1.05. The warrant expires on May 6, 2010. See "Note 12 to Notes to
Consolidated Financial Statements."

LAURUS CONVERSION

Through June 30, 2006, Laurus has converted a total of $710,200 in principal on
the 2004 Note, leaving a remaining principal balance on the 2004 Note of
$1,789,800. The original principal amount of $1,500,000 on the 2005 Note remains
the same. With these principal conversions, repayments of principal on the 2004
Note are now scheduled to begin in February 2007 at a rate of approximately
$41,000 for the first month and approximately $85,000 for each month thereafter.
Payments on the 2005 Note of $51,000 per month commenced in August 2006. Any
future conversions of principal by Laurus on either Note will further reduce our
repayment obligations.

FINANCIAL DERIVATIVES - BENEFICIAL CONVERSION FEATURE AND WARRANTS

In fiscal years 2004 and 2005, we estimated the valuation of the beneficial
conversion feature and the warrants for the May 2004 and January 2005 Notes in
accordance with EITF 00-27 and EITF 98-5, using the Black-Scholes pricing model
and other assumptions deemed reasonable by management. We corrected our
accounting for derivative financial instruments, for the May 2004 and January
2005 Notes, to conform to the requirements of Statements of Accounting Standards
No. 133, as amended, and Financial Accounting Standards Board Emerging Issues
Task Force (EITF) No. 00-19. Embedded beneficial conversion features that meet
the definition of derivative financial instruments have, where applicable, been
bifurcated from host instruments, the May 2004 and January 2005 Notes, and, in
all instances derivative financial instruments have been recorded as assets or
liabilities and are carried at fair value. We restated prior fiscal years
results to conform to the requirements of the Statement of Financial Accounting
Standards No. 154, Accounting Changes and Error Corrections. Net fair value
adjustments included in earnings (loss) related to these instruments amounted to
$298,616 and ($265,928) for the fiscal year ending June 30, 2006 and 2005,
respectively. Accordingly, the balances for fiscal years 2004 and 2005 have been
restated and balances for fiscal 2006 correctly accounted for. See "Note 16 to
Notes to Consolidated Financial Statements."

                                      -11-
<PAGE>

EMPLOYEES

At September 30, 2006, we had 53 full-time employees, 2 part-time employee, 1
temporary, and 1 contract employees for a total of 57 employees, 44 of who were
employed in laboratory operations, laboratory administration and client services
(including our Chief Scientific Officer), 4 were employed in sales, marketing
and business development, and 9 were employed in administrative capacities. One
of our employees holds an M.D. degree, six others hold Ph.D. degrees, and two
others hold masters degrees or other postgraduate degrees. None of our employees
are represented by labor unions. We believe that our relationships with our
employees are good.

AVAILABLE INFORMATION

We make available free of charge on our website at www.pacbio.com, our Annual
Report on Form 10-KSB, Quarterly Reports on Form 10-QSB, Current Reports on Form
8-K and amendments to those reports filed or furnished pursuant to Section 13(a)
or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably
practicable after such reports are electronically filed with, or furnished to,
the SEC.

RISK FACTORS AFFECTING OUR BUSINESS

THE FOLLOWING DISCUSSION IN THIS ANNUAL REPORT ON FORM 10-KSB CONTAINS
FORWARD-LOOKING STATEMENTS REGARDING OUR COMPANY, OUR BUSINESS, PROSPECTS AND
RESULTS OF OPERATIONS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THE RESULTS THAT MAY BE ANTICIPATED BY SUCH
FORWARD-LOOKING STATEMENTS AND DISCUSSED ELSEWHERE IN THIS REPORT. FACTORS THAT
COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO,
THOSE DISCUSSED BELOW, AS WELL AS THOSE DISCUSSED UNDER THE CAPTIONS "BUSINESS"
AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS REPORT. IN EVALUATING
OUR BUSINESS, PROSPECTS AND RESULTS OF OPERATIONS, READERS SHOULD CAREFULLY
CONSIDER THE FOLLOWING FACTORS IN ADDITION TO OTHER INFORMATION PRESENTED IN
THIS REPORT AND IN OUR OTHER REPORTS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION THAT ATTEMPT TO ADVISE INTERESTED PARTIES OF THE RISKS AND FACTORS
THAT MAY AFFECT OUR BUSINESS, PROSPECTS AND RESULTS OF OPERATIONS. SEE
"CAUTIONARY NOTICE REGARDING FORWARD LOOKING STATEMENTS."

RISKS RELATING TO OUR COMPANY AND OUR BUSINESS

     DURING EACH OF OUR PAST FISCAL YEARS, WE HAVE DEPENDED ON ONE OR TWO
     CLIENTS FOR A SIGNIFICANT PORTION OF OUR REVENUE. ANY DECREASE IN REVENUE
     FROM THESE CLIENTS COULD MATERIALLY ADVERSELY AFFECT US.

Historically, our largest two clients in any individual fiscal year have
represented in excess of 50% of our revenue. During the fiscal year ended June
30, 2006, our top two clients represented 50% of our revenue as compared to 40%
during the fiscal year ended June 30, 2005. Our largest client in fiscal 2006
individually accounted for approximately 36% and 23% of our total revenue in
fiscal 2006 and 2005, respectively, while our largest client in fiscal 2005
accounted for approximately 23% and 36% of our total revenue in fiscal 2005 and
2004, respectively. Revenue from our five largest clients represented
approximately 74% and 67% of total revenue in fiscal 2006 and 2005,
respectively. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS" and see "DESCRIPTION OF BUSINESS - Clients/Marketing"
above. Because our revenue has been concentrated in one or two large clients, we
can be materially adversely impacted by decreases in work generated from these
clients, including any delays in undertaking clinical studies or submitting
samples for testing services, any early termination or reductions in work orders
or clinical studies, or any decreases in the volume or timing of new work
orders.

We have expanded our business development efforts and have continued to submit
bids and proposals to these and other companies for our services, to increase
our revenue and to diversify our client base. Although we believe that we have
good relations with all of our large clients and other companies in the
industry, and we expect to receive additional work orders in the future, we
cannot predict the timing or amount of any such additional work or whether we
will be successful in further diversifying our client base. If we are
unsuccessful in our sales and business development efforts with our existing
clients and potential clients, our revenue for the fiscal year ending June 30,
2007 may be less than our revenue for the fiscal year ended June 30, 2006. In
addition, unless we are able to attract additional clients for medium to large
studies, we will continue to be dependent on one or two large clients for a
substantial majority of our revenue.

                                      -12-
<PAGE>

     OUR ABILITY TO ATTRACT AND RETAIN CLIENTS DEPENDS IN LARGE PART ON OUR
     REPUTATION. IF OUR REPUTATION IS HARMED, OUR REVENUE, BUSINESS DEVELOPMENT,
     GROWTH AND OPERATING RESULTS MAY SUFFER.

We compete with other specialty laboratories and central laboratories in large
part on the basis of our reputation for providing quality results in a timely
manner. Accordingly, timely, effective and quality service is essential to
establishing and maintaining our reputation, as well as to generating clients
and revenue. Our reputation may suffer damage, whether from actions outside or
within our control. If our reputation is harmed, our revenue, business
development, growth and operating results may suffer.

     IF WE DO NOT GAIN NEW CLIENTS AND NEW PROJECTS FROM OUR BUSINESS
     DEVELOPMENT EFFORTS, OUR GROWTH MAY BE LIMITED, SALES OF OUR SERVICES MAY
     DECREASE AND OUR OPERATING RESULTS MAY SUFFER.

We generally do not have long-term contracts with clients for our services. In
addition, any project we undertake may generally be terminated at any time by
the client on short notice. As a result, it is difficult for us to forecast
future sales, and our future revenue depends on our ability to generate new
clients and new projects. During fiscal 2007, we are planning on making
additional investments in our business development, technology infrastructure,
operations and other areas of our business in an effort to become more
competitive and to increase our revenue. These efforts will use significant
amounts of time, effort and funding. Our business development efforts are
substantially dependent on our ability to effectively manage our time, personnel
and resources. In particular, our Chief Science Officer and Chief Medical
Officer are often heavily involved in the marketing and business development
process, and time that they spend in this area detracts from their available
time for laboratory and development work. Our success in business development
depends in part on our reputation in the industry and client perceptions
(including as to our laboratory capacity and financial health), and also to a
degree on personal relationships between us and the client. With the significant
consolidation in the pharmaceutical industry, it is often a long and complex
process in finding and meeting with the right person within the client company.
We also understand that some companies in the pharmaceutical industry have
"preferred vendor" lists, such that a vendor cannot participate in requests for
proposal or contract with the company unless the vendor is pre-approved on the
list. We are attempting to expand our efforts in this area. If a client or
prospective client has negative perceptions about our capabilities, our
laboratory capacity or our financial health, this may affect our ability to
develop new clients or projects. If our business development efforts are not
successful, our revenue and cash flow may decrease and our operating results may
suffer.

     WE MAY BEAR FINANCIAL LOSSES BECAUSE MOST OF OUR CONTRACTS ARE OF A FIXED
     PRICE NATURE AND MAY BE DELAYED, TERMINATED OR REDUCED IN SCOPE FOR REASONS
     BEYOND OUR CONTROL.

Many of our contracts provide for services on a fixed price or fee-for-service
with a cap basis and they may be terminated, delayed or reduced in scope by the
other party either immediately or upon notice. See "DESCRIPTION OF BUSINESS -
Contractual Arrangements" above. Contract termination, delay or reduction in
scope may occur for a variety of reasons, most of which are beyond our control,
including:

     o    the failure of the client's products to satisfy safety requirements;
     o    unexpected or undesired results of the client's products;
     o    insufficient patient enrollment by the client;
     o    insufficient investigator recruitment by the client;
     o    the client's decision to terminate the development of a product or to
          end a particular study; and
     o    our failure to perform properly our duties under the contract.

Because we primarily receive revenue on the basis of the number of clinical
samples we test and process, the loss, reduction in scope or delay of a large
contract or the loss or delay of multiple contracts could materially adversely
affect our business, results of operations, financial condition and cash flows.
Our contracts typically entitle us to receive payment for fees earned by us up
to the time of termination and reimbursement for out-of-pocket costs incurred
prior to termination. In certain limited instances, our contracts also entitle
us to a termination fee or payment for the costs of winding down the terminated
projects.

                                      -13-
<PAGE>

     WE MAY BEAR FINANCIAL RISK IF WE UNDERPRICE OUR CONTRACTS OR OVERRUN COST
     ESTIMATES.

Since our contracts are often structured as fixed price or fee-for-service with
a cap, we bear the financial risk if we initially under price our contracts or
otherwise overrun our cost estimates. Such under pricing or significant cost
overruns could have a material adverse effect on our business, results of
operations, financial condition and cash flows.

     OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY IS ESSENTIAL TO THE GROWTH
     AND DEVELOPMENT OF OUR PRODUCTS AND SERVICES.

We rely, in part, on patents, trade secrets and know-how to develop and maintain
our competitive position and technological advantage on our existing
intellectual property and any future intellectual property we develop. See
"DESCRIPTION OF BUSINESS - Technologies and Products" above. We protect our
intellectual property through a combination of license agreements, trademark,
service mark, copyright, trade secret laws and other methods of restricting
disclosure and transferring title. We have and intend to continue entering into
confidentiality agreements with our employees, consultants and vendors; entering
into license agreements with third parties; and generally seeking to control
access to and distribution of our intellectual property.

RISKS RELATING TO OUR INDUSTRY

     FAILURE TO KEEP PACE WITH CHANGES IN THE MARKETPLACE MAY CAUSE US TO LOSE
     MARKET SHARE AND OUR REVENUE MAY DECREASE.

The market for specialty reference and central laboratory services is subject to
rapid technological change and innovation. In particular, laboratories are
regularly developing new assays to incorporate into clinical testing and have to
maintain up-to-date laboratory equipment to stay competitive. In developing and
enhancing our services, we have made, and will continue to make, assumptions
about which features, standards and performance criteria will be attractive to,
or demanded by, our clients. If we implement features, standards and performance
criteria that are different from those required by our clients or if our
competitors introduce products and systems that better address these needs,
market acceptance of our offerings may suffer or may become obsolete. In that
event, our market share and revenue would likely decrease. In addition, clients
are requiring that laboratories maintain secure and sophisticated information
technology systems, as a means for storing data and facilitating communication
between the laboratory and the client. Although we continue to expend efforts
and resources in these areas, we may not be successful in keeping up with client
needs or expectations. In addition, if a client or prospective client has
negative perceptions about our abilities based on our financial strength, this
may affect our ability to develop new clients or projects. Many of our
competitors have greater resources than we do. We are also exploring additional
financing to be used to continue to update our laboratory service capability. If
we are unsuccessful in raising funds as and when needed, we may, or it may be
perceived, that we are less efficient and less economical than our competitors
and we may lose business to our competitors. If this occurs, it would have a
material adverse effect on our revenue and financial performance.

     WE MAY NOT BE ABLE TO SUCCESSFULLY DEVELOP AND MARKET NEW SERVICES.

We may seek to develop and market new services that complement or expand our
existing business. If we are unable to develop new services and or create demand
for those newly developed services, our future business, results of operations,
financial condition and cash flows could be adversely affected.

     WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY, AND WE MAY LOSE OR FAIL TO
     ATTRACT CLIENTS FOR OUR SERVICES TO OUR COMPETITORS.

Competitors in the specialty reference and central laboratory industry range
from small, limited-service providers to full service global contract research
organizations. Our main competition consists of in-house departments of
pharmaceutical companies, full-service contract research organizations, and, to
a lesser degree, universities. See "DESCRIPTION OF BUSINESS - Competition"
above. We compete on a variety of factors, including

     o    technological expertise and efficient drug development processes,

                                      -14-
<PAGE>

     o    reputation for on-time quality performance,
     o    price,
     o    expertise and experience in specific areas,
     o    strengths in various geographic markets and global reach,
     o    ability to manage large-scale clinical trials both domestically and
          internationally, o scope of service offerings,
     o    ability to acquire, process, analyze and report data in a time-saving
          and accurate manner, and
     o    expertise and experience in health economics and outcomes services.

Many of our competitors have greater resources than we do, have global
operations and greater name recognition. If we experience significant
competition which is based on factors which we do not have in our business, such
as global management of projects or size, our business could be materially
adversely affected. Although we have entered into a joint marketing arrangement
with Quintiles in an attempt to improve our competitive position, in fiscal
2006, we did not realize significant financial benefit from this relationship
and this arrangement may not be successful in generating revenue for us or
improving our competitive position.

     DURING FISCAL 2006, WE HAVE EXPERIENCED A SIGNIFICANT INCREASE IN REVENUE.
     IN FISCAL 2005 WE EXPERIENCED A SIGNIFICANT DECREASE IN REVENUE FROM PRIOR
     YEARS. OUR REVENUE IS UNPREDICTABLE AND VARIES SIGNIFICANTLY FROM QUARTER
     TO QUARTER AND YEAR TO YEAR.

We have experienced significant quarterly fluctuations in revenue during fiscal
2006 and fiscal 2005. For fiscal 2006 compared to fiscal 2005, our revenue
increased 233% to approximately $10,750,000 from approximately $3,230,000, and
we incurred a net loss for both fiscal 2006 and fiscal 2005. The impact of
quarterly fluctuations is clearly observed in the first fiscal quarter of 2006
where revenue increased 322% compared to the comparable period in fiscal 2005.
While, for the last nine months of fiscal 2006, our revenue was 219% higher than
for the comparable period of fiscal 2005. The following table shows the
significant swings in our quarterly revenue for each quarter in the current
fiscal year and the past two fiscal years:

     (DOLLARS IN THOUSANDS,                            FISCAL YEAR
     ROUNDED TO NEAREST THOUSAND)               2004       2005       2006
     Q1, ended September 30..............     $ 2,300    $   434    $ 1,834
     Q2, ended December 31...............         542      1,009      3,113
     Q3, ended March 31..................         548      1,048      3,110
     Q4, ended June 30...................       1,411        739      2,693

Our revenue depends in large part on receiving new clinical or diagnostic
studies from our clients, and we cannot predict the timing or amount of revenue
we may recognize from quarter to quarter. During fiscal 2007, we are planning to
make additional investments in our business development, technology
infrastructure, operations and other areas of our business in an effort to
become more competitive and to increase our revenue. These efforts will use
significant amounts of time, effort and funding. These efforts may not be
successful in generating additional revenue.

     WE HAVE HISTORICALLY HAD WORKING CAPITAL DEFICITS. IF OUR REVENUE DOES NOT
     INCREASE, OUR LOSSES, CASH AND WORKING CAPITAL POSITION MAY WORSEN.

Although we have recently received gross proceeds of approximately $4,300,000 in
a private placement of our common stock and warrants in March and April 2006, we
have had cash flow shortages and deficiencies in working capital in previous
fiscal years. At June 30, 2006, we had approximately $5,498,000 in cash and a
positive working capital position of approximately $4,375,000; we also had
significant amounts of debt, including a secured convertible note and notes
payable of $1,991,000 and other liabilities of $2,124,000 and stockholders'
equity of $2,355,000. These amounts include $4,300,000 in gross proceeds
($3,963,000 in net proceeds) we realized from our private placement of common
stock and warrants we closed in April 2006. For the last fiscal year ended June
30, 2006 we had an operating income of approximately $1,846,000. For the
previous fiscal year ended June 30, 2005 we had an operating loss of $2,159,000.
At June 30, 2006, we had an accumulated deficit of approximately $25,919,000.

                                      -15-
<PAGE>

Previously, our cash, cash equivalents, and accounts receivable have been used
to fund our operating losses and investments in capital expenditures. This use
of our cash, cash equivalents, and accounts receivable, has been reduced for the
fiscal year ended June 30, 2006, due to increased revenues and gross profits
that provided operating income and improved cash flow. However, unless revenue
remains at the current level or continues to increase, we will likely experience
losses and our cash and working capital positions may be adversely impacted
through fiscal 2007. To improve our cash position, we are actively seeking to
increase revenue and improve operating income. As noted above, we raised gross
proceeds of approximately $4,300,000 in a private placement of our common stock
and warrants in March and April 2006. This private placement has improved our
cash position and reduced the risk associated with our revenue fluctuations and
growth. However, our continuing efforts to improve our cash position, reduce
expenses and generate revenue may not be successful.

Our future capital requirements depend upon many factors, including, but not
limited to:

     o    the timing and number of clinical trials by clients, the number of
          samples submitted to us for testing, and the amount of revenue
          generated from these tests;
     o    our ability to enter into and build relationships with new clients,
          and obtain additional projects from existing clients;
     o    capital expenditure requirements, including for research and
          development efforts, upgrading or replacing laboratory equipment and
          making investments in information technology;
     o    delays or early terminations of clinical testing agreements with
          clients;
     o    our plans to pursue additional business strategies;
     o    our ability to manage our cash flow, including by managing or reducing
          our expenses, such as insurance and professional fees of our
          accountants and attorneys associated with being a public company; and
     o    other business and economic factors that may occur from time to time.

None of these factors can be predicted with certainty. Additionally, if we
desire to invest in our laboratory technology or research and development, we
may require additional financing.

     OUR ABILITY TO MAKE REQUIRED PAYMENTS OF PRINCIPAL AND INTEREST ON OUR
     SENIOR SECURED DEBT DEPENDS PRIMARILY ON CASH FLOW FROM OPERATIONS,
     AVAILABLE CASH BALANCES, FUNDS FROM FINANCING EFFORTS AND EARLY CONVERSION
     OF THE DEBT, ALL OF WHICH MAY NOT BE SUFFICIENT TO SERVICE THE DEBT.

In fiscal 2004 and 2005, we closed on two debt financings with Laurus Master
Funds Ltd., consisting of $2.5 million effective May 28, 2004 and an additional
$1.5 million effective January 31, 2005. See "DESCRIPTION OF BUSINESS - Laurus
Debt Investments" above. Through June 30, 2006, Laurus has converted a total of
$710,200 in principal on the 2004 Note, leaving a remaining principal balance on
the 2004 Note of $1,789,800. The original principal amount of $1,500,000 on the
2005 Note remains the same. With these principal conversions, repayments of
principal on the 2004 Note are now scheduled to begin in February 2007 at a rate
of approximately $41,000 for the first month and approximately $85,000 for each
month thereafter. Payments on the 2005 Note of $51,000 per month commenced in
August 2006. Any future additional conversions of principal by Laurus on either
Note will further reduce our repayment obligations. Our actual required cash
payments on the two notes will vary depending on interest rates and whether
amounts under the notes are converted into our common stock.

Our ability to make scheduled monthly payments under the two notes primarily
depends on our future performance and working capital, including our ability to
increase revenue and cash flows. We currently have other fixed monthly
commitments under various notes payable, equipment and facility leases. See
"Notes 8 and 9 to Notes to Consolidated Financial Statements" for the fiscal
year ended June 30, 2006 included in this Annual Report on Form 10-KSB. To a
certain extent our ability to increase revenue and control costs are subject to
a number of economic, financial, competitive, regulatory and other factors
beyond our control.

However, if our cash flow is insufficient to enable us to service our debt, we
may have to utilize the funds raised from our private placement of common stock
and warrants, be forced to find alternative sources of financing, or to take
further drastic measures, including significantly reducing expenses or scope of
operations, seeking to sell the

                                      -16-
<PAGE>

company. Any future alternative sources of debt or equity financing may not be
available to us when needed or in amounts required. Although we obtained a new
non-revolving line of credit with Franklin Funding in November 2005 for an
aggregate amount of up to $500,000 for equipment financing, of which we have
borrowed $350,000 as of June 30, 2006 and we raised gross proceeds of
approximately $4,300,000 in a private placement of our common stock and warrants
in March and April 2006, we do not have available to us another bank line of
credit or other general borrowing facility. Alternatively, we may be forced to
attempt to negotiate with our debt holders on our payment terms, which may not
be successful or may be on terms onerous to us.

     WE GRANTED A BLANKET SECURITY INTEREST IN ALL OF OUR ASSETS TO THE HOLDER
     OF OUR SECURED CONVERTIBLE DEBT. IF WE ARE UNABLE TO MAKE OUR REQUIRED
     MONTHLY PAYMENTS ON THE DEBT, OR ANY OTHER EVENT OF DEFAULT OCCURS, IT
     COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND OPERATIONS, AND
     THE DEBT HOLDER MAY FORECLOSE ON OUR ASSETS.

As part of our two debt financings with Laurus, we granted to Laurus a blanket
security interest in all of our assets, including assets of our subsidiaries.
See "DESCRIPTION OF BUSINESS - Laurus Debt Investments" above. In the event we
default in payment on the debt, or any other event of default occurs under the
financing documents, 130% of the outstanding principal amount and accrued
interest will accelerate and be due and payable in full.

The cash required to pay such accelerated amounts on the notes following an
event of default would most likely come out of our working capital. As we rely
on our working capital for our day to day operations, such a default could have
a material adverse effect on our business, operating results, or financial
condition to such extent that we are forced to restructure, file for bankruptcy,
sell assets or cease operations. In addition, upon an event of default, the
holders of the secured debt could foreclose on our assets or exercise any other
remedies available to them. If our assets were foreclosed upon, or if we were
forced to file for bankruptcy or cease operations, stockholders may not receive
any proceeds from disposition of our assets and may lose their entire investment
in our stock.

     EVEN WITH OUR RECENT PRIVATE PLACEMENT OF COMMON STOCK AND WARRANTS IN
     MARCH AND APRIL 2006, WE MAY NEED TO RAISE ADDITIONAL CAPITAL TO FUND
     OPERATIONS IN THE FUTURE. IF OUR FINANCING EFFORTS ARE NOT SUCCESSFUL, WE
     WILL NEED TO EXPLORE ALTERNATIVES TO CONTINUE OPERATIONS, WHICH MAY INCLUDE
     A MERGER, ASSET SALE, JOINT VENTURE, LOANS OR EXPENSE REDUCTIONS.

     We have been successful in generating significant revenue increases for the
fiscal year ended June 30, 2006; however, our efforts to continue revenue
increases and reduce expenses may not be successful. Although we recently
received gross proceeds of approximately $4.3 million in a private placement of
our common stock and warrants in March and April 2006, if we continue to
experience significant quarterly fluctuations in our revenue or if our revenue
does not continue to increase, we may need to raise additional capital through
equity or debt financing or through the establishment of other funding
facilities in order to keep funding operations. On November 3, 2005, we entered
into a Loan and Security Agreement with Franklin Funding, Inc., providing for a
non-revolving line of credit of up to $500,000 for equipment financing
collateralized by the equipment of which we have borrowed $350,000 as of June
30, 2006. These monies are not available to finance our operations. Even with
our recent private placement in March and April 2006, in the current market
condition, raising capital has been, and may continue to be difficult, and we
may not receive sufficient funding. Any future financing that we seek may not be
available in amounts or at times when needed, or, even if it is available, may
not be on terms acceptable to us. Also, if we raise additional funds by selling
equity or equity-based securities, the ownership of our existing stockholders
will be diluted.

We continually evaluate various other alternatives to enable us to fund
continuing operations, which may or may not occur, including, but are not
limited to, any one or more of the following:

     o    engaging a financial advisor to explore strategic alternatives, which
          may include a merger, asset sale, joint venture or other similar
          transaction;
     o    forming a joint venture with one or more strategic partners to provide
          additional capital resources to fund operations.

These potential alternatives may not be open to us, or may only be available on
unfavorable terms. If we are unable to obtain sufficient cash either to continue
to fund operations or to locate a strategic alternative, we may be forced to

                                      -17-
<PAGE>

seek protection from creditors under the bankruptcy laws or cease operations.
Any inability to obtain additional cash as needed could have a material adverse
effect on our financial position, results of operations and ability to continue
in existence. During fiscal 2007, we are planning to make additional investments
in our business development, technology infrastructure, operations and other
areas of our business in an effort to become more competitive and to increase
our revenue. These efforts will use significant amounts of time, effort and
funding.

     THE LOSS OF OUR KEY PERSONNEL, INCLUDING OUR CHIEF SCIENTIFIC OFFICER AND
     CHIEF MEDICAL OFFICER, COULD ADVERSELY AFFECT OUR BUSINESS.

Our success depends to a significant extent upon the efforts of our senior
management team and other key personnel, and in particular Dr. Elizabeth Leary,
our Chief Scientific Officer, and Dr. Mario Ehlers, our Chief Medical Officer.
In addition to the services they provide in our laboratory services, Drs. Leary
and Ehlers are also important to our business development efforts, both due to
their reputations and skills, as well as their contacts and relationships with
clients and prospective clients. The loss of the services of such personnel
could adversely affect our business. Also, because of the scientific and
technical nature of our business, our success is dependent upon our ability to
attract and retain technologically qualified personnel. There is substantial
competition for qualified personnel, and an inability to recruit or retain
qualified personnel may impact our ability to grow our business and compete
effectively in our industry.

     OUR OBLIGATIONS UNDER OUR SECURED DEBT TO LAURUS MAY ADVERSELY AFFECT OUR
     ABILITY TO ENTER INTO POTENTIAL SIGNIFICANT TRANSACTIONS WITH OTHER
     PARTIES.

As a result of our debt financings with Laurus in May 2004 and January 2005, we
incurred significant repayment obligations, we granted a blanket security
interest in our assets, and we agreed to certain restrictive covenants. In
particular, for so long as 25% of the original principal is outstanding under
either note, we will need Laurus' consent before we can take certain actions,
including the following:

     o    pay any dividends;
     o    merge, effect a material reorganization, liquidate or dissolve;
     o    materially change the scope of our business; or
     o    create, incur or assume any debt (other than certain trade debt,
          equipment financings and debt for the purchase of assets in the
          ordinary course of business).

Accordingly, unless we obtain Laurus' consent, we may not be able to enter into
certain transactions. In addition, in connection with any potential significant
transaction (such as a merger, sale of substantially all our assets, joint
venture, or similar transaction), it is likely that we would have to pay off the
debt obligations to Laurus and have the security interests released. Although we
have the right at any time to prepay our secured debt obligations, we can only
do so upon payment of 130% of the then principal balance, plus all other amounts
owing under the notes. See "DESCRIPTION OF BUSINESS - Laurus Debt Investments"
above. Based on a total principal balance of $3,290,800 under both notes as of
June 30, 2006, prepayment would require a cash payment of approximately
$4,277,000, plus accrued interest. These provisions could have the practical
effect of increasing the costs of any potential significant transaction, and
restrict our ability to enter into any such transaction,

     CHANGES IN GOVERNMENT REGULATIONS COULD DECREASE THE NEED FOR OUR SERVICES.

Governmental agencies throughout the world, but particularly in the
country-regionplaceUnited States, highly regulate the drug development and
approval process. See "DESCRIPTION OF BUSINESS - Government Regulation" above.
Our business involves performing safety and efficacy laboratory testing during
clinical trials of new pharmaceutical drugs. Clinical trial laboratory data is
used by pharmaceutical and biotechnology companies in the submission process to
the FDA for the marketing approval of a new drug. Changes in regulations, such
as a relaxation in regulatory requirements or the introduction of simplified
drug approval procedures or an increase in regulatory requirements that we have
difficulty satisfying, could eliminate or substantially reduce the need for our
services. Also, government efforts to contain drug costs and pharmaceutical and
biotechnology company profits from new drugs may have an impact on the drug
development and approval process, and our clients may spend less, or reduce
their growth in spending, on research and development.

                                      -18-
<PAGE>

     FAILURE TO COMPLY WITH EXISTING GOVERNMENT REGULATIONS COULD RESULT IN A
     LOSS OF REVENUE OR EARNINGS FROM A PROJECT.

Any failure on our part to comply with applicable government regulations could
result in the termination of on-going research or sales and marketing projects
or the disqualification of data for submission to regulatory authorities. For
example, if we failed to validate analytical test methods performed on samples
collected during and in support of a trial or if we fail to comply with GCP
(Good Clinical Practice) regulations, the generated test data could be
disqualified. If this were to happen, we could be contractually required to
repeat the trial at no further cost to our client, but at substantial cost to
us.

     WE DEPEND ON THE PHARMACEUTICAL AND BIOTECHNOLOGY INDUSTRIES.

Our revenue depends greatly on the outsourcing expenditures made by the
pharmaceutical and biotechnology industries in research and development.
Accordingly, economic factors and industry trends that affect our clients in
these industries also affect our business. If companies in these industries were
to reduce the number of research and development projects they outsource, our
business could be materially adversely affected.

Our clients in the pharmaceutical and biotechnology industries have experienced
significant consolidation over the last several years and we expect that trend
to continue. The uncertainty caused by consolidation, before, during and after a
business combination can result in product delays, changes in strategy, and
consolidation and/or elimination of research and development efforts. Any of
these effects can have a materially adverse affect on us if it results in
testing delays, sample volume reductions or termination of tests.

     WE MUST MAINTAIN CERTIFICATIONS FROM OUR CLIENTS IN ORDER TO BE ELIGIBLE TO
     BID ON PROJECTS.

Many of our clients require our laboratories to be tested from time to time for
certification that we comply with their internal requirements. If we fail to
comply, we will probably be terminated from existing contracts and we will not
be eligible to bid on that client's future projects. While generally we have
been very successful in maintaining certifications and in gaining new
certifications, if we fail certification tests, especially for our major
clients, our business would be materially adversely affected.

     WE MAY EXPAND OUR BUSINESS THROUGH ACQUISITIONS.

We may review acquisition opportunities. Factors which could affect our ability
to grow successfully through acquisitions include

     o    difficulties and expenses in connection with integrating the acquired
          companies and achieving the expected benefits,
     o    diversion of management's attention from current operations,
     o    the possibility that we may be adversely affected by risk factors
          facing the acquired companies, and
     o    acquisitions could be dilutive to earnings, or in the event of
          acquisitions made through the issuance of our common stock to the
          stockholders of the acquired company, dilutive to the percentage of
          ownership of our existing stockholders.

     WE MAY BE AFFECTED BY POTENTIAL HEALTH CARE REFORM.

In recent years, governments of the country-regionUnited States, Europe and
placeAsia have considered various types of health care reform in order to
control growing health care costs. We are unable to predict what legislative
proposals will be adopted in the future, if any. Implementation of health care
reform legislation that contains costs could limit the profits that can be made
from the development of new drugs. This could adversely affect research and
development expenditures by pharmaceutical and biotechnology companies which
could in turn decrease the business opportunities available to us. In addition,
new laws or regulations may create a risk of liability, increase our costs or
limit our service offerings.

                                      -19-
<PAGE>

     SPECIAL REFERENCE AND CENTRAL LABORATORY SERVICES CREATE A RISK OF
     LIABILITY.

In contracting to work on drug development trials, we face a range of potential
liabilities, including

     o    errors or omissions in laboratory data being generated relating to the
          safety and efficacy of the drug, that could affect the regulatory
          approval of the drug, and
     o    errors and omissions during a trial that may undermine the usefulness
          of a trial or data from the trial.

While we maintain what we believe is adequate insurance coverage and obtain
contractual indemnifications protecting us against liability arising from our
own actions (other than negligence or intentional misconduct), we could be
materially and adversely affected if we were required to pay damages or bear the
costs of defending any claim which is not covered by a contractual
indemnification provision or which is beyond the level of our insurance
coverage. Due to the rising costs of insurance, we may not be able to maintain
such insurance coverage at levels or on terms acceptable to us.


RISKS RELATED TO OUR COMMON STOCK

     OUR COMMON STOCK IS TRADED ON THE OTC BULLETIN BOARD AND IS CONSIDERED A
     "PENNY STOCK".

     OUR STOCKHOLDERS' ABILITY TO SELL SHARES IN THE SECONDARY TRADING MARKET
     MAY BE LIMITED.

Our common stock is currently quoted for trading on the OTC Bulletin Board. As a
result, the liquidity of our common stock is limited, not only in the number of
shares that are bought and sold, but also through delays in the timing of
transactions, and the lack of coverage by security analysts and the news media
of our company.

In addition, because our stock is quoted on the OTC Bulletin Board, our common
stock is subject to certain rules and regulations relating to "penny stock." A
"penny stock" is generally defined as any equity security that has a price less
than $5.00 per share and that is not quoted on the NASDAQ Stock Market or a
national securities exchange. Being a penny stock generally means that any
broker who wants to trade in our shares (other than with established clients and
certain institutional investors) must comply with certain "sales practice
requirements," including delivery to the prospective purchaser of the penny
stock a risk disclosure document describing the penny stock market and the risks
associated therewith. In addition, broker-dealers must take certain steps prior
to selling a "penny stock," which steps include:

     o    obtaining financial and investment information from the investor;
     o    obtaining a written suitability questionnaire and purchase agreement
          signed by the investor; and
     o    providing the investor a written identification of the shares being
          offered and the quantity of the shares.

If these penny stock rules are not followed by the broker-dealer, the investor
has no obligation to purchase the shares. The application of these comprehensive
rules will make it more difficult for broker-dealers to sell our common stock,
and as a practical matter, these requirements may mean that brokers are less
likely to make recommendations on our shares to its general clients.

As a result, for as long as our common stock is quoted on the OTC Bulletin Board
and subject to these penny stock rules, our stockholders may have difficulty in
selling their shares in the secondary trading market. In addition, prices for
shares of our common stock may be lower than might otherwise prevail if our
common stock were quoted on the NASDAQ Stock Market or traded on a national
securities exchange, like The New York Stock Exchange or American Stock
Exchange. This lack of liquidity may also make it more difficult for us to raise
capital in the future through the sale of equity securities.

                                      -20-
<PAGE>

RISKS RELATED TO OUR COMMON STOCK INCLUDE, BUT ARE NOT LIMITED TO THE FOLLOWING:

     o    Our quarterly operating results may vary, and these fluctuations could
          affect the market price of our stock.
     o    Our stock price is volatile and a stockholder's investment in our
          common stock could suffer a decline in value.
     o    The market for our stock has not been liquid.


     AS WE ISSUE ADDITIONAL EQUITY SECURITIES IN THE FUTURE, INCLUDING UPON
     CONVERSION OF ANY OF OUR SECURED CONVERTIBLE DEBT, OUR EXISTING
     STOCKHOLDERS WILL BE DILUTED. IN PARTICULAR, THE SECURED CONVERTIBLE DEBT
     HAS A FULL RATCHET ANTI-DILUTION PROVISION THAT COULD SIGNIFICANTLY DILUTE
     OUR STOCKHOLDERS.

In connection with our two debt financings with Laurus, we issued a $2.5 million
secured convertible note, a $1.5 million secured convertible note and warrants
to Laurus. See "DESCRIPTION OF BUSINESS - Laurus Debt Investment" above. The
$2.5 million note is convertible into shares of our common stock at an initial
conversion price of $1.06 per share, and the $1.5 million note is convertible at
an initial conversion price of $1.17 per share. At these initial conversion
rates, for example, we would issue approximately 2,971,000 shares upon
conversion of the $3,290,000 million owed under the notes at June 30, 2006. The
actual number of shares to be issued will depend on the actual dollar amount of
principal and interest being converted. In addition, each note carries a full
ratchet anti-dilution provision, such that if we issue in the future convertible
or equity securities (subject to certain exceptions, including stock option
grants and issuances in connection with certain acquisition transactions) at a
price less than the initial conversion price, the note conversion price will be
automatically adjusted down to that lesser price. In addition to the conversion
rights of the convertible debt, as we issue stock or convertible securities in
the future, including for any future equity financing or upon exercise of any of
the outstanding stock purchase warrants and stock options, those issuances would
also dilute our stockholders. If any of these additional shares are issued and
are sold into the market, it could decrease the market price of our common stock
and could also encourage short sales. Short sales and other hedging transactions
could place further downward pressure on the price of our common stock.

     WE DO NOT INTEND TO PAY CASH DIVIDENDS, SO ANY RETURN ON INVESTMENT MUST
     COME FROM APPRECIATION.

We have not declared dividends on our common stock in the past, and do not
intend to declare dividends on our common stock in the foreseeable future. In
addition, pursuant to our financing agreements with Laurus, for as long as 25%
of the original principal amount is outstanding under the either secured
convertible note to Laurus, we may not declare or pay any dividends without
Laurus' consent. As a result, any investment return in our common stock must
come from increases in the fair market value and trading price of our common
stock.

ITEM 2. DESCRIPTION OF PROPERTY.

We lease approximately 15,000 square feet of office and laboratory space in
Seattle, Washington for our executive offices and laboratory. This lease has a
term of ten years, expiring on October 31, 2007, and carries an average annual
rental of approximately $234,000 through the remainder of the lease term
subsequent to June 30, 2006.

We believe the leased premises are suitable and adequate for their current
intended use. In the opinion of management, the leased premises are adequately
covered by insurance.

We do not own any real property. We do not have a policy pertaining to
investments in real estate. Our current practice is to invest solely in
short-term money market securities.

                                      -21-
<PAGE>

ITEM 3. LEGAL PROCEEDINGS.

We are not a party to any pending material legal proceedings.


ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended June 30, 2006.


                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS
ISSUER PURCHASES OF EQUITY SECURITIES.

COMMON STOCK

Our common stock is currently quoted for trading on the OTC Bulletin Board under
the symbol "PBME."

The following table shows, for each quarter of fiscal 2006 and 2005, the high
and low closing sales prices as reported by the OTC Bulletin Board. The
quotations from the OTC Bulletin Board reflect inter-dealer prices without
retail mark-up, mark-down, or commissions and may not represent actual
transactions.

                                                        OTC BULLETIN BOARD
                                                          High       Low
     FISCAL 2006:
     Fourth quarter, ended June 30, 2006..............   $1.46      $1.03
     Third quarter, ended March 31, 2006..............    1.98       1.15
     Second quarter, ended December 31, 2005..........    1.20       0.90
     First quarter, ended September 30, 2005..........    1.01       0.77

     FISCAL 2005:
     Fourth quarter, ended June 30, 2005..............   $1.30      $0.73
     Third quarter, ended March 31, 2005..............    1.33       0.87
     Second quarter, ended December 31, 2004..........    1.20       0.60
     First quarter, ended September 30, 2004..........    1.03       0.65


HOLDERS

As of September 30, 2006, there were 18,336,884 shares of common stock issued
and outstanding, held by approximately 216 holders of record.

DIVIDENDS

We have never declared or paid any cash dividends with respect to our common
stock, and do not plan to do so in the foreseeable future.

We anticipate that we will retain future earnings for use in the operation and
expansion of our business and do not anticipate paying cash dividends on our
equity in the foreseeable future. Any future determination with regard to the
payment of dividends will be at the discretion of our board of directors and
will be dependent upon our future earnings, financial condition, applicable
dividend restrictions and capital requirements and other factors deemed relevant
by the board of directors.

                                      -22-
<PAGE>

ISSUER REPURCHASES OF COMMON STOCK

In August 2006, our Board of Directors authorized us to repurchase shares of
common stock up to an aggregate value of $500,000 as part of a new buyback
program. The shares will be repurchased from time to time in open market
transactions at our discretion, subject to market conditions and other factors.
The repurchase program will occur over a period of 12 months through August 31,
2007, and may be modified, extended or discontinued at any time. There is no
guarantee as to the exact number of shares that may be repurchased.

Through September 30, 2006, no repurchases have been made.


ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.

YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION WITH OUR
CONSOLIDATED AUDITED FINANCIAL STATEMENTS AND RELATED NOTES FOR THE FISCAL YEAR
ENDED JUNE 30, 2006, INCLUDED ELSEWHERE IN THIS REPORT. EXCEPT FOR HISTORICAL
INFORMATION, THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS. SEE
"CAUTIONARY NOTICE REGARDING FORWARD LOOKING STATEMENTS" AND "RISK FACTORS."

OVERVIEW

We provide specialty central laboratory services to support pharmaceutical and
laboratory diagnostic manufacturers in the conduct of human clinical research,
for use in their drug and diagnostic product development efforts. Our clients
include a number of the world's largest multi-national pharmaceutical,
biotechnology and diagnostic companies. Our well-recognized specialty areas
include cardiovascular disease (dyslipidemia, atherosclerosis, and coronary
heart disease), diabetes (and obesity), and bone and joint diseases
(osteoporosis as well as osteo and rheumatoid arthritis). Coupled with our
specialty testing, we also have central laboratory capability and provide
full-service central laboratory support for multi-center clinical trials,
including routine safety lab tests (general chemistry, hematology, and
urinalysis). Our company is a StateDelaware corporation, incorporated in May
1996, and we conduct our operations primarily through our wholly-owned
subsidiary, Pacific Biometrics, Inc., a StateplaceWashington corporation.

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

The discussion and analysis of our financial condition and results of operations
is based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
country-regionplaceUnited States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenue and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
estimates including, among others, those affecting revenue, the allowance for
doubtful accounts, and the useful lives of tangible and intangible assets. The
discussion below is intended as a brief discussion of some of the judgments and
uncertainties that can impact the application of these policies and the specific
dollar amounts reported on our financial statements. We base our estimates on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form our basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions, or if management made
different judgments or utilized different estimates. Many of our estimates or
judgments are based on anticipated future events or performance, and as such are
forward-looking in nature, and are subject to many risks and uncertainties,
including those discussed below and elsewhere in this Report. We do not
undertake any obligation to update or revise this discussion to reflect any
future events or circumstances.

We have identified below some of our accounting policies that we consider
critical to our business operations and the understanding of our results of
operations. This is not a complete list of all of our accounting policies, and
there may be other accounting policies that are significant to our company. For
a detailed discussion on the application of these and our other accounting
policies, see Note 2 to the Consolidated Financial Statements included in this
Report.

                                      -23-
<PAGE>

REVENUE RECOGNITION

We recognize revenue in the period that the related services are performed.
Historically, a majority of our net revenue has been earned under contracts
which range in duration from six months to eighteen months, but can extend in
duration up to two years or longer. Service contracts generally take the form of
fixed-price arrangements. Under fixed-price contracts, revenue is recognized as
services are performed, with performance generally assessed using output
measures, such as units-of-work performed to date as compared to the total
units-of-work contracted. Changes in the scope of work generally result in a
renegotiation of contract pricing terms. Renegotiated amounts are not included
in net revenue until earned and realization is assured. We also receive advances
from certain clients related to the services to be performed for them. These
advances are deferred and recognized as revenue in the period the related
services are performed. Estimates of costs to complete are made, as appropriate,
to provide for losses expected on contracts. Costs are not deferred in
anticipation of contracts being awarded, but instead are expensed as incurred.
All out-of-pocket costs are included in total revenue and expenses.

FINANCIAL DERIVATIVES - BENEFICIAL CONVERSION FEATURE AND WARRANTS

Embedded beneficial conversion features that meet the definition of derivative
financial instruments have, where applicable, been bifurcated from host
instruments (secured convertible notes - see Note 8. Notes Payable and Note 16.
Restatement) and, in all instances derivative financial instruments have been
recorded as assets or liabilities and are carried at fair value, using the
Black-Scholes pricing model. We record the value allocated to warrants issued
with the convertible instruments, measured at fair value, using the
Black-Scholes pricing model and recognized by allocating a portion of the
proceeds to a derivative liability with an offset to discount on the convertible
instrument. The recorded discount is amortized as interest expense using the
straight-line interest method over the life of the debt.

For convertible debt and related warrants, the recorded discount is amortized as
interest expense using the effective interest method over the life of the debt.

STOCK-BASED COMPENSATION

We have traditionally applied APB Opinion 25, "ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES," and related interpretations in accounting for our stock-based
employee compensation plan. Beginning with the quarter ended March 31, 2006, we
adopted the provisions of SFAS No. 123(R), "ACCOUNTING FOR STOCK-BASED
COMPENSATION." For the fiscal year ended June 30, 2006 and June 30, 2005, we
granted 125,000 (granted prior to March 31, 2006) and 253,000, respectively, of
incentive-based stock options under incentive compensation plans. For prior
reporting periods, had compensation cost been determined based on the fair value
of stock options granted in a manner consistent with the method promulgated by
SFAS No. 123, our net loss and loss per share would have been changed to the pro
forma amounts as reported in our financial statements the fiscal year ended June
30, 2006 and June 30, 2005. We will continue to disclose on a pro forma basis
according to SFAS No. 123 during the transition period to be in accordance with
SFAS No. 123(R).

                                      -24-
<PAGE>

BAD DEBT ALLOWANCE

We endeavor to assess and monitor the creditworthiness of our clients to which
we grant credit terms in the ordinary course of business. We maintain a
provision for doubtful accounts to provide for the possibility that amounts due
to us may not be collected. As of June 30, 2006, the allowance for bad debt was
approximately 2% of our total accounts receivable. This bad debt provision is
monitored on a monthly basis and adjusted as circumstances warrant. As the
recorded bad debt provision is based upon management's judgment, actual bad debt
write-offs may be greater or less than the amount recorded. Historically bad
debt write-offs have not been material.

OPERATING EXPENSES

Historically, we have segregated our recurring operating expenses among three
categories: laboratory and cost of goods sold; selling, general and
administrative expenses; and research and development. Laboratory expenses and
cost of goods sold consist of amounts necessary to complete the revenue and
earnings process, and includes direct labor and related benefits, other direct
costs, and an allocation of facility charges and information technology costs,
and depreciation and amortization. Also, laboratory expenses and cost of goods
sold include shipping and handling fees and reimbursable out-of-pocket costs.
Laboratory expenses and cost of goods sold, as a percentage of net revenue,
tends, and is expected, to fluctuate from one period to another, as a result of
changes in labor utilization and the mix of service offerings involving studies
conducted during any period of time. Selling, general and administrative
expenses include business development activities, sales and marketing expenses
and related commissions, and laboratory administration expenses. Selling,
general and administrative expenses consist primarily of administrative payroll
and related benefit charges, legal and accounting fees, advertising and
promotional expenses, administrative travel and an allocation of facility
charges, information technology costs, and depreciation and amortization.
Research and development expenses consist of direct labor and related benefits,
supplies, legal fees for patent applications, travel expenses, and depreciation
and amortization.

We depreciate equipment and computers over three to five years, while leasehold
improvements are depreciated over the remaining life of the lease or ten years.
This estimate of a three to five-year useful life on equipment and computers and
a useful life based on the remaining years left on the building lease for
leasehold improvements reflects management's judgment that these useful life
periods reflect a reasonable estimate of the life over which the equipment,
computers and leasehold improvements will be used by us. However, the amount of
depreciation expense we record in any given period will change if our estimates
of the useful life of our equipment, computers or leasehold interests were to
increase or decrease.

RESULTS OF OPERATIONS FOR THE FISCAL YEARS ENDED JUNE 30, 2006 AND 2005
(RESTATED)

REVENUE:

                                     YEARS ENDED
Dollars in thousands,                  JUNE 30,
rounded to nearest thousand        2006       2005            $        %
                                           (RESTATED)       Change   Change
                                ---------------------      -----------------
REVENUE                          $10,750     $3,230         $7,520    233%


Our revenue is primarily generated from clinical pharmaceutical trials testing
services and from diagnostic services. The approximately 233% increase in fiscal
2006 revenue over fiscal 2005 was primarily attributable to an increase in the
size and number of clinical pharmaceutical trials testing and diagnostic testing
services we performed. This increase reflects the significant increases in
revenue and open work orders we have been experiencing over five of the past six
quarters. We have made significant investments in our business development
initiatives over the last two fiscal years that have been responsible for a
significant portion of the revenue increase. A portion of this increased revenue
was expected to be realized in the fourth quarter of fiscal 2005. However, the
clinical pharmaceutical trials testing and diagnostic testing services that we
provide are many times subject to setup and initiation delays that change our
planned revenues. These revenues were realized in the third and fourth quarters
of fiscal 2006. We also saw a significant increase in referral business from
other laboratories during this time period.

The overall revenue increase for the fiscal year ended June 30, 2006 reflects
revenue increases throughout the fiscal year. Combined revenue for the first
quarter for the fiscal year ended June 30, 2006 showed an increase of

                                      -25-
<PAGE>

approximately $1,400,000 over the comparable quarter in the prior fiscal year.
Each successive quarter for fiscal 2006, second through fourth, showed an
approximate increase in revenue of at least $2,000,000 over the comparable
quarters in the prior fiscal year. We have previously experienced quarterly
fluctuations in revenue that were above or below previous fiscal years'
revenues. Typically our revenue fluctuations are primarily explained by the
timing between our work on testing and open work orders, and prior work orders
having been completed or terminated.

Historically, our largest two clients in any individual fiscal year have
represented in excess of 50% of our revenue. During the fiscal year ended June
30, 2006, our top two clients represented 50% of our revenue as compared to 40%
during the fiscal year ended June 30, 2005. Our largest client in fiscal 2006
individually accounted for approximately 36% and 23% of our total revenue in
fiscal 2006 and 2005, respectively, while our largest client in fiscal 2005
accounted for approximately 23% and 36% of our total revenue in fiscal 2005 and
2004, respectively. Revenue from our five largest clients represented
approximately 74% and 67% of total revenue in fiscal 2006 and 2005,
respectively.

LABORATORY EXPENSE AND COST OF GOODS SOLD:

                                     YEARS ENDED
Dollars in thousands,                  JUNE 30,
rounded to nearest thousand        2006       2005            $        %
                                           (RESTATED)       Change   Change
                                ---------------------      -----------------
LABORATORY EXPENSE AND
COST OF GOODS SOLD                $5,161     $2,456         $2,705    110%

PERCENTAGE OF REVENUE                48%        76%


For the comparable fiscal years ended June 30, 2006 and 2005, laboratory expense
and cost of goods sold increased approximately 110%. As a percentage of revenue,
laboratory expense and cost of goods sold decreased in fiscal 2006 to
approximately 48% from approximately 76% in fiscal 2005. The relative decrease
in laboratory expense and cost of goods sold as a percentage of revenue was
primarily the result of the significant increase in revenues over the comparable
periods and the fixed components of laboratory expense and cost of goods sold.

Laboratory expense and cost of goods sold consist primarily of payment of
salaries and related benefits to employees performing analysis of clinical trial
samples, the cost of supplies for analysis of clinical trial samples, payments
to subcontractors of laboratory services, and other expenses such as payment of
business and occupation taxes. During the fiscal years ended June 30, 2006 and
2005, respectively, salaries and related benefits accounted for approximately
35% and 42% of total laboratory expense and cost of goods sold, lab supplies
were approximately 42% and 30%, and outside services were approximately 6% and
4%. The 194% increase in outside services resulted from approximately $315,000
we paid for outside services during fiscal 2006 compared to approximately
$107,000 for outside services for fiscal 2005. Approximately 60% of the amount
paid for outside services was a pass-through expense for a single referral lab
study. Laboratory salaries and related benefits increased approximately 74% to
$1,791,000 from $1,030,000 for the fiscal years ended June 30, 2006 and 2005,
respectively. The majority of hiring in the laboratory area was for laboratory
technicians, data managers, and project managers to address the significant
increase in testing volume that produced the substantially increased revenues
for fiscal 2006.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE:

                                     YEARS ENDED
Dollars in thousands,                  JUNE 30,
rounded to nearest thousand        2006       2005            $        %
                                           (RESTATED)       Change   Change
                                ---------------------      -----------------
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSE           $3,696      $2,819          $877      31%

PERCENTAGE OF REVENUE               34%         87%


Our selling, general and administrative expense consists primarily of
compensation for our executive officers, board members and other selling,
general and administrative personnel, compensation income (expense) on our stock
options, legal and accounting fees, and payments under consulting arrangements.

                                      -26-
<PAGE>

For the comparable years ended June 30, 2006 and 2005, respectively, selling,
general and administrative expense increased approximately 31% to approximately
$3,696,000 from $2,819,000. As a percentage of revenue, selling, general and
administrative expenses were approximately 34% and 87%, respectively, for the
comparable fiscal years ended June 30, 2006 and 2005.

The dollar increase in our selling, general and administrative expenses for the
comparable periods is due in large part to salaries and benefits for management,
sales and administrative personnel, which increased approximately $623,000. The
increase in our selling, general and administrative expenses for the comparable
periods is also due to a change in auditors in December 2004 that required both
auditors' approval and expense through the period ended December 31, 2005. We
accrued approximately $171,000 for audit fees for an internal-audit of
Washington State business and occupation taxes (resulting in tax refunds of
approximately $271,000 as described in "Other Expense" below), investor
relations program with IRG which we commenced in January 2005, increases in
advertising expense and outside consulting services for fiscal year 2006. We had
decreased expenses for legal, recruiting, other outside services, insurance,
printing, while expenses associated with bonuses, restricted share grants,
recruiting, trade shows and travel all increased for the comparable periods.

RESEARCH AND PRODUCT DEVELOPMENT:

                                        YEARS ENDED
Dollars in thousands,                     JUNE 30,
rounded to nearest thousand           2006       2005            $        %
                                              (RESTATED)       Change   Change
                                   ---------------------      -----------------
RESEARCH AND PRODUCT DEVELOPMENT      $46         $114          $(68)    (60)%

PERCENTAGE OF REVENUE                  0%           4%

Research and development expenses consist mainly of our expenditures incurred in
connection with development of our LIDA and cell viability technology that is
held by our subsidiary, PBI Technology.

For the comparable fiscal years ended June 30, 2006 and 2005, research and
product development expenses decreased approximately 60% to approximately
$46,000 from $114,000. The decrease was primarily the result of decreased
compensation expense as a result of fewer employees in research and product
development in the current year period over the comparable prior year period.
For the fiscal year ended June 30, 2006, the research and product development
expenses consist of depreciation charges for laboratory instruments. For the
fiscal year ended June 30, 2005, we had increased costs of $85,000 associated
with our agreement with Utek Corporation, which we entered into September 30,
2005, for Utek to assist us in identifying one or more licensing, royalty or
asset sale opportunities for the technology assets held by PBI Technology. We
terminated this agreement in June 2005.

We anticipate that we will continue to incur research and development expenses
related to the technology held by PBI Technology. However, if we are unable to
increase revenue or raise additional funding to continue to fund our existing
research and development efforts, we will seek to further reduce our research
and development efforts and expenses.

OTHER EXPENSE:

                                        YEARS ENDED
Dollars in thousands,                     JUNE 30,
rounded to nearest thousand           2006       2005            $        %
                                              (RESTATED)       Change   Change
                                   ---------------------      -----------------
OTHER EXPENSE                       $(1,667)     $(821)        $(846)    103%

PERCENTAGE OF REVENUE                  (16)%      (25)%


Total other expense increased 103% to approximately $1,667,000 from expense of
approximately $821,000 during the fiscal years ended June 30, 2006 and 2005,
respectively. There were three major components of other expense in the year
ended June 30, 2006 associated with the Laurus 2004 and 2005 Notes. We recorded
cash interest expense, approximately $339,000 and $229,000, paid on the 2004 and
2005 Notes, and we recorded approximately $771,000 and $144,000 of non-cash
expense related to the amortization of the intrinsic value of the warrants

                                      -27-
<PAGE>

associated with both notes. As of June 30, 2006, approximately $1,648,000 of the
beneficial conversion feature and warrant discount remained unamortized. Because
of the extension and deferral of interest on the 2004 and 2005 Notes, we
adjusted the amortization schedule of the intrinsic value of the beneficial
conversion and will be amortized at approximately $64,000 per month, using the
straight-line method, over the remaining life of the 2004 and 2005 Notes or upon
their earlier conversion. (See Note 8 to Notes to Consolidated Financial
Statements -- DEFERRAL & EXTENSION OF SECURED CONVERTIBLE NOTES). We entered
into the financing arrangements with Laurus effective May 28, 2004 and January
31, 2005, so we had approximately $423,000 in comparable expenses related only
to the May 2004 secured convertible note for the comparable twelve month period
ended June 30, 2005.

The second component is we have changed accounting regarding treatment of
derivatives. In fiscal years 2004 and 2005, we estimated the valuation of the
beneficial conversion feature and the warrants for the May 2004 and January 2005
Notes in accordance with EITF 00-27 and EITF 98-5, using the Black-Scholes
pricing model and other assumptions deemed reasonable by management. We
corrected our accounting for derivative financial instruments, for the May 2004
and January 2005 Notes, to conform to the requirements of Statements of
Accounting Standards No. 133, as amended, and Financial Accounting Standards
Board Emerging Issues Task Force (EITF) No. 00-19. Embedded beneficial
conversion features that meet the definition of derivative financial instruments
have, where applicable, been bifurcated from host instruments, the May 2004 and
January 2005 Notes, and, in all instances derivative financial instruments have
been recorded as assets or liabilities and are carried at fair value. We
restated prior fiscal years results to conform to the requirements of the
Statement of Financial Accounting Standards No. 154, Accounting Changes and
Error Corrections. Net fair value adjustments included in earnings (loss)
related to these instruments amounted to $298,616 and ($265,928) for the fiscal
year ending June 30, 2006 and 2005, respectively. Accordingly, the balances for
fiscal years 2004 and 2005 have been restated and balances for fiscal 2006
correctly accounted for. See Note 16 to Notes to Consolidated Financial
Statements - Restatement (FINANCIAL DERIVATIVES).

The third major component of other expense associated with Laurus related to the
approximately $293,500 in fees and expenses related to the 2004 Note, and
approximately $168,000 in fees and expenses in the fiscal year ended June 30,
2005, related to the 2005 Note. We are amortizing these fees to deferred
financing costs over the amended 48-month life of each note, resulting in
approximately $107,000 of expense recognized for the fiscal year ended June 30,
2006 compared to approximately $116,000 of expense recognized as of June 30,
2005. For fiscal 2006, we expect to continue to amortize these expenses at the
rate of approximately $9,000 per month, or $27,000 per quarter.

Another major component of other expense for fiscal 2006 was approximately
$1,079,000 of warrant expense associated with our private placement of common
stock and warrants in March and April 2006, for which we had no comparable
expense in fiscal 2005. The warrant expense associated with our private
placement of common stock and warrants is a one-time charge in the fiscal year
ended June 30, 2006, without any remaining amounts to be amortized in future
periods.

For fiscal 2006, our net "other expense" also included approximately $271,000 in
Washington state sales and business and occupation tax refunds (which accrued
from a review of past years tax remittances and application of new apportionment
rules where we incurred approximately $171,000 of expense for the audit, as
described in Selling, General and Administrative Expense above), and
approximately $7,000 from warrant expense associated with our Franklin Funding
equipment financing.

NET INCOME (LOSS):

                                        YEARS ENDED
Dollars in thousands,                     JUNE 30,
rounded to nearest thousand           2006       2005            $        %
                                              (RESTATED)       Change   Change
                                   ---------------------      -----------------
NET INCOME (LOSS)                     $179     $(2,980)        $3,159    1764%

PERCENTAGE OF REVENUE                   2%        (92)%

We had a net income of approximately $179,000 in fiscal 2006 compared to a net
loss of approximately $2,980,000 in fiscal 2005. This increase to net income,
from net loss, is principally due to a significant increase in revenue

                                      -28-
<PAGE>

during fiscal 2006 and increases in gross margin in excess of large dollar
increases in our selling, general and administrative expenses and changes to
accounting for derivatives in other expenses. As a percentage of revenue, all
expense categories declined. In addition, our net income position was favorably
impacted by a gain from adjustment to fair value of the derivative instruments
during fiscal 2006. These positive impacts to net income in fiscal 2006 were
partially offset by the warrant expense associated with our private placement in
March and April 2006.

EARNINGS BEFORE TAXES, INTEREST, DEPRECIATION, AND AMORTIZATION (EBITDA):

                                        YEARS ENDED
Dollars in thousands,                     JUNE 30,
rounded to nearest thousand           2006       2005            $        %
                                              (RESTATED)       Change   Change
                                   ---------------------      -----------------
EBITDA                               $1,723    $(2,249)        $3,972    177%

PERCENTAGE OF REVENUE                   16%       (70)%


EBITDA is an alternative view of earnings performance used by management which
is a non-GAAP (generally accepted accounting principles) financial measure.
However, we have added the EBITDA metric to our financial reporting for fiscal
2006 because we believe this metric more clearly illustrates company performance
and we use it for internal reporting and budgeting, as well as for reviewing
competitor's performance. We believe that investors' understanding of our
company performance is enhanced by disclosing this metric. EBITDA is an income
measure that provides a view of our operations without including certain
non-cash charges and certain expenses, specifically interest, taxes,
depreciation and amortization. In particular, this measure eliminates the charge
to net income due to the beneficial conversion feature on the Laurus convertible
debt, as well as amortized warrant costs from our Franklin Funding equipment
financing for the fiscal years 2006 and 2005 (see Note 8 to Notes to
Consolidated Financial Statements). These non-cash, non-operating charges have
varied significantly from year to year, making comparisons of our operating
performance more difficult. The EBITDA measure is not a substitute for GAAP Net
Income, and should not be viewed as such.

We had positive EBITDA of approximately $1,723,000 compared to negative EBITDA
of approximately $2,249,000 in fiscal 2005. This significant EBITDA improvement
in EBITDA is primarily the result of the significant increase in revenue during
fiscal 2006 and an increase in gross margin in excess of large dollar increases
in our selling, general and administrative expenses and other expenses.

A reconciliation of EBITDA income and GAAP Net Income is provided below.

                                      -29-
<PAGE>

RECONCILIATION OF EBITDA INCOME (LOSS) TO GAAP NET INCOME:
--------------------------------------------------------------------------------
Dollars in thousands,                                           YEARS ENDED
rounded to nearest thousand                                       JUNE 30,
                                                         -----------------------
                                                           2006         2005
                                                                     (RESTATED)
--------------------------------------------------------------------------------

GAAP NET EARNINGS (LOSS)                                    $179      $(2,980)

Interest expense                                             402          317
Interest expense from amortization of beneficial
conversion feature and warrants                              771          145
Amortized Finance Costs                                      107          116
Depreciation and Amortization                                257          153
Amortized Options & Warrants                                   7          --

EBITDA                                                    $1,723      $(2,249)
--------------------------------------------------------------------------------

LIQUIDITY AND CAPITAL RESOURCES:

We had significant improvement in revenues and net operating income for the
fiscal year ended June 30, 2006, compared to significant net operating losses
for the fiscal year ended June 30, 2005. By comparison, revenues for the fiscal
year ended June 30, 2005 were significantly lower than those in the comparable
prior fiscal years. While revenues have increased to a record level for fiscal
2006, we have experienced significant volatility in our revenues over the past
several years. We may experience significant losses and our cash and working
capital position will be adversely impacted if our revenues decrease
significantly in future periods. Our operations historically have been funded
through revenues generated from operations and from the sale and issuance of our
common stock, preferred stock and debt.

At June 30, 2006, our cash and cash equivalents were approximately $5,498,000,
compared to approximately $1,439,000 at June 30, 2005. The increase in our cash
and equivalents is primarily attributable to our private placement of common
stock and warrants in March and April 2006. To a lesser degree the net increase
in our cash and cash equivalents is the result of: (a) an increase in advances
from customers, (b) an increase in our accounts payables, and (c) increase in
secured convertible note - current portion. These items were more than offset as
a the result of: (i) increases in accounts receivable, (ii) decreases in accrued
liabilities, (iii) decreases in other notes payable - current portion.

At June 30, 2006, we had approximately $1,978,000 in accounts receivable,
compared to approximately $608,000 as of June 30, 2005, reflecting the timing of
revenues billed and collected. We generally have a high collectibility rate on
our accounts receivable, no bad debt in the last two fiscal years, and our
allowance for doubtful accounts is only $32,100 which we believe is reasonable
based on our past experience. Our accounts receivable generally reflect our
billings, and may include one or several individually large customer receivables
from time to time.

Total liabilities recorded on our balance sheet as of June 30, 2006 were
approximately $6,668,000 compared to approximately $6,881,000 as of June 30,
2005. The slight decrease in liabilities was the result of decreases in our
other notes payable, accounts payable and capital lease obligations, and a
slight decrease in our secured Laurus convertible debt net of the beneficial
discount for the 2004 and 2005 Notes. This was offset by increases in customer
advances, an increase in accrued liabilities and capital lease obligations.
Significant components of our liabilities include the 2004 and 2005 Notes with
Laurus, and, to a lesser degree, our prior borrowings in fiscal 2006 under our
$500,000 credit facility with Franklin Funding, $350,000 of which has been
utilized. As required by U.S. generally accepted accounting principles, the
liability we recorded for the 2004 and 2005 Notes reflected a discount from the
face value of the notes by approximately $1,648,000, related to the valuation of
the beneficial conversion feature and the warrants. During the fiscal year ended
June 30, 2006, Laurus converted $646,600 of the principal amount

                                      -30-
<PAGE>

due on the 2004 Note compared to $63,600 of the principal amount converted
during the fiscal year ended June 30, 2005. As of June 30, 2006 the remaining
principal balance on the 2004 Note was $1,789,800. No amounts of the 2005 Note
have been converted, and as of June 30, 2006 the remaining principal balance on
the 2005 Note was $1,500,000. Accordingly, if the discount to face value is
disregarded, our total liabilities as of June 30, 2006 and June 30, 2005,
respectively, would be approximately $5,763,000 and $6,449,000.

At June 30, 2006, we had positive working capital of approximately $4,375,000,
compared to a negative working capital of approximately ($20,000) at June 30,
2005. The approximately $4,394,000 increase in working capital is attributable
to several changes in the components of working capital. Changes providing
favorable impact include increases in accounts receivable, prepaid expenses,
deferred financing costs related to the 2004 and 2005 Notes, along with
decreases in accounts payable, and decreases in our current notes payable and
the current portion (net of discounts), payable on our 2004 and 2005 Notes.

Net cash provided in operating activities was approximately $681,000 for the
fiscal year ended June 30, 2006, used primarily to facilitate our purchases of
capital equipment. For the fiscal year ended June 30, 2006, net cash used in
operations included the effect of approximately $771,000 of amortization related
to the 2004 and 2005 Notes, approximately $257,000 in depreciation and
amortization. Our investing activities used approximately $513,000 for the
fiscal year ended June 30, 2006 primarily for the purchase of capital equipment
related to our laboratory information system discussed above. Cash flows
provided in financing activities included approximately $3,891,000 consisting
primarily of approximately $350,000 in borrowings under our note payable with
Franklin Funding and approximately $3,963,000 in net proceeds from our private
placement of common stock and warrants in March and April 2006. We made payments
of approximately $422,000 on notes payable and on capital lease obligations.

As described above, we experienced a significant increase in revenue for the
year ended June 30, 2006, and we incurred a net loss. We have realized an
improvement of our cash and working capital position from operations, and we
expect these trends will continue during fiscal 2007, at approximately the same
rate. Our cash position also improved from the net proceeds from our private
placement of common stock and warrants. In fiscal 2007 we will continue to
actively pursue business development and marketing activities to broaden our
client and revenue base, and we anticipating make additional investments from
time to time in our technology infrastructure, operations and other areas of our
business. These efforts will use significant amounts of time, effort and
funding. Our efforts to improve our operations and increase revenue may not be
successful.

Because of the extension and deferral of interest on the 2004 and 2005 Notes, we
expect that our current cash, current assets and any cash flows from operations
will be sufficient to fund operations through fiscal 2008. (See "Note 8 to
Consolidated Financial Statements" included in this Report). However, any
decreases in revenue would adversely affect our financial condition, and we may
need to seek additional capital during fiscal 2007. We may not be able to raise
sufficient financing, whether debt or equity. We have no additional amounts
available to us under our Franklin Funding credit facility, and we do not have
any other credit facility in place. In addition, based on the terms of the
Laurus debt financings, raising additional capital may be difficult or highly
dilutive to existing stockholders.

ITEM 7. FINANCIAL STATEMENTS.

Financial Statements are listed in the Index to Financial Statements and filed
and included elsewhere herein as a part of this Annual Report on Form 10-KSB,
beginning at page F-1.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

None

                                      -31-
<PAGE>

ITEM 8A. CONTROLS AND PROCEDURES.

We maintain disclosure controls and procedures designed to ensure that
information required to be disclosed in our reports filed or submitted under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission's
rules and forms. As of the end of the period covered by this Annual Report on
Form 10-KSB, we carried out an evaluation, under the supervision and with the
participation of management, including our Chief Executive Officer and
Controller, of the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that
evaluation, management and our Chief Executive Officer and controller concluded
that our disclosure controls and procedures are effective.

A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Because of the inherent limitations in all control systems no
evaluation of controls can provide absolute assurance that all control issues if
any, within a company have been detected.

There has been no change in our internal control over financial reporting in
connection with this evaluation that occurred during the fourth quarter of
fiscal 2006 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting. In response to the
Sarbanes-Oxley Act of 2002, we are continuing a comprehensive review of our
disclosure procedures and internal controls and expect to make minor
modifications and enhancements to these controls and procedures.

ITEM 8B. OTHER INFORMATION

Not applicable


                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT

We have a Code of Ethics that applies to our principal executive officer,
principal financial officer, controller and other employees performing similar
functions. We previously filed a copy of the Code of Ethics with the SEC as an
exhibit to our annual report on Form 10-KSB for our fiscal year ended June 30,
2004.

The other information called for by Part III, Item 9, will be included in our
proxy statement relating to our 2006 annual meeting of stockholders, and is
incorporated herein by reference. The proxy statement will be filed within 120
days of June 30, 2006, our fiscal year end.

ITEM 10. EXECUTIVE COMPENSATION

Information called for by Part III, Item 10, will be included in our proxy
statement relating to our 2006 annual meeting of stockholders, and is
incorporated herein by reference.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND
RELATED STOCKHOLDER MATTERS.

Certain information called for by Part III, Item 11, will be included in our
proxy statement relating to our 2006 annual meeting of stockholders, and is
incorporated herein by reference.

                                      -32-
<PAGE>

EQUITY COMPENSATION PLAN INFORMATION

The following table gives information as of June 30, 2006, regarding our common
stock that may be issued upon the exercise of options, warrants and other rights
under our equity compensation plans. See also "Notes 12 and 13 to Consolidated
Financial Statements" included in this Report.






































                                      -33-
<PAGE>
<TABLE><CAPTION>
                                        (A)
                                   No. of Shares                  (B)                       (C)
                                    to be Issued            Weighted Average       No. of Shares Available
                                  Upon Exercise of          Exercise Price of        for Future Issuance,
                                Outstanding Options,      Outstanding Options,       excluding securities
Plan Category                   Warrants and Rights        Warrants and Rights     reflected in Column (a)
-------------                   -------------------        -------------------     -----------------------
<S>                                  <C>                         <C>                        <C>
Equity Compensation Plans
Approved by Stockholders (1)          1,493,207                   $0.82                      306,793


Equity Compensation Plans                                 No options, warrants,
Approved by Stockholders (2)                             and rights issued as of
                                      3,000,000               June 30, 2006                3,000,000

Equity Compensation Plans Not
Approved by Stockholders              4,498,492                   $1.22                         --

   TOTAL                              8,991,699                   $1.12                    3,306,793
</TABLE>

(1)  Consists solely of the Pacific Biometrics, Inc. 1996 Stock Incentive Plan.
(2)  Consists solely of the Pacific Biometrics, Inc. 2005 Stock Incentive Plan.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Information called for by Part III, Item 12, will be included in our proxy
statement relating to our 2006 annual meeting of stockholders, and is
incorporated herein by reference.

ITEM 13. EXHIBITS.


 EXHIBIT
   NO.                               DESCRIPTION
---------     ------------------------------------------------------------------

  3.1(1)      Amended and Restated Certificate of Incorporation of the Company,
              as amended - includes (a) Amended and Restated Certificate of
              Incorporation dated July 9, 1996, (b) Certificate of Amendment to
              Certificate of Designation for Series A Convertible Preferred
              Stock, dated as of August 28, 2002, (c) Certificate of Amendment
              to Restated Certificate of Incorporation, dated February 14, 2003,
              and (d) Certificate of Designation for Series B Convertible
              Preferred Stock, dated as of March 6, 2003
  3.2(2)      Amended and Restated By-Laws of the Company
  4.1(2)      Specimen Stock Certificate
  10.1A(3)    1996 Stock Incentive Plan, as amended
  10.1B(11)   Form of stock option agreement (for employees and officers) under
              1996 Stock Incentive Plan
  10.1C(11)   Form of stock option agreement (for directors) under 1996 Stock
              Incentive Plan
  10.2A(16)   2005 Stock Incentive Plan
  10.2B**     Form of stock option agreement under 2005 Stock Incentive Plan
  10.2C**     Form of restricted stock award agreement under 2005 Stock
              Incentive Plan
  10.3A(15)   Executive Employment Agreement, dated June 1, 2006, between
              Pacific Biometrics, Inc. and Ronald R. Helm
  10.3B(17)   First Amendment to Executive Employment Agreement, between Pacific
              Biometrics, Inc. and Ronald R. Helm
  10.4++(12)  Employment Agreement, dated October 1, 2004, by and between the
              Company and Dr. Elizabeth Leary
  10.5(4)     Office Lease, dated April 23, 1997, between Tom Kane and Elsa Kane
              and the Company
  10.6(5)     Asset Purchase Agreement, dated as of June 27, 2002, among the
              Company, PBI-WA and Saigene Corporation
  10.7(6)     Amendment Number One to Asset Purchase Agreement, dated as of
              August 28, 2002, among the Company, Saigene Corporation, and
              PBI-WA

                                      -34-
<PAGE>

  10.8(3)     Option Agreement, dated August 28, 2002, between the Company and
              Saigene Corporation
  10.9(10)    Common Stock Purchase Warrant issued by the Company in favor of
              Source Capital Group, Inc.
  10.10(7)    Amended and Restated Financing Agreement, dated as of October 1,
              2002, among the Company, Transamerica Technology Finance
              Corporation, successor in interest to Transamerica Business Credit
              Corporation, and Saigene Corporation
  10.11(7)    Restructure Agreement, dated as of October 1, 2002, among the
              Company, Transamerica Technology Finance Corporation, successor in
              interest to Transamerica Business Credit Corporation, and Saigene
              Corporation
  10.12(7)    Amendment to Warrant Agreements, dated as of October 1, 2002,
              among the Company, Transamerica Technology Finance Corporation,
              successor in interest to Transamerica Business Credit Corporation,
              and Saigene Corporation
  10.13(7)    Promissory Note, dated as of October 1, 2002, in the principal
              amount of $245,000 in favor of Transamerica Technology Finance
              Corporation
  10.14(7)    Investment Agreement, dated as of December 19, 2002, between
              Saigene Corporation and the Company
  10.15(8)    Securities Purchase Agreement, dated May 28, 2004 between the
              Company and Laurus Master Fund, Ltd.
  10.16(8)    $2.5 Million Secured Convertible Term Note, dated May 28, 2004,
              made by the Company in favor of Laurus Master Fund, Ltd.
  10.17(8)    Master Security Agreement dated May 28, 2004, among the Company,
              BioQuant, Inc., Pacific Biometrics, Inc., a placeStateWashington
              corporation, PBI Technology, Inc., and Laurus Master Fund, Ltd.
  10.18(8)    Registration Rights Agreement, dated May 28, 2004, between the
              Company and Laurus Master Fund, Ltd.
  10.19(8)    Common Stock Purchase Warrant, dated May 28, 2004, issued by the
              Company in favor of Laurus Master Fund, Ltd. for 681,818 shares of
              common stock.
  10.20(8)    Subsidiary Guaranty dated May 28, 2004, among Pacific Biometrics,
              Inc., a placeStateWashington corporation, BioQuant, Inc., and PBI
              Technology, Inc.
  10.21(8)    Stock Pledge Agreement dated May 28, 2004, between the Company and
              Laurus Master Fund, Ltd.
  10.22(13)   Amendment No. 1 and Waiver, dated January 31, 2005, between the
              Company and Laurus Master Fund, Ltd.
  10.23(13)   Amendment No. 2, dated January 31, 2005, among the Company,
              Pacific Biometrics, Inc., a placeStateWashington corporation,
              BioQuant, Inc., PBI Technology, Inc. and Laurus Master Fund, Ltd.
  10.24(13)   Securities Purchase Agreement, dated January 31, 2005 between the
              Company and Laurus Master Fund, Ltd.
  10.25(13)   $1.5 Million Secured Convertible Term Note, dated January 31,
              2005, made by the Company in favor of Laurus Master Fund, Ltd.
  10.26(13)   Registration Rights Agreement, dated January 31, 2005, between the
              Company and Laurus Master Fund, Ltd.
  10.27(13)   Common Stock Purchase Warrant, dated January 31, 2005, issued by
              the Company in favor of Laurus Master Fund, Ltd. for 326,087
              shares of common stock.
  10.28(14)   Amendment No. 1, dated May 6, 2005, between Pacific Biometrics,
              Inc. and Laurus Master Fund, Ltd.
  10.29(14)   Amendment No. 2, dated May 6, 2005, between Pacific Biometrics,
              Inc. and Laurus Master Fund, Ltd.
  10.30(14)   Common Stock Purchase Warrant, dated May 6, 2005, issued by
              Pacific Biometrics, Inc. in favor of Laurus Master Fund, Ltd. for
              1,000,000 shares of common stock.
  10.31(18)   Loan and Security Agreement, dated November 3, 2005, between
              Pacific Biometrics, Inc. and Franklin Funding, Inc.
  10.32(19)   Form of Unit Subscription Agreement for March 2006 private
              placement
  10.33(19)   Form of Common Stock Purchase Warrant for March 2006 private
              placement
  14.1(11)    Code of Ethics for Financial Officers
  21.1(9)     Subsidiaries of Pacific Biometrics, Inc.

                                      -35-
<PAGE>

  23.1**      Consent of Williams & Webster P.S.
  31.1**      Certification by Ronald R. Helm, Chief Executive Officer
  31.2**      Certification by John P. Jensen, Controller
  32.1**      Certification by Ronald R. Helm, Chief Executive Officer, pursuant
              to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
              the Sarbanes-Oxley Act of 2002
  32.2**      Certification by John P. Jensen, Controller, pursuant to 18 U.S.C.
              Section 1350, as adopted pursuant to Section 906 of the
              Sarbanes-Oxley Act of 2002
------------------------
  **      Filed herewith
  ++      Portions of the marked exhibit have been omitted pursuant to a
          request for confidential treatment filed with the SEC.
  (1)     Incorporated by reference to Exhibits of Registrant's Quarterly
          Report on Form 10-QSB for the quarter ended March 31, 2003, filed
          on May 15, 2003.
  (2)     Incorporated by reference to Exhibits of Registrant's
          Pre-Effective Amendment No. 1 to Registration Statement on Form
          SB-2, Registration No. 333-11551, filed on October 11, 1996.
  (3)     Incorporated by reference to Exhibits of Registrant's Annual
          Report on Form 10-KSB for the fiscal year ended June 30, 2003,
          filed on September 29, 2003.
  (4)     Incorporated by reference to Exhibits of Registrant's Annual
          Report on Form 10-KSB for the fiscal year ended June 30, 1997,
          filed on September 29, 1997.
  (5)     Incorporated by reference to Exhibits of Registrant's Current
          Report on Form 8-K filed on July 3, 2002.
  (6)     Incorporated by reference to Exhibits of Registrant's Current
          Report on Form 8-K filed on September 6, 2002.
  (7)     Incorporated by reference to Exhibits of Registrant's Quarterly
          Report on Form 10-QSB for the quarter ended December 31, 2002,
          filed on February 14, 2003.
  (8)     Incorporated by reference to Exhibits of Registrant's Current
          Report on Form 8-K filed on June 7, 2004.
  (9)     Incorporated by reference to Exhibits of Registrant's Quarterly
          Report on Form 10-QSB for the quarter ended March 31, 2004, filed
          on May 14, 2004.
  (10)    Incorporated by reference to Exhibits of Registrant's Registration
          Statement on Form SB-2, Registration No. 333-116968, filed on June
          29, 2004.
  (11)    Incorporated by reference to Exhibits of Registrant's Annual
          Report on Form 10-KSB for the fiscal year ended June 30, 2004,
          filed on September 23, 2004.
  (12)    Incorporated by reference to Exhibits of Registrant's Quarterly
          Report on Form 10-QSB for the quarter ended September 30, 2004,
          filed on November 15, 2004.
  (13)    Incorporated by reference to Exhibits of Registrant's Current
          Report on Form 8-K filed on February 1, 2006.
  (14)    Incorporated by reference to Exhibit of Registrant's Current
          Report on Form 8-K filed on May 10, 2005.
  (15)    Incorporated by reference to Exhibit of Registrant's Current
          Report on Form 8-K filed on June 7, 2005.
  (16)    Incorporated by reference to Appendix A of Registrant's Definitive
          Proxy Statement on Schedule 14A filed on October 25, 2005.
  (17)    Incorporated by reference to Exhibit of Registrant's Current
          Report on Form 8-K filed on September 5, 2006.
  (18)    Incorporated by reference to Exhibit of Registrant's Current
          Report on Form 8-K filed on November 7, 2005.
  (19)    Incorporated by reference to Exhibit of Registrant's Current
          Report on Form 8-K filed on March 13, 2006.


ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information called for by Part III, Item 14, will be included in our proxy
statement relating to our 2006 annual meeting of stockholders, and is
incorporated herein by reference.

                                      -36-
<PAGE>

                                   SIGNATURES


In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized, on October 3, 2006.


                                       PACIFIC BIOMETRICS, INC.


                                       By: /s/ Ronald R. Helm
                                           ------------------------
                                           Ronald R. Helm
                                           President and Chief Executive Officer

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


        SIGNATURE                    CAPACITIES                       DATE
        ---------                    ----------                       ----

/s/ Ronald R. Helm             Chief Executive Officer,          October 3, 2006
--------------------------     President, and Director
Ronald R. Helm                 (PRINCIPAL EXECUTIVE OFFICER)


/s/ John P. Jensen             Controller                        October 3, 2006
--------------------------     (PRINCIPAL FINANCIAL OFFICER
John P. Jensen                 AND PRINCIPAL ACCOUNTING
                               OFFICER)


/s/ Terry M. Giles             Director                          October 3, 2006
--------------------------
Terry M. Giles


/s/ Paul G. Kanan              Director                          October 3, 2006
--------------------------
Paul G. Kanan


/s/ Richard W. Palfreyman      Director                          October 3, 2006
--------------------------
Richard W. Palfreyman


/s/ Curtis J. Scheel           Director                          October 3, 2006
--------------------------
Curtis J. Scheel


                                      -37-
<PAGE>
                            PACIFIC BIOMETRICS, INC.

                            Form 10-KSB Annual Report


                   Index to Consolidated Financial Statements


                                                                          Page
                                                                          ----

Report of Independent Registered Public Accounting Firm                    F-2

Consolidated Financial Statements:

     Consolidated Balance Sheets as of June 30, 2006 and 2005              F-3

     Consolidated Statements of Operations for the years ended
         June 30, 2006 and 2005                                            F-4

     Consolidated Statements of Cash Flows for the years ended
         June 30, 2006 and 2005                                            F-5

     Consolidated Statement of Stockholders' Equity (Deficit) for
         the years ended June 30, 2006 and 2005                            F-6


     Notes to Consolidated Financial Statements                            F-7












                                      F-1
<PAGE>


[LOGO]                      Williams & Webster, P.S.
               Certified Public Accountants & Business Consultants

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

Pacific Biometrics, Inc.
Seattle, WA


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
             -------------------------------------------------------

We have audited the accompanying balance sheets of Pacific Biometrics, Inc. as
of June 30, 2006 as of 2005, and the related statements of operations,
stockholders' equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Pacific Biometrics, Inc. as of
June 30, 2006 and 2005 and the results of its operations, stockholders' equity
and its cash flows for the years then ended in conformity with accounting
principles generally accepted in the United States of America.

As described in Note 16, subsequent to the issuance of the Company's June 30,
2005 financial statements, management became aware of errors related to the
accounting for its derivative financial instruments. Accordingly, adjustments
have been made to the accompanying financial statements as of June 30, 2005 to
correct these errors.


/s/ Williams & Webster, P.S.

Williams & Webster, P.S.
Certified Public Accountants
Spokane, Washington
September 30, 2006


      Members of Private Companies Practice Section, SEC Practice Section,
                                AICPA and WSCPA
              Bank of America Financial Center - 601 W Riverside,
                         Suite 1940 - Spokane, WA 99201
      Phone (509) 838-5111 - Fax (509) 838-5114 - www.wi/liams-webster com


                                       F-2
<PAGE>

                            PACIFIC BIOMETRICS, INC.
                           CONSOLIDATED BALANCE SHEETS
                                 AS OF JUNE 30,
<TABLE><CAPTION>
                                                                                     2006              2005
                                                                                                    (RESTATED)
                                                                                 ------------      ------------
<S>                                                                              <C>               <C>
                                    ASSETS
Current assets:
    Cash and cash equivalents                                                    $  5,497,737      $  1,438,543

    Accounts receivable, net of allowance for doubtful
          accounts of $32,100 and $22,100, respectively                             1,977,589           607,867
    Other receivables                                                                 258,263             2,020
    Prepaid expenses and other assets                                                 363,966           601,444
    Deferred financing cost on secured convertible notes - current portion            107,170           107,170
                                                                                 ------------      ------------
          Total current assets                                                      8,204,725         2,757,044

Property and equipment, net                                                           693,231           437,436

Other assets:
    Deferred financing cost on secured convertible notes - long-term portion          125,617           232,787
                                                                                 ------------      ------------

                                                                                 ------------      ------------
          Total assets                                                           $  9,023,573      $  3,427,267
                                                                                 ============      ============

                  LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
    Accounts payable                                                             $    549,517      $    438,342
    Accrued liabilities                                                               499,858           846,267
    Advances from clients                                                             966,573           697,561
    Capital lease obligations - current portion                                        51,994            51,994
    Secured convertible notes - current portion                                       923,129            83,333
    Compound embedded derivative liability - current portion                          800,239           327,110
    Other notes payable - current portion                                              38,148           331,429
                                                                                 ------------      ------------
          Total current liabilities                                                 3,829,458         2,776,036

Capital lease obligations - long-term portion                                          56,500           108,493
Secured convertible notes - long-term portion, net of unamortized fair value
    assigned to beneficial conversion feature and warrants of $1,648,210 and
    $2,419,639, respectively                                                          718,461         1,433,428

Compound embedded derivative liability - long-term portion                          1,752,994         2,524,739
Other notes payable - long-term portion                                               310,938            38,148
                                                                                 ------------      ------------
          Total liabilities                                                         6,668,351         6,880,844
                                                                                 ------------      ------------

Commitments and contingencies                                                            --                --


Stockholders' equity (deficit):
    Preferred stock, Series A convertible $0.01 par value, 5,000,000 shares
       authorized, 0 shares and 1,550,000 shares issued and outstanding 2006
       and 2005, respectively, liquidation preference of $2.00 per share                 --              15,500
    Common stock, $0.01 par value, 30,000,000 shares authorized,
       18,336,884 and 13,325,705 shares issued and outstanding, respectively          355,098           304,985
    Additional paid-in capital                                                     27,921,488        22,326,406
    Accumulated deficit                                                           (25,919,941)      (26,099,044)
                                                                                 ------------      ------------
    Treasury stock                                                                     (1,423)           (1,423)
                                                                                 ------------      ------------
          Total stockholders' equity (deficit)                                      2,355,222        (3,453,577)
                                                                                 ------------      ------------

          Total liabilities and stockholders' equity (deficit)                   $  9,023,573      $  3,427,267
                                                                                 ============      ============


          The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
                                      F-3
<PAGE>

                                  PACIFIC BIOMETRICS, INC.
                            CONSOLIDATED STATEMENTS OF OPERATIONS
                                    YEARS ENDED JUNE 30,
<TABLE><CAPTION>
                                                                      2006              2005
                                                                                     (RESTATED)
                                                                  ------------      ------------
<S>                                                               <C>               <C>

Revenues                                                          $ 10,750,023      $  3,230,374
                                                                  ------------      ------------

Laboratory expense and cost of goods sold                            5,161,011         2,456,295
                                                                  ------------      ------------

          Gross profit                                               5,589,012           774,079
                                                                  ------------      ------------

Operating expenses:
    Research and product development                                    46,283           113,741
    Selling, general and administrative                              3,696,284         2,819,249
                                                                  ------------      ------------

Operating income (loss)                                              1,846,445        (2,158,911)
                                                                  ------------      ------------

Other income (expense):
  Interest expense                                                    (402,072)         (317,267)
  Interest expense from amortization of beneficial conversion
     feature and warrants - secured convertible debt                  (771,429)         (144,535)
  Gain (loss) on adjustment of compound embedded derivative
     to fair value                                                     298,616          (265,928)
  Interest income                                                       18,275             7,385
  Other income                                                         321,378            15,463
  Amortization of deferred financing costs - secured
     convertible debt                                                 (107,170)         (116,167)
  Warrant expense from common stock and equipment financing         (1,024,940)             --
                                                                  ------------      ------------
                                                                    (1,667,342)         (821,049)

Income (loss) before tax expense                                       179,103        (2,979,960)
                                                                  ------------      ------------

Tax expense                                                               --                --

Net income (loss)                                                      179,103        (2,979,960)
                                                                  ============      ============


Earnings per share:
  Basic net income (loss) per share                               $       0.01      $      (0.24)
                                                                  ============      ============
  Diluted net income (loss)  per share                            $       0.01      $      (0.24)
                                                                  ============      ============

Weighted average common shares outstanding:
  Basic                                                             13,295,169        12,643,180
                                                                  ============      ============
  Diluted                                                           16,245,998        12,643,180
                                                                  ============      ============

     The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
                                      F-4
<PAGE>

                            PACIFIC BIOMETRICS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                              YEARS ENDED JUNE 30,
<TABLE><CAPTION>
                                                                                                  2006              2005
                                                                                                                 (restated)
                                                                                              ------------      ------------
<S>                                                                                           <C>               <C>
Cash flows from operating activities:
    Net income (loss)                                                                         $    179,103      $ (2,979,960)

    Adjustment to reconcile net income (loss) to net cash provided by operating
    activities:
       Depreciation and amortization                                                               256,889           152,505
       Warrant expense from common stock financing                                               1,024,940              --
       Amortization of fair value assigned to beneficial conversion feature and warrants
          on secured convertible note                                                              771,429           144,535
       Amortization of deferred financing costs on secured convertible note                        107,170           (43,832)
       Derivative liability relating to secured convertible note                                  (298,616)          265,928
       Compensation (income) expense from fair value adjustment to re-priced employee
          options                                                                                      395            (1,457)
       Compensation expense from exercise of stock options                                             548              --
       Changes in assets and liabilities:
          Accounts receivable, net                                                              (1,369,722)         (240,418)
          Other receivable                                                                        (256,243)             --
          Prepaid expenses and other assets                                                        231,645          (338,222)
          Advances from clients                                                                    269,012           486,639
          Accounts payable                                                                         111,175           (41,104)
          Accrued liabilities                                                                     (346,409)          198,281
                                                                                              ------------      ------------
            Net cash provided by (used in) operating activities                                    681,317        (2,397,105)
                                                                                              ------------      ------------

Cash flows from investing activities:
    Purchases of capital equipment                                                                (512,684)         (182,393)
                                                                                              ------------      ------------
            Net cash used in investing activities                                                 (512,684)         (182,393)
                                                                                              ------------      ------------

Cash flows from financing activities:
    Payments on notes payable                                                                     (370,492)         (315,935)
    Payments on notes payable to related parties                                                      --             (22,183)
    Transfer to restricted cash                                                                       --              71,395
    Net proceeds line of credit                                                                    350,000              --
    Payments on capital lease obligation                                                           (51,993)          (48,253)
    Net proceeds from private placement of common stock                                          3,963,045              --
    Proceeds from secured convertible note payable, net of financing
       cost - Laurus Master Funds                                                                     --           1,392,000
                                                                                              ------------      ------------
Net cash provided by financing activities                                                        3,890,560         1,077,024
                                                                                              ------------      ------------

Net increase (decrease) in cash and cash equivalents                                             4,059,193        (1,502,474)
Cash and cash equivalents, beginning of year
                                                                                                 1,438,543         2,941,014
                                                                                              ------------      ------------
Cash and cash equivalents, end of year                                                        $  5,497,736      $  1,438,543
                                                                                              ============      ============


Non-Cash investing and financing activities:
           Non-cash proceeds from exercise of stock options and warrants                      $      1,022      $       --
           Warrants issued in consideration of issuance costs for private placement           $    300,154      $       --
           Warrants issued to private placement investors                                     $    599,149      $       --
           Warrants issued in conjunction with equipment financing                            $     34,723      $       --
           Common stock issued to Laurus Master Funds - convertible feature                   $    646,600      $     63,600
           Common stock issued in prepayment of R&D costs to UTEK                             $       --        $     84,993
           Common stock issued in prepayment of public relations costs to IRG                 $       --        $    101,250
           Fair value of beneficial conversion feature on secured convertible note                              $    229,989
           Warrants issued in conjunction with secured convertible note                                         $    589,743
           Adjustment to beneficial conversion feature and warrants issued in conjunction
              with amendments  to secured convertible notes                                   $       --        $    512,578

Supplemental Information:
                  Income tax paid                                                             $       --        $       --
                  Interest paid during the year                                               $    408,311      $    272,914


                    The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
                                       F-5
<PAGE>

                            PACIFIC BIOMETRICS, INC.
            CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE><CAPTION>

                                                    Series A Preferred
                                                          Stock                       Common Stock
                                              ----------------------------    ----------------------------      Treasury
                                                 Shares          Amount          Shares          Amount          Stock
                                              ------------    ------------    ------------    ------------    ------------
<S>                                           <C>             <C>             <C>             <C>             <C>
Balance June 30, 2004 - RESTATED - Note 17       1,550,000    $     15,500      13,048,820    $    302,215    ($     1,423)

Fair value adjustment to options                      --              --              --              --              --

Common stock issued to Laurus Master Funds            --              --              --              --              --
     for note payment                                 --              --            60,000             600            --
Common stock issued to UTEK Corporation for
     strategic alliance agreement-cancelled
     6/23/05                                          --              --            91,885             920            --
Common stock issued to IRG Corporation for            --              --
     public relations services agreement              --              --           125,000           1,250            --
Adjustment to fair value of beneficial
     conversion feature and warrants in
     conjunction with amendments to secured
     convertible note payable                         --              --              --              --              --
Fair value of warrants issued to lender in
     conjunction  with secured convertible note
     payable                                          --              --              --              --              --
Adjustment to fair value of beneficial                --              --
     conversion feature in conjunction with
     secured convertible note payable                 --              --              --              --              --

RESTATED - Note 17                                    --              --              --              --              --
Net loss for year ended June 30, 2005                 --              --              --              --              --
                                              ------------    ------------    ------------    ------------    ------------
Balance June 30, 2005 - RESTATED Note 17         1,550,000          15,500      13,325,705         304,985          (1,423)
Warrants issued in conjunction with private
placement of common stock                             --              --              --              --              --
Fair value of warrants issued to lender in
conjunction  with non-revolving line of
credit                                                --              --              --              --              --
Fair value adjustment to stock options                --              --              --              --              --
Common stock issued to Laurus Master Funds
for note payment                                      --              --           610,000           6,100            --
Fair value of warrants issued to placement
agent - Laurus Master Funds note payment              --              --              --              --              --
Common stock issued to investors - private
placement of common stock and warrants                --              --         3,185,231          31,853            --
Cancellation of common stock released from            --
escrow, previously held in trust as
security for note payable                             --              --          (583,333)         (5,833)           --
Common stock issued for conversion of
preferred Series A shares                             --              --         1,791,907          17,919            --

Preferred Series A shares converted into
common stock                                    (1,550,000)        (15,500)           --              --              --

Stock options exercised - cashless exercise           --              --             7,374              74            --

Income tax (expense) benefit - deferred tax           --              --              --              --              --

Net income for year ended June 30, 2006               --              --              --              --              --
                                              ------------    ------------    ------------    ------------    ------------

Balance June 30, 2006                                 --      $       --        18,336,884    $    355,098    ($     1,423)
                                              ============    ============    ============    ============    ============

                                                                                  Total
                                               Additional                     Stockholders'
                                                Paid-in       Accumulated       Equity
                                                Capital         Deficit        (Deficit)
                                              ------------    ------------    ------------
Balance June 30, 2004 - RESTATED - Note 17    $ 22,080,788    ($23,119,084)   $   (722,004)

Fair value adjustment to options                    (1,457)           --            (1,457)

Common stock issued to Laurus Master Funds          63,000            --
     for note payment                                 --              --            63,600
Common stock issued to UTEK Corporation for
     strategic alliance agreement-cancelled
     6/23/05                                        84,075            --            84,994
Common stock issued to IRG Corporation for
     public relations services agreement           100,000            --           101,250
Adjustment to fair value of beneficial
     conversion feature and warrants in
     conjunction with amendments to secured
     convertible note payable                      512,578            --           512,578
Fair value of warrants issued to lender in
     conjunction  with secured convertible not
     payable                                       229,989            --           229,989
Adjustment to fair value of beneficial
     conversion feature in conjunction with
     secured convertible note payable              589,743         589,743

RESTATED - Note 17                              (1,332,310)           --        (1,332,310)
Net loss for year ended June 30, 2005                 --        (2,979,960)     (2,979,960)
                                              ------------    ------------    ------------
Balance June 30, 2005 - RESTATED Note 17        22,326,406     (26,099,044)     (3,453,577)
Warrants issued in conjunction with private
placement of common stock                          978,137            --           978,137
Fair value of warrants issued to lender in
conjunction  with non-revolving line of
credit                                               7,142            --             7,142
Fair value adjustment to stock options                 (79)           --               (79)
Common stock issued to Laurus Master Funds
for note payment                                   640,500            --           646,600
Fair value of warrants issued to placement
agent - Laurus Master Funds note payment            39,661            --            39,661
Common stock issued to investors - private
placement of common stock and warrants           3,931,192            --         3,963,045
Cancellation of common stock released from
escrow, previously held in trust as
security for note payable                             --              --            (5,833)
Common stock issued for conversion of
preferred Series A shares                          (17,919)           --              --

Preferred Series A shares converted into
common stock                                        15,500            --              --

Stock options exercised - cashless exercise            948            --             1,022

Income tax (expense) benefit - deferred tax           --              --              --

Net income for year ended June 30, 2006               --           179,103         179,103
                                              ------------    ------------    ------------

Balance June 30, 2006                         $ 27,921,488    ($25,919,941)   $  2,355,222
                                              ============    ============    ============

        The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
                                      F-6
<PAGE>

                            PACIFIC BIOMETRICS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.       ORGANIZATION AND BASIS OF PRESENTATION

Pacific Biometrics, Inc., a Delaware corporation ("PBI" or the "Company"),
provides specialty reference laboratory services to the pharmaceutical and
diagnostics industries. The Company was incorporated in Delaware in May 1996.
The Company conducts its business primarily through its wholly owned subsidiary,
Pacific Biometrics, Inc., a Washington corporation ("PBI-WA"). The Company's
other wholly owned subsidiaries include PBI Technology, Inc., a Washington
corporation, and BioQuant, Inc., a Michigan corporation.

The Company had previously been engaged in the development and commercialization
of non-invasive diagnostics to improve the detection and management of chronic
diseases. Due to a lack of significant resources, the Company had suspended such
activities. With the recent infusion of capital from the Company's private
placement of common stock, the Company has decided to allocate a small portion
of the proceeds to business development activities for the technologies held by
PBI Technology, Inc. Except for the revenues from laboratory services, nominal
revenues have been generated from the Company's products. Laboratory services
constitute the majority of the Company's commercial efforts.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

These consolidated financial statements include consolidated financial position,
results of operations, and statements of stockholders' equity and cash flows of
Pacific Biometrics, Inc. and its subsidiaries. All material intercompany
balances and transactions have been eliminated in the accompanying consolidated
financial statements.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents consist of highly liquid investments with an original
maturity of three months or less when purchased.

ACCOUNTS RECEIVABLE

Accounts receivable are stated at amounts billed to and due from clients net of
an allowance for doubtful accounts. Credit is extended based on evaluation of a
client's financial condition, and collateral is not required. In determining the
adequacy of the allowance, management identifies specific receivables for which
collection is not certain and estimates the potentially uncollectible amount
based on the most recently available information. The Company writes off
accounts receivable when they are determined to be uncollectible, and payments
subsequently received on such receivables are credited to the allowance for
doubtful accounts. For the years ended June 30, 2006 and 2005, the Company
deemed no accounts receivable uncollectible.

LONG -LIVED ASSETS

Property and equipment are recorded at cost. Depreciation is provided using the
straight-line method over the useful lives of the related assets, which range
from three to five years. Leasehold improvements are amortized over the shorter
of the estimated useful life of the improvements or the remaining term of the
lease. The cost and related accumulated depreciation of property or equipment
sold or otherwise disposed of are removed from the accounts and the resulting
gains or losses are included in the statement of operations.

In accordance with the Financial Accounting Standards Board's Statements of
Financial Accounting Standards Statement No. 144 - "ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS" ("SFAS 144"), all of the Company's
long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate the carrying amount may not be recovered. If the sum of
the expected future cash flows is less than the carrying amount of the asset, a
loss is recognized.

                                      F-7
<PAGE>

TECHNOLOGY ASSETS

PBI Technology, Inc., a wholly owned subsidiary of the Company, has been
established to hold certain technologies and intellectual property, including
isothermal DNA amplification method (LIDA), Cell Viability technology,
Osteopatch and Saliva Sac(R). The Company wrote off the entire balance of
$476,874 related to the technology assets to operations as impairment of
technology assets as of June 30, 2004. With the infusion of capital from the
Company's private placement of common stock in March and April 2006, the Company
has decided to allocate a portion of the proceeds to business development
activities for the technologies held by PBI Technology, Inc.

CLIENT ADVANCES

The Company receives advances from certain clients to perform consulting,
laboratory services, and clinical studies. These advances are applied as
payments to invoices as work is completed until the amounts advanced are
exhausted. Advances are also applied to invoices for setup and administrative
fees, billed upon contract approval. These setup and administrative fees are
deferred as unearned income when billed and amortized over the life of the
project.

INCOME TAXES

The Company recognizes deferred tax assets and liabilities based on differences
between the financial reporting and tax bases of assets and liabilities using
the enacted tax laws and rates that are expected to be in effect when the
differences are expected to be recovered. The Company provides a valuation
allowance for deferred tax assets due to the uncertainty of realization. The
Company follows SFAS 109, as amended, to prepare income tax reporting.

FINANCIAL INSTRUMENTS

The carrying amounts of cash, cash equivalents, and accounts receivable
approximate fair value due to the short-term maturities of these instruments.
The carrying value of the Company's secured convertible note is recorded net of
the unamortized fair value assigned to beneficial conversion feature and
warrants, representing its estimated fair value. (See Note 9.) The carrying
value of the Company's other debt approximates their estimated fair values due
to the rates of interest on the debt approximate current interest rates for
similar obligations with like maturities.

DERIVATIVE FINANCIAL INSTRUMENTS

The Company generally does not use derivative financial instruments to hedge
exposures to cash-flow or market risks. However, certain other financial
instruments, such as the embedded conversion features of debt instruments that
are indexed to the Company's common stock, are classified as liabilities when
either (a) the holder possesses rights to net-cash settlement or (b) physical or
net share settlement is not within the control of the Company. In such
instances, net-cash settlement is assumed for financial accounting and
reporting, even when the terms of the underlying contracts do not provide for
net-cash settlement. Such financial instruments are initially recorded at fair
value and subsequently adjusted to fair value at the close of each reporting
period. Fair value for option based derivative financial instruments is
determined using the Black-Scholes option pricing model.

FINANCIAL DERIVATIVES - BENEFICIAL CONVERSION FEATURE AND WARRANTS

Embedded beneficial conversion features that meet the definition of derivative
financial instruments have, where applicable, been bifurcated from host
instruments (secured convertible notes - see Note 8. Notes Payable and Note

                                      F-8
<PAGE>

16. Restatement) and, in all instances derivative financial instruments have
been recorded as assets or liabilities and are carried at fair value, using the
Black-Scholes pricing model. The Company records the value allocated to warrants
issued with the convertible instruments, measured at fair value, using the
Black-Scholes pricing model and recognized by allocating a portion of the
proceeds to a derivative liability with an offset to discount on the convertible
instrument. The recorded discount is amortized as interest expense using the
straight-line interest method over the life of the debt.

STOCK-BASED COMPENSATION

The Company has traditionally applied APB Opinion 25, "ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES," and related interpretations in accounting for its
stock-based employee compensation plan. Beginning with the quarter ended March
31, 2006, the Company has adopted the provisions of SFAS No. 123(R), "ACCOUNTING
FOR STOCK-BASED COMPENSATION." For the fiscal year ended June 30, 2006 and June
30, 2005, the Company granted 125,000, granted prior to March 31, 2006,and
253,000, respectively, of incentive-based stock options under incentive
compensation plans. For prior reporting periods, had compensation cost been
determined based on the fair value of stock options granted in a manner
consistent with the method promulgated by SFAS No. 123, the Company's net loss
and loss per share would have been changed to the pro forma amounts in the table
below for the fiscal year ended June 30, 2006 and June 30, 2005. The Company
will continue to disclose on a pro forma basis according to SFAS No. 123 during
the transition period to be in accordance with SFAS No. 123(R).

                                                       Years Ended June 30,
                                                      2006             2005
                                                  ------------     ------------
          Net income (loss), as reported          $    179,103     $ (2,979,960)

          Adjust:  Total stock-based employee
          compensation expense
          determined under fair value based
          method for all awards, net
          of related tax effects                        62,135          241,500
                                                  ------------     ------------

          Pro forma net income (loss)             $    116,968     $ (3,221,460)
                                                  ============     ============


          Net income (loss) per share:

            Basic - as reported                   $       0.01     $      (0.24)
                                                  ============     ============
            Diluted - as reported                 $       0.01     $      (0.24)
                                                  ============     ============

            Basic - pro forma                     $       0.01     $      (0.24)
                                                  ============     ============
            Diluted - pro forma                   $       0.01     $      (0.24)
                                                  ============     ============

To estimate compensation expense, the Company uses the Black-Scholes
option-pricing model and assumptions deemed reasonable by management. The
options are valued as of the date of grant. If the date of grant had been June
30, 2006, the following assumptions would have been used to compute the fair
value of option grants for the year ended June 30:

                                                      2006             2005
                                                  ------------     ------------
          Expected volatility                               83%             108%
          Expected dividend yield                            0%               0%
          Risk-free interest rate                         5.05%            3.94%
          Expected life                               10 years         10 years

REVENUE RECOGNITION

The Company recognizes revenue in the period that the related services are
performed and collectibility is reasonably assured. Currently, the Company
derives substantially all of its revenues from laboratory services. Service
contracts generally take the form of fixed-price contracts. Under fixed-price
contracts, revenue is recognized as services are performed, with performance
generally assessed using output measures, such as units-of-work performed to
date as compared to the total units-of-work contracted. Changes in the scope of
work generally result in a renegotiation of contract pricing terms and/or a
contract amendment. Renegotiated amounts are not

                                      F-9
<PAGE>

included in net revenues until earned, and realization is assured. Advance
payments on service contracts are treated as a deposit and applied to periodic
billing during the contract period. Setup and administrative fees are billed
upon contract approval. Revenues from setup and administrative fees are
amortized over the life of the contract. Historically, costs are not deferred in
anticipation of work on contracts after they are awarded, but instead are
expensed as incurred. All out-of-pocket costs are included in expenses.

RESEARCH AND DEVELOPMENT EXPENSES

Expenditures for research and development are expensed as incurred.

EARNINGS (LOSS) PER SHARE

Basic net income (loss) per share is based upon the weighted average number of
common shares outstanding. Diluted earnings per share is computed on the basis
of the weighted average number of common shares outstanding plus the effect of
outstanding stock options and warrants using the "treasury stock" method and the
effect of preferred stock on an as-converted basis. All per share calculations
exclude treasury shares. Shares held in trust as security for a note payable
were excluded for the fiscal year ended June 30, 2005. For the fiscal year ended
June 30, 2006, pursuant to payment of the note payable, the shares previously
held in trust as security were released. (See Note 13 - Promissory Note to Prior
Landlord). As of June 30, 2006, vested, in-the-money options to purchase
1,175,101 shares of common stock and in-the-money warrants to purchase 1,775,727
shares of common stock were outstanding and were included in the computation of
diluted earnings per share for fiscal 2006, but were not included in the
computation of diluted loss per share because the effect would be antidilutive
for fiscal 2005. Shares of Series A preferred convertible stock were also not
included in the computation of diluted loss per share because the shares of
Series A preferred stock were converted into common stock during April of the
fiscal year ended June 30, 2006.

As of June 30, 2005, vested, in-the-money options to purchase 812,123 shares of
common stock and in-the-money warrants to purchase 570,727 shares of common
stock were outstanding, but were not included in the computation of diluted loss
per share because the effect would be antidilutive. In addition, 1,550,000
shares of Series A preferred stock convertible into 516,667 shares of common
stock were also not included in the computation of diluted loss per share
because the effect would be antidilutive.

USE OF ESTIMATES

In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America ("U.S. GAAP"), management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

NEW ACCOUNTING PRONOUNCEMENTS

In March 2006, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 156, "Accounting for Servicing of Financial
Assets--an amendment of FASB Statement No. 140." This statement requires an
entity to recognize a servicing asset or servicing liability each time it
undertakes an obligation to service a financial asset by entering into a
servicing contract in any of the following situations: a transfer of the
servicer's financial assets that meets the requirements for sale accounting; a
transfer of the servicer's financial assets to a qualifying special-purpose
entity in a guaranteed mortgage securitization in which the transferor retains
all of the resulting securities and classifies them as either available-for-sale
securities or trading securities; or an acquisition or assumption of an
obligation to service a financial asset that does not relate to financial assets
of the servicer or its consolidated affiliates. The statement also requires all
separately recognized servicing assets and servicing liabilities to be initially
measured at fair value, if practicable and permits an entity to choose either
the amortization or fair value method for subsequent measurement of each class
of servicing assets and liabilities. The statement further permits, at its
initial adoption, a one-time reclassification of available for sale securities
to trading securities by entities with recognized servicing rights, without
calling into question the treatment of other available for sale securities under
Statement 115, provided that the available for sale securities are identified in
some manner as offsetting the entity's exposure to changes in fair value of
servicing assets or servicing liabilities that a servicer

                                      F-10
<PAGE>

elects to subsequently measure at fair value and requires separate presentation
of servicing assets and servicing liabilities subsequently measured at fair
value in the statement of financial position and additional disclosures for all
separately recognized servicing assets and servicing liabilities. This statement
is effective for fiscal years beginning after September 15, 2006, with early
adoption permitted as of the beginning of an entity's fiscal year. Management
believes the adoption of this statement will have no immediate impact on the
Company's financial condition or results of operations at June 30, 2006.

In February 2006, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 155, "Accounting for Certain Hybrid Financial
Instruments, an Amendment of FASB Standards No. 133 and 140" (hereinafter "SFAS
No. 155"). This statement established the accounting for certain derivatives
embedded in other instruments. It simplifies accounting for certain hybrid
financial instruments by permitting fair value remeasurement for any hybrid
instrument that contains an embedded derivative that otherwise would require
bifurcation under SFAS No. 133 as well as eliminating a restriction on the
passive derivative instruments that a qualifying special-purpose entity ("SPE")
may hold under SFAS No. 140. This statement allows a public entity to
irrevocably elect to initially and subsequently measure a hybrid instrument that
would be required to be separated into a host contract and derivative in its
entirety at fair value (with changes in fair value recognized in earnings) so
long as that instrument is not designated as a hedging instrument pursuant to
the statement. SFAS No. 140 previously prohibited a qualifying special-purpose
entity from holding a derivative financial instrument that pertains to a
beneficial interest other than another derivative financial instrument. This
statement is effective for fiscal years beginning after September 15, 2006, with
early adoption permitted as of the beginning of an entity's fiscal year.
Management believes the adoption of this statement will have no immediate impact
on the Company's financial condition or results of operations at June 30, 2006.

In May, 2005, The Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 154, "Accounting Changes and Error
Corrections - a Replacement of APB Opinion No. 20 and FASB Statement No. 3
("hereinafter" "SFAS No. 154"). This statement replaces APB Opinion No. 20,
"Accounting Changes" and FASB Statement No. 3, "Reporting Accounting Changes in
Internal Financial Statements" and revises the requirements regarding accounting
for and reporting a change in accounting principle. This statement requires
retrospective application of the accounting change to the financial statements
of prior periods, unless it is impractical to determine the period-specific
effects or the cumulative effect of changing to the new accounting principle.
This statement also addresses the reporting issues related to a change in
accounting principle if it is impractical to determine the period-specific
effects or the cumulative effect of the change. The initial adoption of this
statement had no immediate material effect on the Company's financial condition
or results of operations for the fiscal year ended June 30, 2005. As of June 30
2006, the Company followed SFAS No. 154 in restatement of results for fiscal
years 2004 and 2005 (see note 16. Restatement).

In December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123(R), "Accounting for Stock Based
Compensations" (SFAS 123R). This statement supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and its related implementation
guidance. This statement establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. It also addresses transactions in which an entity incurs liabilities
in exchange for goods or services that are based on the fair value of the
entity's equity instruments or that may be settled by the issuance of those
equity instruments. This statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. This statement does not change the accounting guidance for share
based payment transactions with parties other than employees provided in
Statement of Financial Accounting Standards No. 123(R). This statement does not
address the accounting for employee share ownership plans, which are subject to
AICPA Statement of Position 93-6, "Employers' Accounting for Employee Stock
Ownership Plans." The Company has adopted SFAS No. 123(R) and is recognizing the
effect for employee stock compensation during fiscal year 2006 in accordance
with SFAS No. 123(R) beginning with the quarter ended March 31, 2006. Because
the Company did not grant any stock options in the third or fourth quarter of
the fiscal year ended June 30, 2006, the adoption of this statement has no
immediate impact on the Company's financial statements, although it will for
future periods.

In December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 153 (hereinafter "SFAS No. 153"). This
statement addresses the measurement of exchanges of nonmonetary assets. The
guidance in APB Opinion No. 29, "Accounting for Nonmonetary Transactions," is
based on the

                                      F-11
<PAGE>

principle that exchanges of nonmonetary assets should be measured based on the
fair value of the assets exchanged. The guidance in that opinion, however,
included certain exceptions to that principle. This statement amends Opinion 29
to eliminate the exception for nonmonetary exchanges of similar productive
assets and replaces it with a general exception for exchanges of nonmonetary
assets that do not have commercial substance. A nonmonetary exchange has
commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. This statement is effective
for financial statements for fiscal years beginning after June 15, 2005. During
the year ended June 30, 2006, the Company adopted SFAS No. 153. The Company has
determined that there was no financial impact from the adoption of this
statement.

In November 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 151, "Inventory Costs-- an
amendment of ARB No. 43, Chapter 4". This statement amends the guidance in ARB
No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal
amounts of idle facility expense, freight, handling costs, and wasted material
(spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that ". . .
under some circumstances, items such as idle facility expense, excessive
spoilage, double freight, and rehandling costs may be so abnormal as to require
treatment as current period charges. . . ." This statement requires that those
items be recognized as current-period charges regardless of whether they meet
the criterion of "so abnormal." In addition, this statement requires that
allocation of fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. This statement is effective
for inventory costs incurred during fiscal years beginning after June 15, 2005.
Management does not believe the adoption of this statement will have any
immediate material impact on the Company.

3.       CONCENTRATION OF CREDIT RISK

The largest client in fiscal 2006 individually accounted for approximately 36%
and 23% of the Company's total revenues in fiscal 2006 and 2005, respectively,
while the Company's largest client in fiscal 2005 accounted for approximately
23% and 36% of the Company's total revenues in fiscal 2005 and 2004,
respectively. As of June 30, 2006 and 2005, respectively, approximately 27% and
60% of the Company's accounts receivable balance was from the two largest
clients at that time.

The Company maintains its cash in two commercial accounts at major financial
institutions. Although the financial institutions are considered creditworthy
and have not experienced any losses on their deposits, at June 30, 2006, the
Company's cash balance exceeded Federal Deposit Insurance Corporation (FDIC)
limits by $5,397,737 and at June 30, 2005, the Company's cash balance in one
account exceeded (FDIC) limits by $1,338,543.

4.       PREPAID EXPENSES AND OTHER ASSETS

Prepaid expenses consisted of the following at June 30:
<TABLE><CAPTION>
                                                                   2006             2005
                                                               ------------     ------------
<S>                                                            <C>              <C>
          Laboratory Information System Software .........     $    233,477     $    216,405
          Backup Power Generator .........................             --            132,585
          Investor Relations Consulting ..................           14,464           59,063
          Laboratory Equipment ...........................            1,929           47,725
          Insurance ......................................           39,801           47,140
          Commissions ....................................             --             25,187
          Property Taxes .................................           12,402           24,731
          Service Contracts ..............................           44,689           22,378
          Trade Show and Conference Fees .................            6,750           19,000
          Other ..........................................           10,454            7,230
                                                               ------------     ------------
                                                               $    363,966     $    601,444
                                                               ============     ============
</TABLE>

5.       PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at June 30:

                                      F-12
<PAGE>

<TABLE><CAPTION>
                                                                   2006             2005
                                                               ------------     ------------
<S>                                                            <C>              <C>
          Laboratory equipment ...........................     $  1,010,112     $    773,389
          Computer equipment .............................          357,345          255,028
          Office furniture and equipment .................          180,158          101,480
          Leasehold improvements .........................          168,507           73,541
                                                               ------------     ------------
          Total property and equipment ...................        1,716,122        1,203,438
          Less: accumulated depreciation and
            amortization .................................        1,022,891          766,002
                                                               ------------     ------------
          Net property and equipment .....................     $    693,231     $    437,436
                                                               ============     ============
</TABLE>

At June 30, 2006 and 2005, respectively, these amounts included assets under
capital leases of $358,856 and $160,487, and related accumulated amortization of
$282,806 and $232,106. Depreciation expense for the fiscal years ended June 30,
2006 and 2005, respectively, was $256,889 and $152,505.

6.       ACCRUED LIABILITIES

Accrued liabilities consisted of the following at June 30:
<TABLE><CAPTION>
                                                                   2006             2005
                                                               ------------     ------------
<S>                                                            <C>              <C>
          Accrued Laurus note costs ......................     $    131,592     $    160,000
          Accrued payroll and related payroll taxes ......          136,060          121,819
          Accrued vacation ...............................           82,556          116,032
          Accrued professional services ..................             --             88,390
          Accrued consulting expense .....................             --             65,000
          Accrued software expense .......................             --             43,281
          Accrued audit fees .............................           28,566           41,002
          Accrued interest expense .......................           27,840           31,689
          Accrued 401(k) .................................           19,449           24,854
          Accrued board of directors fees ................           20,135           13,635
          Accrued commissions ............................             --             13,443
          Accrued fees due to PBRF .......................            7,835            7,835
          Other ..........................................           45,825          119,287
                                                               ------------     ------------
                                                               $    499,858     $    846,267
                                                               ============     ============
</TABLE>

7.       CAPITAL LEASE OBLIGATIONS

The Company leases laboratory and other equipment under capital lease
arrangements. The obligations under capital leases have interest rates ranging
from approximately 7.5% to 17.64% and mature at various dates through 2008.
Annual future minimum lease payments for years subsequent to June 30, 2006 are
as follows:

           2007 ......................................     $   62,253
           2008 ......................................         50,924
           2009 ......................................          4,109
                                                           ----------
          Total minimum payments .....................        117,286
          Less: amount representing interest .........         (8,792)
                                                           ----------
          Obligations under capital leases ...........     $  108,494
                                                           ==========

          Total minimum payments
          Less: current portion ......................     $  108,494
          Long-term portion ..........................        (51,994
                                                           ----------

                                                           $   56,500
                                                           ==========

8.       NOTES PAYABLE

LAURUS DEBT

Effective May 28, 2004, the Company entered into a financing arrangement with
Laurus Master Fund, Ltd., a New York City based investment fund ("Laurus"). The
financing consisted of a $2.5 million secured convertible note with a term of
three years. In connection with the financing, the Company also issued Laurus a
warrant to purchase up to 681,818 shares of common stock at an exercise price of
$1.25, exercisable at any time prior to May 28, 2011. The note bears interest at
an initial rate equal to the prime rate plus two percent (2%) for a total of six
percent (6%),

                                      F-13
<PAGE>

subject to reduction on a month to month basis if certain specified conditions
are met. The note interest rate was equal to 10.25% and 8.25% for the fiscal
years ended June 30, 2006 and 2005, respectively.

Under the terms of the note, the Company was originally obligated to make
monthly payments of accrued interest beginning July 1, 2004 and, commencing
December 1, 2004, monthly payments of $85,000 to reduce the principal amount by
$83,333.

For any cash payments made on the note, the Company is required to pay an amount
equal to 102% of the principal amount due. In addition, the Company can prepay
the note at any time upon payment of an amount equal to 130% of the
then-outstanding principal balance, plus accrued and unpaid interest.

Laurus has the option at any time to convert any or all of the outstanding
principal and accrued and unpaid interest on the note into shares of common
stock at an initial conversion price of $1.06 per share. In addition, for each
monthly payment under the note, Laurus will be obligated to convert a portion of
the monthly payment into common stock at the applicable conversion price, if
certain specified conditions are met. As of June 30, 2006, Laurus had converted
$710,200 in principal into 670,000 shares of the Company's common stock. On June
30, 2006, the principal balance on this first note owing to Laurus was
$1,789,800.

The initial note conversion price ($1.06 per share) is subject to certain
anti-dilution adjustments, including full ratchet anti-dilution if the Company
issues convertible or equity securities at a price per share less than the
conversion price. As security for the obligations to Laurus, the Company and
each of its subsidiaries granted a blanket security interest in all of their
respective assets to Laurus, and the Company entered into a stock pledge with
Laurus for the capital stock in each of its subsidiaries. The Company was
obligated to register with the SEC for resale the shares of common stock that
are issuable upon conversion of the note and upon exercise of the warrant. The
registration was deemed effective by the SEC on September 28, 2004. To date, the
Company has maintained the effectiveness of the registration statement and is
obligated to maintain it effective for up to three years from the closing date.
If the Company fails to comply with the registration obligations, Laurus will be
entitled to certain specified remedies, including monetary liquidated damages.

In conjunction with the financing, the Company incurred and recorded fees of
$293,500 as deferred financing costs, which are being amortized to other expense
over the life of the note. This amount includes a potential payment to the
Company's broker of up to $100,000 should Laurus convert all or a portion of the
2004 Note. At June 30, 2006, the unamortized balance of the deferred financing
costs was $232,787. As of May 6, 2005, the Company modified the amounts being
amortized to other expense to account for the extension of 12 months in the term
of the 2004 Note.

As of May 2004, the Company also recorded discounts to the secured convertible
note in the amount of $683,962 and $573,266, respectively, representing the
value of the beneficial conversion feature and value allocated to the warrant to
purchase 681,818 shares. As of May 6, 2005, the Company modified the discount
balance of the loan to account for the warrants issued as of January 31, 2005
for the postponement of principal payments due and for the warrants issued as of
May 6, 2005 as consideration for the deferral and extension of the 2004 Note. In
accounting for the issuance of the new warrants, the Company recorded discounts
to the secured convertible note of $1,084,906, $452,076, $120,445 and $383,013,
respectively, representing the value of the beneficial conversion feature, the
value allocated to the warrant to purchase 681,818 shares issued on May 28,
2004, the value allocated to the warrant to purchase 200,000 shares issued on
January 31, 2005, and the value allocated to the warrant to purchase 625,000
shares issued on May 6, 2005. The warrant to purchase 625,000 shares represents
the pro-rata share of the May 2004 Note related to the warrant to purchase a
total of 1,000,000 shares issued on May 6, 2005.

Upon conversion of any amounts owing under the note, the Company is obligated to
issue warrants for up to a maximum of 181,818 shares of common stock to its
broker, in the amount of 8% of amounts converted, at an exercise price of $1.25
per share, exercisable for five years.

Effective January 31, 2005, the Company entered into a second financing
arrangement with Laurus for a $1.5 million secured convertible note with a term
of three years. In connection with the financing, the Company issued Laurus a
warrant to purchase up to 326,087 shares of common stock at an exercise price of
$1.37, exercisable at any time prior to January 31, 2012. The note bears
interest at an initial rate equal to the prime rate plus two percent (2%) for a
total of six percent (6%), subject to reduction on a month to month basis if
certain specified conditions are met.

                                      F-14
<PAGE>

The note interest rate was equal to 10.25% and 8.25% for the fiscal years ended
June 30, 2006 and 2005, respectively.

Under the original terms of the note, the Company was obligated to make monthly
payments of accrued interest beginning March 1, 2005 and, commencing August 1,
2005, monthly payments of $51,000 to reduce the principal amount by $50,000.

For any cash payments made on the note, the Company is required to pay an amount
equal to 102% of the principal amount due. In addition, the Company can prepay
the note at any time upon payment of an amount equal to 130% of the
then-outstanding principal balance, plus accrued and unpaid interest.

Laurus has the option at any time to convert any or all of the outstanding
principal and accrued and unpaid interest on the note into shares of common
stock at an initial conversion price of $1.17 per share. In addition, for each
monthly payment under the note, Laurus will be obligated to convert a portion of
the monthly payment into common stock at the applicable conversion price, if
certain specified conditions are met.

The initial note conversion price ($1.17 per share) is subject to certain
anti-dilution adjustments, including full ratchet anti-dilution if the Company
issues convertible or equity securities at a price per share less than the
conversion price.

As security for the obligations to Laurus, the Company and each of its
subsidiaries granted a blanket security interest in all of their respective
assets to Laurus, and the Company entered into a stock pledge with Laurus for
the capital stock in each of its subsidiaries. The Company was obligated to
register with the SEC for resale the shares of common stock that are issuable
upon conversion of the note and upon exercise of the warrant. The registration
was deemed effective by the SEC on April 1, 2005. To date, the Company has
maintained the effectiveness of the registration statement and is obligated to
maintain it effective for up to three years from the closing date. If the
Company fails to comply with the registration obligations, Laurus will be
entitled to certain specified remedies, including monetary liquidated damages.

In conjunction with the January 2005 financing, the Company incurred and
recorded fees of $168,000 as deferred financing costs, which are being amortized
to other expense over the life of the note. This amount includes a potential
payment to the Company's broker of up to $60,000 should Laurus convert all or a
portion of the 2005 Note. At June 30, 2006, the unamortized balance of the
deferred financing costs was $147,156. As of May 6, 2005, the Company modified
the amounts being amortized to other expenses to account for the extension of 12
months in the term of the 2004 Note.

As of January 2005, the Company also recorded discounts to the secured
convertible note of $397,436 and $279,191, respectively, representing the value
of the beneficial conversion feature and value allocated to the warrant to
purchase 326,087 shares. As of May 6, 2005, the Company modified the discount
balance of the loan to account for the warrants issued as of January 31, 2005
for the warrants issued as of May 6, 2005 for the deferral and extension of the
2005 Note. In accounting for the issuance of the new warrants, the Company
recorded discounts to the secured convertible note of $589,743, $229,898, and
$244,356, respectively, representing the value of the beneficial conversion
feature, the value allocated to the warrant to purchase 326,087 shares issued on
January 31, 2005, and the value allocated to the warrant to purchase 375,000
shares issued on May 6, 2005. The warrant to purchase 375,000 shares represents
the pro-rata share of the January 2005 Note related to the warrant to purchase a
total of 1,000,000 shares issued on May 6, 2005.

Upon conversion of any amounts owing under the note, the Company is obligated to
issue warrants for up to a maximum of 105,263 shares of common stock to its
broker, in the amount of 8% of amounts converted, at an exercise price of $1.37
per share, exercisable for five years.

                                      F-15
<PAGE>

LAURUS WAIVER -- MAY 2004 $2.5 MILLION SECURED CONVERTIBLE NOTE

On January 31, 2005, Laurus formally agreed that the Company would not be
required to pay the principal portion of any monthly amount due for the
six-month period from December 2004 through May 2005, and instead such deferred
principal amounts would be due on May 1, 2007, the maturity date of the 2004
Note. There was no change in the interest rate charged by Laurus on the unpaid
principal.

In consideration for the principal payment deferral and the waiver, the Company
issued a warrant to Laurus to purchase up to 200,000 shares of the common stock
of the Company at an exercise price of $1.48. The warrant expires on January 31,
2010. The cost to the Company associated with the issuance of this warrant was
attributed to the discount balance on the May 2004 Note.

LAURUS DEFERRAL AND EXTENSION -- MAY 2004 $2.5 MILLION AND JANUARY 2005 $1.5
MILLION SECURED CONVERTIBLE NOTES

On May 6, 2005, Laurus and the Company amended the terms of the 2004 Note and
the 2005 Note, to provide for a twelve-month deferral and extension of both.
With respect to 2004 Note, Laurus agreed to (a) extend the term for an
additional year, to be due in full on May 28, 2008, and (b) defer 12 months of
principal payments (originally due June 1, 2005 through May 1, 2006) to be paid
monthly beginning June 1, 2007 through May 1, 2008. With respect to the 2005
Note, Laurus agreed to (a) extend the term for an additional year, to be due in
full on January 31, 2009, and (b) defer 12 months of principal payments
(originally due August 1, 2005 through July 1, 2006) to be paid monthly
beginning February 1, 2008 through January 1, 2009, with the balance on the 2005
Note to be paid in full on January 31, 2009.

As a result of these amendments, the first repayments of principal owed to
Laurus on the 2004 and 2005 Notes became due on June 1, 2006 and August 1, 2006,
respectively, and the maturity dates for the 2004 and 2005 Notes are now May 1,
2008 and January 1, 2009, respectively. There was no change in the interest rate
charged by Laurus on the unpaid principal. Furthermore, commencing as of May 31,
2005, the Company adjusted the amortization schedules for the 2004 Note and 2005
Note related to the beneficial conversion feature, stock purchase warrants and
deferred finance costs.

In consideration for the principal payment deferral and the extension of the
2004 and 2005 Notes, the Company issued an additional common stock purchase
warrant to Laurus to purchase up to 1,000,000 shares of the Company's common
stock at an exercise price of $1.05. The warrant expires on May 6, 2010. The
cost to the Company associated with the issuance of this warrant was attributed
to the discount balances of the May 2004 and January 2005 Notes based on the
pro-rata amounts of the respective Notes.

Through June 30, 2006, Laurus has converted a total of $710,200 in principal on
the 2004 Note, leaving a remaining principal balance on the 2004 Note of
$1,789,800. The original principal amount of $1,500,000 on the 2005 Note remains
the same. With these principal conversions, repayments of principal on the 2004
Note are now scheduled to begin in February 2007 at a rate of approximately
$40,000 for the first month and approximately $85,000 for each month thereafter,
per the 102% payment of principal requirement that applies to both notes. These
payments will reduce the outstanding principal of the 2004 Note by $83,333 per
month. Payments on the 2005 Note of $51,000 per month were scheduled to begin in
August 2006. These payments will reduce the outstanding principal of the 2005
Note by $50,000 per month. Any future additional conversions of principal by
Laurus on either Note will further reduce our repayment obligations.

In fiscal years 2004 and 2005, the Company estimated the valuation of the
beneficial conversion feature and the warrants for the May 2004 and January 2005
Notes in accordance with EITF 00-27 and EITF 98-5, using the Black-Scholes
pricing model and other assumptions deemed reasonable by management. At June 30,
2006The Company corrected its accounting for derivative financial instruments,
for the May 2004 and January 2005 Notes, to conform to the requirements of
Statements of Accounting Standards No. 133, as amended, and Financial Accounting
Standards Board Emerging Issues Task Force (EITF) No. 00-19. Embedded beneficial
conversion features that meet the definition of derivative financial instruments
have, where applicable, been bifurcated from host instruments, the May 2004 and
January 2005 Notes, and, in all instances derivative financial instruments have
been recorded as assets or liabilities and are carried at fair value. The
Company restated prior fiscal years results to conform to the requirements of
the Statement of Financial Accounting Standards No. 154, Accounting Changes and
Error

                                      F-16
<PAGE>

Corrections. Net fair value adjustments included in earnings (loss) related to
these instruments amounted to $298,616 and ($265,928) for the fiscal year ending
June 30, 2006 and 2005, respectively. Accordingly, the balances for fiscal years
2004 and 2005 have been restated and balances for fiscal 2006 correctly
accounted for. See OTHER NOTES PAYABLE table below and Note 16. Restatement.

LOAN AND SECURITY AGREEMENT WITH FRANKLIN FUNDING

On November 3, 2005, the Company entered into a loan and security agreement with
Franklin Funding, Inc., providing for a non-revolving line of credit of up to
$500,000 for equipment financing collateralized by the equipment. In connection
with the loan and security agreement, the Company agreed to grant to Franklin
Funding stock purchase warrants to purchase up to 50,000 shares of the Company's
common stock, in increments of 5,000 shares, for each $50,000 borrowed, each
with an exercise price determined as of the respective date of borrowing and
expiration date of 10 years. Through June 30, 2006, the Company borrowed a total
of $350,000 under this equipment line of credit and issued to Franklin Funding
warrants to purchase 35,000 shares, at an exercise price of $1.17 per share, and
the Company recognized expenses of approximately $7,142 related to the grant of
the warrants. The loan and security agreement provides that a maximum of
$500,000 be available for borrowing until May 3, 2006, consequently no further
borrowings may be made under the loan and security agreement.

























                                      F-17
<PAGE>

OTHER NOTES PAYABLE

The Company had the following other notes payable as of June 30:
<TABLE><CAPTION>
                                                                                        2006              2005
                                                                                    ------------      ------------
<S>                                                                                 <C>               <C>
          May 2004 Secured Convertible Note Payable:
          ------------------------------------------
          Secured convertible note to Laurus, secured by all assets, interest
             at prime plus 2% (subject to reduction upon specified conditions),
             monthly payments of $83,333 plus interest beginning May 1, 2006,
             due May 1, 2008                                                        $  2,500,000      $  2,500,000
             Less: Principal amount converted into common stock                         (710,200)          (63,600)
          Less: Fair value of beneficial conversion feature and warrants                (896,701)       (1,497,614)
                                                                                    ------------      ------------
                                                                                         893,099           938,786

             Less: Current Portion                                                      (373,129)          (83,333)
                                                                                    ------------      ------------
             Long-Term Portion                                                      $    519,970      $    855,453
                                                                                    ============      ============


          January 2005 Secured Convertible Note Payable:
          ----------------------------------------------
          Secured convertible note to Laurus, secured by all assets, interest
             at prime plus 2% (subject to reduction upon specified conditions),
             monthly payments of $51,000 plus interest beginning August 1,
             2006, due February 1, 2009                                             $  1,500,000      $  1,500,000

          Less: Fair value of beneficial conversion feature and warrants                (751,509)         (922,025)
                                                                                         748,491           577,975
                                                                                    ------------      ------------

             Less: Current Portion                                                      (550,000)
                                                                                    ------------      ------------

             Long-Term Portion                                                      $    198,491      $    577,975
                                                                                    ============      ============


          Other Notes Payable:
          --------------------
          Loan and security agreement, secured by specific equipment, 17.64%
             interest, monthly payments of $8,709, balloon payment of $30,000
             due August 2006                                                        $     38,148      $    127,188


           Loan and security agreement, secured by specific equipment, 17.64%
              interest, monthly payments of $11,878, balloon payment of $60,000
              due November 2008                                                          310,938              --

          Promissory note to prior landlord, secured by common stock held in
             escrow, 10% interest, quarterly payments of $25,000, due July 31,
             2005 (See Note 13)                                                             --             181,670

          Note payable to Transamerica, secured by security interest in
             previously leased assets, 8% interest October 1, 2003 to February
             28, 2004, 14.123% beginning March 1, 2004, monthly payments
             including interest of $2,000 through February 28, 2004 and $14,500
             thereafter, due October 1, 2005                                                --              47,719

          Demand notes payable, 18% interest, current monthly payments of
             interest only                                                                  --              13,000
                                                                                                      ------------
                                                                                         349,086           369,577
                                                                                    ------------      ------------

             Less: Current Portion                                                       (38,148)         (331,429)
                                                                                    ------------      ------------
             Long-Term Portion                                                      $    310,938      $     38,148
                                                                                    ============      ============
</TABLE>
                                      F-18
<PAGE>

Aggregate maturities of notes payable (at face value, gross of the unamortized
fair value assigned to beneficial conversion feature and warrants related to the
secured convertible note financing with Laurus) are approximately as follows for
the years ending June 30:

                                2007           $   923,129
                                2008             1,599,996
                                2009               766,675
                                               -----------
                                               $ 3,289,800
                                               ===========

9.       PREFERRED AND COMMON STOCK

The Company's common stock currently is quoted on the OTC Bulletin Board under
the symbol "PBME".

SERIES A PREFERRED STOCK

Effective March 31, 2006, the holders of the outstanding shares of Series A
preferred stock entered into an agreement with the Company agreeing to
voluntarily exchange their shares of Series A preferred stock into common stock.
The exchange rate for the Series A preferred stock was based on a price of $1.73
per share, which represents the highest ten-trading day average during the first
30 days after the quarterly results for the second quarter of fiscal 2006
(provided that at least 12,000 shares must have traded during the day in order
for any day to qualify in the average), beginning February 16, 2006. The number
of shares of common stock issuable on exchange equal the total cash
consideration originally paid by the Series A preferred holders (aggregate
amount of $3,100,000) divided by the exchange rate. Accordingly, at a rate of
$1.73, upon delivery to the Company of the Series A preferred stock certificates
for cancellation, the Company issued 1,791,907 shares of common stock and the
outstanding 1,550,000 Series A preferred stock shares were cancelled. After
giving effect to the exchange, the Company no longer has any preferred stock
shares outstanding.

COMMON STOCK

Laurus has the option at any time to convert any or all of the outstanding
principal and accrued and unpaid interest on the May 2004 and January 2005 Notes
into shares of common stock at an initial conversion price of $1.06 or $1.17 per
share, respectively. On various dates throughout fiscal 2006 and fiscal 2005,
Laurus converted at a price of $1.06 a total of $646,600 and $63,600 of the
principal amount, respectively, due under the May 2004 Note into 634,400 and
60,000 shares, respectively, of the Company's common stock. Through June 30,
2006, Laurus has converted a total of $710,200 in principal on the 2004 Note,
leaving a remaining principal balance on the 2004 Note of $1,789,800.

As of June 30, 2006, the Company held treasury common stock in the amount of
82,072 shares. For the fiscal years ended June 30, 2006 and 2005, there were no
shares of common stock added to the treasury stock.














                                      F-19
<PAGE>

10.      INCOME TAXES

The Company follows SFAS 109, as amended, to prepare its income taxes. The
income tax expense reconciled to the tax expense computed at the statutory rate
was approximately as follows during the years ended June 30:
<TABLE><CAPTION>
                                                                                 2006              2005
                                                                             ------------      ------------
<S>                                                                          <C>               <C>
          Tax benefit computed at federal statutory rate                     $     61,000      $ (1,018,000)
          Permanent differences                                                   550,000           133,000
          Valuation allowance (tax benefit of recognizing prior year net
              operating loss carryforward)                                   $   (611,000)     $    885,000
                                                                             ------------      ------------

                                                                             $       --        $       --
                                                                             ============      ============
</TABLE>

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's net deferred tax assets were approximately as follows at June 30:
<TABLE><CAPTION>
                                                                                 2006             2005
                                                                             ------------     ------------
<S>                                                                          <C>              <C>
          Net operating loss carryforward                                    $  4,902,000     $  5,510,000
          Research and experimentation credit                                     326,000          326,000
          Effect of stock option variable pricing                                  50,000           50,000
          Accrued liabilities                                                      22,000           44,000
          Allowance for bad debts                                                  11,000            8,000
          Depreciation and amortization                                            50,000           34,000
                                                                             ------------     ------------
                                                                                5,361,000        5,972,000
          Less valuation allowance                                             (5,361,000)      (5,972,000)
                                                                             ------------     ------------

          Net deferred tax asset                                             $       --       $       --
                                                                             ============     ============
</TABLE>

At June 30, 2006, operating loss carryforwards of approximately $14 million
expiring through 2026 were available to offset future taxable income. For
financial reporting purposes, a valuation allowance of approximately $5,361,000
has been recognized to offset the deferred tax asset due to the uncertainty of
future utilization of net operating loss carryforwards and realization of other
deferred tax assets. For the fiscal year ended June 30, 2006, the valuation
allowance was decreased by approximately $611,000. For the fiscal year ended
June 30, 2005, the valuation allowance was increased by approximately $885,000.

Internal Revenue Code Section 382 places a limitation on the amount of taxable
income that can be offset by carryforwards after a change in control (generally
greater than 50% change in ownership). As a result of these provisions,
utilization of the NOL and credit carryforwards may be limited.

11.      STOCK OPTION PLAN

1996 STOCK INCENTIVE PLAN

The Company's 1996 Stock Incentive Plan (the "1996 Plan") provided for the
issuance of up to 1,800,000 shares of common stock under this Plan. Options
granted under the 1996 Plan may be either incentive stock options within the
meaning of Section 422(b) of the Internal Revenue Code, or nonqualified options.
The Company may also award stock appreciation rights, restricted stock,
performance shares, loans or tax offset payments. The option price of each
incentive stock option granted shall not be less than the fair value of the
underlying common stock, and will expire no later than ten years following the
date of grant. With respect to nonqualified options, the exercise price and term
will be determined at the discretion of the Board. However, the exercise price
will not be less than 85% of the fair value of the underlying stock, and the
term will not exceed a period of ten years. The options generally vest over a
range of immediately to five years. As of June 30, 2006, 583,891 shares of
common stock remained available for future grant under the 1996 Plan.

                                      F-20
<PAGE>

On May 3, 2002, the Company's board of directors voted to reduce the exercise
price of all then outstanding options to $0.06 per share. No initial expense was
recognized on this repricing, as the new exercise price equaled the market value
of the Company's stock on that date. For the fiscal years ended June 30, 2006
and 2005, in accordance with accounting for options under variable pricing
rules, the Company recognized approximately $943 and $3,352, respectively, in
compensation income representing the decrease in the market price of the
Company's common shares to $1.23 and $0.94 per share, as well as the reduction
of 7,374 in the number of outstanding options due to either expiration or
exercise. As long as any of the repriced options remains outstanding, the
Company will recognize compensation expense in the future for all outstanding
repriced stock options if the market value of the common stock increases, and
will recognize income if the market value decreases.

The following is a summary of the activity in the 1996 Plan for the years ended
June 30, 2006 and 2005:
<TABLE><CAPTION>
                                                                  Shares Under Option
                                              ----------------------------------------------------------
                                                     Number             Weighted            Weighted
                                                                         Average             Average
                                                       Of                Exercise         Fair Value of
                                                                         Price per            Options
                                                     Shares                share              Granted
                                              ----------------------------------------------------------
<S>                                                 <C>                 <C>                 <C>
          Options outstanding at June 30, 2004      1,281,396           $     0.77          $     --

                 Granted                              253,000                 1.01
                                                                                                  1.01
                 Exercised                            (10,017)                0.81
                 Terminated                          (148,270)                0.79
                                                   ----------           ----------
          Options outstanding at June 30, 2005      1,376,109                 0.81

                 Granted                              125,000                 0.86

                                                                                                  0.86
                 Exercised                             (7,902)                0.60
                 Terminated                                (0)                0.00
                                                   ----------           ----------
          Options outstanding at June 30, 2006      1,493,207           $     0.82
                                                   ==========           ==========
</TABLE>

The weighted average contractual life remaining of options outstanding at June
30, 2006 is approximately 7.9 years.

As of June 30, 2006, outstanding options had exercise periods which expired over
the following time periods:

                                         Weighted Average
         Exercise        Number           Remaining Life            Number
          Price        Outstanding          (in years)            Exercisable
          -----        -----------          ----------            -----------
          $0.51           183,917                6.2                 183,917
          $0.70             3,000                8.2                   3,000
          $0.8075          60,761                7.4                  60,761
          $0.81           855,529                7.6                 692,978
          $0.86           125,000                9.0                  22,360
          $0.90             6,000                7.7                   6,000
          $0.96            90,000                8.5                  90,000
          $1.01             3,000                8.0                   3,000
          $1.04           160,000                9.0                  44,443
          $1.75             6,000                7.4                   6,000
                       ----------           ---------             ----------
                        1,493,207                7.9               1,112,459
                       ==========           =========             ==========

As of June 30, 2006, the fair value of options to be vested is $396,828.

The 1996 Plan expired by its terms on July 9, 2006, but outstanding options and
awards previously granted under the 1996 Plan continue in accordance with their
terms.

                                      F-21
<PAGE>

2005 STOCK INCENTIVE PLAN

The Company has a Stock Incentive Plan (the "2005 Plan") with 3,000,000 shares
of common stock reserved for issuance under this Plan. Options granted under the
Plan may be either incentive stock options within the meaning of Section 422(b)
of the Internal Revenue Code, or nonqualified options. The Company may also
award stock appreciation rights, restricted stock, performance shares, loans or
tax offset payments. The option price of each incentive stock option granted
shall not be less than the fair value of the underlying common stock, and will
expire no later than ten years following the date of grant. With respect to
nonqualified options, the exercise price and term will be determined at the
discretion of the Board. However, the exercise price will not be less than 85%
of the fair value of the underlying stock, and the term will not exceed a period
of ten years. The options generally vest over a range of immediately to three
years. As of June 30, 2006, 3,000,000 shares of common stock remained available
for future grant under the 2005 Plan.

12.      STOCK PURCHASE WARRANTS

The following is a summary of outstanding warrants as of June 30, 2006 and 2005:
<TABLE><CAPTION>
                                                                                Weighted Average
                                                         Exercise Price         Exercise Price
                                                            per Share             per Share            Number
<S>                                                      <C>                         <C>              <C>
         Warrants outstanding at June 30, 2005           $0.1875 - $1.60             $1.22            4,498,492
                                                         ---------------             -----            ---------

         Warrants outstanding at June 30, 2006           $0.1875 - $1.48             $1.08            3,085,713
                                                         ---------------             -----            ---------
</TABLE>

In May 2005, in connection with the extension and deferral of principal payments
on the $2.5 million secured convertible note and the $1.5 million secured
convertible note and, the Company granted the lender a warrant to purchase up to
1,000,000 shares of common stock at an exercise price of $1.05 per share,
exercisable at any time prior to May 28, 2010.

In January 2005, in connection with a $1.5 million secured convertible note, the
Company granted the lender a warrant to purchase up to 681,818 shares of common
stock at an exercise price of $1.25 per share, exercisable at any time prior to
May 28, 2011. In addition, the Company issued to our broker a five-year warrant,
exercisable as and to the extent that any amounts owing under the convertible
note are converted into common stock, for up to 181,818 shares of common stock
at an exercise price of $1.25 per share. Also in January 2005, in connection
with a the deferral of principal on the $2.5 million secured convertible note,
the Company granted the lender a warrant to purchase up to 200,000 shares of
common stock at an exercise price of $1.48 per share, exercisable at any time
prior to January 31, 2010.

In June 2004, in connection with a $2.5 million secured convertible note, the
Company granted the lender a warrant to purchase up to 681,818 shares of common
stock at an exercise price of $1.25 per share, exercisable at any time prior to
May 28, 2009. In addition, the Company issued to our broker a five-year warrant,
exercisable as and to the extent that any amounts owing under the convertible
note are converted into common stock, for up to 181,818 shares of common stock
at an exercise price of $1.25 per share.

In March and April 2006, in connection with a private placement of common stock,
the Company granted warrants to investors covering 955,600 shares of
unregistered common stock at $1.60 per share and the placement agents covering
225,200 shares of unregistered common stock at $1.60 per share.

13.      COMMITMENTS AND CONTINGENCIES

OPERATING LEASES

The Company has entered into non-cancelable operating leases for office
facilities. Under these leases, the Company is responsible for its proportionate
share of real estate taxes, insurance and common area maintenance costs. Rent
expense was $225,264 and $240,575 for the years ended June 30, 2006 and 2005,
respectively.

                                      F-22
<PAGE>

Future minimum lease payments are as follows:

                             Year Ended June 30,
                             -------------------

                                    2007            $   231,192
                                    2008                 78,052
                                    2009                   --
                                                    -----------
                                                    $   309,244
                                                    ===========

PROMISSORY NOTE TO PRIOR LANDLORD

In May 2003, the Company's prior landlord, the Company, and Saigene Corporation
(a Company shareholder) entered into a settlement agreement confirming amounts
due the prior landlord. Under the terms of the settlement agreement, the Company
and Saigene jointly and severally entered into a promissory note dated May 31,
2003 to the landlord for $320,315. In conjunction with the promissory note and
settlement agreement, and to secure performance thereunder, the Company also
entered into an escrow agreement, providing for 666,666 shares of the Company's
common stock to be held in escrow for the benefit of the landlord. As of June
30, 2006, the balance of the promissory note was $181,670 and the Company had
made payments sufficient to release 583,333 of escrow shares to the Company,
which shares are to be cancelled and are currently outstanding.

SECURITY INTEREST

In connection with its secured convertible note agreements, the Company and each
of its subsidiaries have granted to Laurus Master Fund, Ltd. a secured interest
in all of their assets.


14.      RELATED PARTY TRANSACTIONS

CONSULTING AGREEMENT

On August 28, 2002, the Company entered into a consulting agreement with Mr.
Terry M. Giles, a former director of the Company and greater than 5%
stockholder. Pursuant to the consulting agreement, the Company agreed to engage
Mr. Giles as a consultant and to pay Mr. Giles compensation of $10,000 per month
until the conversion of Mr. Giles shares of Series A preferred stock into common
stock, and until such shares are either (a) registered pursuant to an effective
registration statement, or (b) deemed tradable pursuant to Rule 144. The
conversion of Series A preferred stock was effective as of March 31, 2006,
consequently the consulting agreement was cancelled as of that date. As of June
30, 2006, no amounts were owed relating to this consulting agreement.


15.      RETIREMENT PLAN

The Company has a 401(k) Plan that was reopened to employees in May 2005. The
401(k) Plan covers covers all employees over the age of 21 with 1,000 hours of
service in a 12-month eligibility computation. The Company makes a contribution
equal to one-half of the employee's contribution up to the maximum of 6%. The
Company can make discretionary contributions as determined by its board of
directors, not to exceed the amount permissible under the Internal Revenue Code.
The Company did not make any discretionary contributions in 2005 or 2004. For
the fiscal year ended June 30, 2006, the Company's matching expense was $53,385
and 401(k) payable balance was $19,449.

16.      RESTATEMENT

FINANCIAL DERIVATIVES

The Company corrected its accounting for derivative financial instruments to
conform to the requirements of Statements of Accounting Standards No. 133, as
amended, and Financial Accounting Standards Board Emerging Issues Task Force
(EITF) No. 00-19. The Company previously accounted for these instruments under
EITF 00-27 and EITF 98-5. Embedded beneficial conversion features that meet the
definition of derivative financial instruments have, where applicable, been
bifurcated from host instruments (Laurus secured convertible notes - see note 8.
Notes Payable) and, in all instances derivative financial instruments

                                      F-23
<PAGE>

have been recorded as assets or liabilities and are carried at fair value. The
Company restated prior fiscal years results to conform to the requirements of
the Statement of Financial Accounting Standards No. 154, Accounting Changes and
Error Corrections. Net fair value adjustments included in earnings (loss)
related to these instruments amounted to $298,616 and ($265,928) for the fiscal
year ending June 30, 2006 and 2005, respectively. Accordingly, the balances for
fiscal years 2004 and 2005 have been restated and balances for fiscal 2006 have
been correctly accounted for. The restated values for fiscal years 2004 and 2005
are listed in the following table:
<TABLE><CAPTION>

                         CONSOLIDATED BALANCE SHEETS - Summary of Adjustments for Derivative Liabilities


                                             June 30,       Create          June 30,        June 30,       Adjust        June 30,
                       ASSETS                  2004       Derivative          2004           2005        Derivative        2005
                                            (audited)      Liability       (restated)      (audited)     Liability      (restated)
                                           -----------     ---------       --------------------------    ---------      -----------
<S>                                         <C>             <C>             <C>            <C>            <C>            <C>
                                           -----------                     --------------------------                   -----------
TOTAL ASSETS                                 4,054,530                       4,054,530      3,427,267                     3,427,267
                                           ===========                     ==========================                   ===========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

-----------------------------------------------------------------------------------------------------------------------------------
Compound embedded derivative liability -
   current portion                                             293,352         293,352                       327,111        327,111
-----------------------------------------------------------------------------------------------------------------------------------
          Total current liabilities          2,036,774                       2,330,126      2,448,926                     2,776,035

Capital lease obligations - long term
   portion                                     160,487                         160,487        108,493                       108,493



-----------------------------------------------------------------------------------------------------------------------------------
Secured convertible note - long-term
   portion                                     985,536                         985,536      1,193,783        239,644      1,433,428
-----------------------------------------------------------------------------------------------------------------------------------

-----------------------------------------------------------------------------------------------------------------------------------
Compound embedded derivative liability -
   long- term                                                  963,876         963,876                     2,524,739      2,524,739
-----------------------------------------------------------------------------------------------------------------------------------
Other notes payable - long term portion        336,510                         336,510         38,148                        38,148
          Total liabilities                  3,519,307                       4,776,535      3,789,350                     6,880,843

STOCKHOLDERS' EQUITY (DEFICIT)
    Preferred stock                             15,500                          15,500         15,500                        15,500
    Common stock                               302,214                         302,214        304,985                       304,985
-----------------------------------------------------------------------------------------------------------------------------------
    Additional paid-in capital              23,338,016      (1,257,228)     22,080,788     25,430,844     (3,104,438)    22,326,406
-----------------------------------------------------------------------------------------------------------------------------------
    Accumulated deficit                    (23,119,084)                    (23,119,084)   (26,111,988)        12,944    (26,099,044)
-----------------------------------------------------------------------------------------------------------------------------------
    Treasury stock                              (1,423)                         (1,423)        (1,423)                       (1,423)
          Total stockholders' equity
             (deficit)                         535,223                        (722,005)      (362,083)                   (3,453,577)
                                           -----------                     --------------------------                   -----------
</TABLE>

The restatement of financial statements for the compound embedded derivative
liability, in the balance sheet table above, for fiscal years ended June 30,
2005 and 2004, respectively, did not change any amounts in "TOTAL ASSETS". For
the fiscal year ended June 30, 2004: current liabilities, the "Compound embedded
derivative liability - current portion" shows a gain to the "Total current
liabilities" balance of $293,352; long-term liabilities, the "Compound embedded
derivative liability - long-term portion" shows a gain to the "Total
liabilities" balance of $2,524,739; stockholders' equity, the adjustment shows a
loss to "Additional paid-in capital" of $1,257,288. For the fiscal year ended
June 30, 2005: current liabilities, the "Compound embedded derivative liability
- current portion", shows the balance of the derivative as a gain of $327,111 to
"Total current liabilities", inclusive of the fiscal 2004 total; long-term
liabilities, "the Compound embedded derivative liability - long-term portion",
shows the balance of the derivative as a gain of $2,524,739 to "Total
liabilities", inclusive of the fiscal 2004 total; for stockholders' equity, the
adjustment shows the balance of the derivative as a loss to "Additional paid-in
capital" of $3,104,438 and offsetting adjustments to "Secured convertible note
long-term portion" of $239,644 and to "Accumulated deficit" of $12,944.

                                      F-24