UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

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FORM 10-KSB

|(Mark One)                               |  |                                                                                    
|---------------------------------------- |  | -----------------------------------------------------------------------------------
|                                         |  |                                                                                    
|ý                                        |  | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.    
|For the fiscal year ended April 30, 2004
|o                                        |  | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from            to

Commission file number: 001-12531

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ISONICS CORPORATION(Name of small business issuer in its charter)

|California                                                     |  | 77-0338561                      
|-------------------------------------------------------------- |  | --------------------------------
|(State or other jurisdiction of
incorporation or organization) |  | (IRS Employe
Identification No.)
|5906 McIntyre Street
Golden, Colorado                          |  | 80403                           
|(Address of principal executive offices)                       |  | (Zip Code)                      

Issuer's
telephone number:(303) 279-7900

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

Securities registered pursuant to Section 12(g) of the Act:Common Stock, no par value
Class B Common Stock Purchase Warrants
Redeemable Class C Common Stock Purchase Warrants

(Title
of Class)

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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 twelve (12) months (or for such
shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes ý No o

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B 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. Yes ý No o

Registrant's revenues for the fiscal year ended April 30, 2004 were $8,721,000.

The
aggregate market value of the voting stock held by non-affiliates of the Registrant based on the average bid and asked prices of the Registrant's Common Stock on
July 14, 2004 was $18,442,466. Excludes 3,764,896 shares of common stock held by Directors, Officers and holders of 5% or more of the Registrant's outstanding Common Stock on that date.
Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of
the Registrant, or that such person is controlled by or under common control with the Registrant. There is no non-voting common equity of the Registrant.

The
number of shares outstanding of the Registrant's Common Stock, no par value, as of July 14, 2004, was 18,173,073 shares. The following document is incorporated by reference
into Part III of this Form 10-KSB: None.

Transitional
Small Business Disclosure Format (check
one): Yes o No ý



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ITEM 1. BUSINESS

Because we want to provide you with more meaningful and useful information, this Form 10-KSB contains certain
"forward-looking statements" (as such term is defined in section 21E of the Securities Exchange Act of 1934, as amended). These statements reflect our current expectations regarding our
possible future results of operations, performance, and achievements. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act
of 1995 and applicable common law and SEC rule.

Wherever possible, we have tried to identify these forward-looking statements by using words such as "anticipate," "believe," "estimate," "expect," "plan,"
"intend," and similar expressions. These statements reflect our current beliefs and are based on information currently available to us. Accordingly, these statements are subject to certain risks,
uncertainties, and contingencies, which could cause our actual results, performance, or achievements to differ materially from those expressed in, or implied by, such statements. We have described
these risks, uncertainties and contingencies under "Risk Factors" and "Management's Discussion and Analysis of Financial Condition or Plan of Operation."

We have no obligation to update or revise any such forward-looking statements that may be made to reflect events or circumstances after the date of this
report.

General Discussion

Isonics Corporation

We are an advanced materials and technology company focusing on the supply of isotopes for life sciences and health-care applications and
silicon-on-insulator ("SOI") wafers to the semiconductor industry. Most
recently, in June 2004 we acquired the business and assets of Encompass Materials Group Ltd. ("EMG") which was engaged in the business of manufacturing and reclamation of silicon wafers.
In addition, we continue to develop additional products created from materials whose natural isotopic ratios have been modified as well as non-isotopic (natural) materials. An isotope is
one of two or more species (or nuclides) of the same chemical element that differ from one another only in the number of neutrons in the atom's nucleus. The different number of neutrons can create
significantly different nuclear properties. The most well known of these properties is radioactivity. Radioactive isotopes (or radioisotopes) can be found in nature. Most of our radioisotopes,
however, are man-made. Stable isotopes, as distinguished from radioisotopes, are not radioactive.

Several
manufacturers, located primarily in republics that once were part of the Soviet Union, produce radioactive and stable isotopes. We buy these isotopes from the manufacturers and
resell them in the form of common chemical compounds. For example, oxygen-18 is sold as water, and zinc-68 is sold as zinc oxide. Today our business addresses the material
needs of two primary markets:



While
we currently are focusing on these two markets, we continue to evaluate other applications for stable isotopes, radioisotopes and non-isotopic materials. In
December 2002, we acquired certain isotope-based trace detection technology that can be used to detect explosives and chemical and biological weapons, and we acquired additional technology in
June 2004. In both cases, we acquired this technology through our 85%-owned subsidiary, IUT Detection Technology, Inc. ("IUTDT") from Institut of Umwelttechnologien GmbH ("IUT"), an
entity in which we hold a 6% ownership interest. (IUT owns the remaining 15% of IUTDT.) If and when we begin sales of these detection products, we expect these products to constitute a third market
(the homeland security market) for our products. We are continuing to pursue research and development opportunities with respect to the technology we

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acquired
from IUT under a research and development agreement we entered into with IUT, as well as continuing research and development of our silicon-28 semiconductor materials.

We
also sell isotopes for use in basic scientific research and industrial applications. We believe our core competency is our ability to identify, develop, source, and commercialize
products and services based on isotopically engineered materials as well as non-isotopic semiconductor materials.

During
our 2003 fiscal year, we commenced two new operations. These consist of our SOI wafer manufacturing operation in Vancouver, Washington, and our acquisition of detection technology
from IUT. After the conclusion of our 2004 fiscal year, we expanded our SOI wafer manufacturing operations when we acquired the business and assets of EMG, a Vancouver, Washington-based company
engaged in the business of manufacturing and reclamation of silicon wafers.

We
have been required to make a significant cash investment in our SOI wafer manufacturing operations, our newly-acquired wafer manufacturing and reclamation operations, and for research
and development of our homeland security and silicon-28 semiconductor technology and we will be required to make significant additional investments of cash, personnel, and materials in
these operations in the future. At the end of our most recent fiscal year we had sufficient working capital to finance our anticipated operations and projected negative cash flow into our 2006 fiscal
year. However, as a result of our acquisition of the silicon wafer manufacturing and recycling assets of EMG in June 2004, we will need to raise significant additional capital in fiscal year
2005 if we are to successfully implement our current business plan for the acquired assets. As a result, we are currently working with several different sources, including both strategic and financial
investors, in order to raise the capital necessary to finance both our continuing operations and our newly acquired assets from EMG.

Based
on available funds, financing opportunities, current plans and business conditions, we believe that our available cash, financing sources and amounts generated from operations will
be sufficient to meet our cash requirements for the next 12 months. The assumptions underlying this belief include, among other things, that there will be no material adverse developments in
the business or market in general. There can be no assurances however that those assumed events will occur. If our plans are not achieved, there may be further negative effects on the results of
operations and cash flows, which could have a material adverse effect on our financial position.

We
were formed in March 1992, as a partnership, and were subsequently incorporated in California in March 1993, as A&R Materials, Inc. In September 1996, we
changed our name to Isonics Corporation. Our web site is www.isonics.com. Our common stock is traded on the Nasdaq SmallCap Market under the symbol "ISON." The market for our stock and warrants has
historically been characterized by low volume, and broad price and volume volatility. Although our common stock and warrants have been quoted on the Nasdaq SmallCap market, our stock has at times
traded at prices below the $1.00 per share minimum Nasdaq maintenance requirements. Although currently our common stock is trading above the $1.00 per share minimum, should the market price of our
common stock drop, we would be at risk of Nasdaq action to remove our securities from its SmallCap market. We cannot give any assurance that we will be able to meet the Nasdaq requirements to maintain
our SmallCap listing, or that if we do, a stable trading market will develop for our stock or our warrants.

The
address of our principal executive offices and our telephone and facsimile numbers at that address are:



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We
currently conduct some of our operations through one wholly owned-subsidiary and one partially owned subsidiary. The following chart provides some information about those
subsidiaries:

|Name and Headquarters                              |  | Place of
Formation |  | Ownership
Percentage |   | Business                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|-------------------------------------------------- |  | ------------------ |  | -------------------- | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Chemotrade GmbH
Dusseldorf, Germany
("Chemotrade") |  | Germany            |  | 100                  | % | Chemotrade is a value-added re-seller of stable and radioactive isotopes. It supplies radioactive isotopes for pharmaceutical and industrial research as well as for industrial and medical imaging, calibration sources and
for brachytherapy applications. Additionally, Chemotrade supplies various stable isotope labeled compounds for pharmaceutical research and drug design, as well as oxygen-18 for use in producing a radioisotope used in positron emission tomography.
Chemotrade's market is primarily Europe, North America and Asia.
|IUT Detection
Technologies, Inc.                   |  | Colorado, USA      |  | 85                   | % | IUTDT owns and we anticipate will commercialize the detection technology that we acquired from IUT. This isotope-based trace detection technology will be used to detect explosives and chemical and biological weapons.                                                                                                                                                                                                                                                                                                                            

The
foregoing does not include Isonics' minority ownership in two companies:



In
May 2004 we established our wholly owned subsidiary Isonics Vancouver, Inc. ("Isonics Vancouver"). Isonics Vancouver is a Washington based entity that conducts our SOI and
manufacturing and reclamation of silicon wafer operations.

Trading Symbols

Common Stock

"ISON"Class B Warrants

"ISONL"Class C Warrants

"ISONZ"


Our Isotope Business.In order to develop our isotopic products, it is necessary to increase ("enrich") or decrease
("deplete") the concentration of a particular isotope or isotopes. There are over 280 naturally occurring stable isotopes of 83 different elements. The number of isotopes of any given element varies
widely. Although stable isotopes of a given element typically do not differ significantly in their chemical behavior, they do differ in mass and diameter, as well as several nuclear properties, such
as cross-section, spin, and magnetic moment. Differences in these properties can result in substantially different effects, and some of these different effects have the potential for commercial
application.

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Isotopes
are typically referred to by their atomic mass number, which number is derived from the number of protons and neutrons in the atom's nucleus. For example, oxygen-18
has eight protons and ten neutrons in its nucleus, and silicon-28 has 14 protons and 14 neutrons in its nucleus. In ultra chemically pure crystals, grown for electronics or optical
applications, isotopic impurities can be the greatest contributor to crystal disorder because of mass and diameter differences. Eliminating these variations by using a single enriched isotope (i.e. an
isotopically-pure substance) increases thermal conductivity and optical transparency, thus improving product performance. Similarly, enriching or depleting isotopes based upon their
nuclear cross-sections allows materials to be engineered for applications in the nuclear power industry, for controlled doping of semiconductors in the computer industry, and for use as targets to
produce radioisotopes for the life sciences and other industries.

Stable Isotopes.Stable isotopes may be thought of as extremely pure materials. Not only are these isotopes chemically pure,
but they frequently consist of only one isotope depending on the level of enrichment. This extra degree of purification, accomplished on the sub-atomic level, provides enhanced performance
properties as distinguished from normal (i.e., chemical only) purity materials. Depleted isotopes are the result of the elimination (or reduction in level) of an isotope, or isotopes, and can prevent
the creation of undesirable byproducts in subsequent processing steps. In some instances the undesirable byproducts are produced during the intended use of the non-depleted isotope
material. Stable isotopes have commercial uses in several areas, including, but not limited to:



We
have successfully developed and commercialized several isotope products (notably, even-numbered cadmium isotopes for use with helium-cadmium lasers and depleted zinc oxide
for nuclear power plants). We intend to promote the emergence and growth of new stable isotope applications.

Radioisotopes.The radioisotopes we acquire and sell are typically used in medical diagnostic and therapy applications. A key
property of a radioisotope is its half-life. The half-life is a measure of how fast a radioisotope decays into either a stable isotope or another radioisotope. Since most
radioisotopes used in life science applications have short half-lives, they are rarely found in nature. Therefore, most radioisotopes are manmade and must generally be used shortly after
production. Radioisotopes are typically produced by irradiating a target material (often an enriched or depleted stable isotope) in a nuclear reactor, cyclotron or linac. These devices generate the
appropriate particles required to transmute or convert the target material into the desired radioisotope.

Wafer Manufacturing.As described in more detail below, we commenced manufacturing SOI wafers in our own facility in
November 2002. Also as described in more detail below, we acquired the assets and the manufacturing and reclamation of silicon wafers business from EMG, an unaffiliated entity in
June 2004. We expect that our acquisition of EMG's business and assets will enable us to expand our SOI operations and enter into the business of manufacturing and reclaiming silicon wafers.

Homeland Security.As described in more detail below, in December 2002, we acquired certain isotope-based trace
detection technology to be used to detect explosives and chemical and biological weapons from IUT. In June 2004, we acquired additional technology from IUT and we entered into an agreement with
IUT to continue its research and development efforts with respect to specific products that we believe can be developed from the technology acquired. These products include NeutroTest, a

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hand-held
instrument designed to give first responders a tool for quickly evaluating an explosive threat in the form of a suspicious package or purported explosive device. We believe that
this product (which we expect will be modestly priced) may become an essential item for bomb squads, police departments, fire departments, customs agencies, and security services
world-wide. We believe that the NeutroTest product will be in prototype form in the latter half of calendar 2004, and ready for the commercial market in calendar 2005. The
June 2004 research and development agreement with IUT includes a number of other potential products that are in much earlier stages of development than the NeutroTest product.

Company Strategy

We believe our strength lies in our ability to bring the necessary resources together to identify, evaluate, develop, engineer and successfully commercialize
applications for stable isotopes, radioactive isotopes, non-isotopic materials and value-added products manufactured from these foregoing materials.

We
believe we have created a product development model that can serve as a basis for our current and future expansion. To capitalize on the commercial opportunities that have been
identified for stable isotopes, we have adopted a business strategy designed to maximize the value of our technologies, business development, and management resources, while minimizing capital costs.
This strategy involves:



To
further our strategy, in calendar year 2002 we commenced two new lines of businessthe manufacture and marketing of SOI wafers and the acquisition of detection technology
for the commencement of our homeland security operations. In June 2004 we expanded our SOI wafer manufacturing operations when we acquired the business and assets of EMG, which was engaged in
the business of manufacturing and reclamation of silicon wafers.

Recent Business Dispositions

Sale of Chemotrade Leipzig GmbH ("CTL").On July 31, 2002, Chemotrade sold its
75% interest in CTL to the 25% shareholder for 50,000 Euros (approximately $48,000). In accordance with the sales agreement, the transaction was effective May 1, 2002 with the new 100%
shareholder controlling the operations from that point forward. CTL, which primarily resells oxygen-18, was notified that its then current distribution agreement (which expired on
December 31, 2002) would not be renewed. The loss of this agreement was significant as it accounted for approximately 80% of CTL's revenue and as a result, CTL's
ability to generate revenues after December 31, 2002 was uncertain.

As
a result of this disposition, Chemotrade was free to pursue other opportunities (including selling oxygen-18 throughout the European market) that may have been in conflict
with the interests of

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CTL.
We recognized revenue and gross margin related to CTL of approximately $1,575,000 and $326,000, respectively for the year ended April 30, 2002. We fully replaced the lost revenue during
fiscal year 2003 with additional product sales to new and existing customers both domestically and in Europe.

Products

During fiscal years 2003, and 2004 our revenues were generated from sales of stable and radioactive isotopes and SOI wafers. Our sales mix has remained
approximately the same through July 14, 2004. We expect that our revenues for fiscal year 2005 will reflect a significant increase in revenues as a result of sales of SOI wafers and our entry
into the manufacturing and reclamation of silicon wafers business following our June 2004 acquisition of the assets and business of EMG. We can offer no assurances however that this will come
to fruition.

As
evidenced by the commencement of our own manufacturing operations for SOI wafers, our June 2004 acquisition of the assets and business of EMG and our homeland security
operations, we are attempting to develop new product lines, which we expect to add to our revenue stream in the future. The following is a more specific discussion of our current products.

We Supply Isotopes for Life Sciences Applications

For the past several years, we have supplied stable isotopes in elemental and simple compound forms for use in life science applications. In 1998, we expanded our
product offerings to include radioisotopes. We will continue selling our current stable and radioactive isotope products/services, develop new ones along similar lines and expand our offerings through
vertical integration. From time to time we evaluate building additional isotope production facilities in the United States or Western Europe. Although we currently do not have the capital to build
additional facilities, this is an important aspect of our strategic plan because we expect that it will reduce our reliance on foreign manufacturers and enhance our bottom line. In addition, we are
working towards several solutions that will allow us to expand our value-added manufacturing capabilities.

Our
existing and emerging life sciences products include isotopes used for a large number of purposes and can be categorized as follows:



Although
there is currently little FDA oversight affecting our supply of the raw material isotopes to our customers for their use in life science applications, FDA regulation may
increase in the next few years. It is not immediately apparent what implications any additional regulation may have for us. The following paragraphs provide a brief summary of our existing and
emerging life sciences products:

Biomedical Research.Stable and radioactive isotopes are used by researchers to investigate living
systems, determine the chemical structure of important biological compounds, design new drugs and measure extremely low levels of environmental toxins. Known quantities of isotopes including carbon,
nitrogen, hydrogen, oxygen, and other elements, are combined into thousands of different chemical compounds. These isotopes are then introduced into biological systems and tracked/measured using a
variety of analytic tools. Our products are typically simple labeled-compounds that are used by our customers to synthesize more complex and higher-value compounds. Examples of existing and emerging
applications for these products include:



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Medical Imaging and Therapy.Radioisotopes have been used for years in the diagnosis and treatment of
many medical conditions. The trend in these two areas has been towards more specific labeled compounds that, after labeling with the radioisotope and introduction into the patient, quickly concentrate
at the disease site(s). In theory, the appropriate choices of chemical and radioisotope labels facilitate disease detection and stage determination, which improves therapy selection, administration
and monitoring. The medical community is developing and testing several classes of chemical compounds ranging from monoclonal antibodies to peptides for use in the detection, and, eventually, the
treatment of many diseases. The FDA has approved some of these for use.

We
currently supply stable isotopes of oxygen, thallium, zinc, cadmium, xenon, strontium, and many others that are routinely used in a variety of medical imaging and therapy
applications. These isotopes are used in their enriched stable form, such as xenon-129, or converted to a specific radioactive isotope in a cyclotron or nuclear reactor. We believe that
the increased supply of new isotopes combined with the ongoing development of highly specific biochemical therapies represents a major growth opportunity in this market segment.

The
two applications below represent a significant portion of our revenues this year and we believe they will continue to do so for several years to come. For the first application, we
supply a stable isotope, which is converted by the customer to a radioactive isotope and then is used to detect cancer
and other metabolic disorders. For the second, we supply the radioisotopes as radiochemicals for incorporation by the customer into cancer-fighting therapeutic devices.



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Calibration Standards.There are many medical devices that measure levels of radiation in patients.
These devices need to be calibrated using standards of known radiation strength and type in order to ensure their accuracy. These standards derive from radioisotopes such as cobalt-57 and
gadolinium-153. We supply many of the stable isotope target materials, as well as radioisotopes, to many of the manufacturers of the equipment needing calibration.

Medical
equipment calibration is one of the largest markets for radioactive source standards. These medical devices are found in the nuclear medicine departments at thousands of
hospitals around the world. The continued growth in the numbers and complexity of nuclear medicine imaging equipment, especially PET, ensure growth in the demand for these radioisotopes.

Our Silicon-on-Insulator Wafer Manufacturing and Marketing Operations

SEI License Agreement.On September 14, 2001 we licensed technology owned by Silicon
Evolution, Inc. ("SEI") which allowed us to enter the business of manufacturing SOI wafers and other silicon wafers. We issued 500,000 shares of our newly-created Series B Preferred
Stock to SEI which automatically converted into 500,000 shares of our Common Stock following our November 13, 2001 shareholders' meeting. The license is exclusive, perpetual, and does not bear
any royalty obligation.

The
technology we licensed from SEI allows us to manufacture SOI wafers for integrated circuit component ("IC's" or "Chips") and micro electrical-mechanical system ("MEMS")
manufacturers. We licensed SEI's core intellectual property ("IP") technology for precision wafer polishing, cleaning, and
bonding silicon wafers to produce thick-film SOI wafers in the 100 mm, 150 mm, 200 mm and 300mm form factors.

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SEI filed for Chapter 7 bankruptcy on November 21, 2001. As part of the Bankruptcy Trustee's duties in the case, the Trustee reviewed our entire financial and business
relationship with SEI. Ultimately we entered into a series of agreements with the Trustee in which, among other things, the Trustee:



The
Bankruptcy Court approved all of these agreements and we completed these transactions in April 2003.

SOI Wafer Manufacturing.In an effort to commence our SOI business operations, on December 19,
2001, we entered into an alliance agreement with Silicon Quest International, Inc. ("SQI") whereby SQI agreed to exclusively manufacture and supply SOI wafers for us and to provide certain
sales and marketing services to us as requested. As a result of the establishment of our own thick-film SOI manufacturing facilities, the alliance agreement with SQI was terminated
effective November 22, 2002.

We
shipped our first SOI wafers to one of our customers in late January 2002 and have continued to ship SOI wafers to our customers since that time. Our agreement with SQI
permitted us to commence the manufacturing and marketing of SOI wafers using the technology we licensed from SEI, without
incurring the significant cash investment we originally contemplated. During the years ended April 30, 2004 and 2003, we recognized revenue of $519,000 and $197,000, respectively, related to
the sale of semiconductor materials and products (which included a $200,000 sale of silicon-28 as a bulk isotope in fiscal year 2004). We anticipate increasing our revenues from the sale
of SOI wafers during fiscal year 2005, however we can offer no assurance that this will come to fruition.

In
September 2002, we entered into several lease agreements related to building space, equipment and services in order to establish our own stand-alone wafer manufacturing
facilities ("Fab-1") in Vancouver, Washington. In addition to leasing the building space, we have acquired the equipment necessary to establish our operations through bankruptcy sales (of
which the majority of the cost was offset against our receivable from SEI), draws against our equipment financing agreement with Fidelity Capital and cash acquisitions. We are currently producing
limited amounts SOI wafers at Fab-1.

In
June 2004, we acquired the business and assets of EMG, a Vancouver, Washington-based company engaged in the business of manufacturing and reclamation of silicon wafers. We are
in the process of consolidating our SOI manufacturing operations with the assets and operations we acquired from EMG. We anticipate that this will allow us to expand not only our SOI manufacturing
operations and meet what we believe is the market demand for SOI wafers but also to continue to expand EMG's business of manufacturing and reclamation of silicon wafers.

As
is apparent in the discussion below in "Management's Discussion and Analysis," we are increasing our sales activities but the ramp-up in sales is anticipated to be a slow
process as we still need to complete the certification process with most new potential customers and many potential customers are proceeding cautiously with SOI wafers. Our acquisition of EMG's
business and assets has provided an ISO 9001 certified manufacturing facility and additional business operations of reclaiming and manufacturing silicon wafers, which we will continue in addition to
expanding our SOI operations in the facilities formerly occupied by EMG. As a result, we fully expect to gradually increase our

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revenues
from the sale of SOI wafers and other silicon wafers in fiscal year 2005, although there is a chance that we may not be able to generate significant additional revenue from the sale of SOI
wafers until the last quarter of fiscal year 2005, if at all.

SOI Business Operations.Based on our market research, it appears to us that the use of SOI wafers is
growing rapidly in three major markets:



Chip
designers are relentlessly driven by the marketplace to seek innovative ways to improve device performance in three key areas:



Based
on our review, it appears that the SOI technology enables circuit designers to improve device speed approximately 30%; and as the oxide provides a superior source of insulation,
leakage current is reduced, providing an energy savings of better than 30%, as well as enabling circuits to be spaced on a finer pitch. SOI technology also provides a degree of radiation hardening to
integrated circuits, thus improving circuit reliability and resistance to soft errors caused by background radiation sources. In MEMS and MOEMS fabrication the use of SOI technology wafers
significantly simplifies the manufacturing process.

Silicon Wafer Reclamation and Manufacturing Operations

On June 11, 2004, we completed a transaction by which our wholly-owned subsidiary, Isonics Vancouver, Inc., acquired the silicon wafer reclamation
and manufacturing business and related assets from EMG. To complete the transaction, we paid EMG:



We
completed the transaction pursuant to an asset purchase agreement that we executed on June 7, 2004.

The
assets that we purchased included all of EMG's trade receivables, inventory to support EMG's normal business operations, property, plant and equipment necessary to operate EMG's
business operations and EMG's prepayments for the purchase of materials and supplies to be consumed in the ordinary course of business. We also assumed a number of contracts that we believe are
valuable to the continuing operations of the business previously conducted by EMG, including certain supply contracts, the real estate leases, maintenance agreements, unfilled customer orders, and two
sales representative agreements.

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The
equipment that we acquired is the equipment necessary to continue EMG's silicon wafer reclamation and manufacturing business including grinders, polishers, final clean system,
packaging unit, and metrology tools. We intend to consolidate our equipment located in our separate Vancouver, Washington facility with the EMG equipment in EMG's leased space and conduct and expand
our SOI wafer manufacturing business while attempting to expand the silicon wafer reclamation and manufacturing business we have acquired from EMG.

EMG's
principal business was to reclaim silicon wafers used by other parties. Because of the cost of silicon wafers, many manufacturers of integrated circuits ("ICs" or "chips") produce
test wafers incorporating the chip design. Generally these wafers are made from reclaimed silicon wafers which, while not suitable for production, are suitable for circuit design and testing and are
significantly less expensive to the user. When silicon wafers have been used for testing purposes (or when new silicon wafers are abandoned because of flaws in the design or manufacturing process),
the owner of the silicon wafers will frequently return them to a reclamation facility to remove all of the foreign substances from the silicon wafer, generally through application of chemicals. These
reclaimed silicon wafers are then grounded and polished, and can be returned to the owner and used for test wafer purposes. In many cases, the owner keeps title to the silicon wafers and the
reclamation facility (such as our subsidiary) stores the silicon wafers until needed and then provides the services necessary to complete the reclamation process.

At
the facilities formerly used by EMG, we (through Isonics Vancouver) can also grind, and polish new silicon test wafers in addition to the SOI wafers discussed above. SOI wafers have
not achieved universal recognition, and some manufacturers and processes continue to require the use of silicon wafers that are not SOI.

We Are Developing Products to Detect Explosives, Chemical Weapons, Illegal Drugs and Other Chemical Compounds.

In December 2002, we acquired certain isotope-based trace detection technology to be used to detect explosives and chemical and biological weapons from
IUT, an entity in which we hold a 6% ownership interest. We issued to IUT 250,000 shares of our restricted common stock as consideration for the technology (which we valued at $273,000). In addition,
we granted IUT a 15% ownership interest in a newly created subsidiary, IUTDT that will own and commercialize the trace detection technology. Our ownership percentage may be reduced to the extent we
raise additional equity capital through this subsidiary or acquire additional technologies. We also paid $50,000 for an option that would have allowed us, upon exercise to acquire an additional 29.1%
interest in IUT from an unaffiliated party for a total purchase price of $450,000. The option expired, unexercised, on February 28, 2003.

We
acquired additional technology from IUT in June 2004 in consideration of a research and development agreement by which, upon receipt of certain payments, IUT agreed to develop
a number of products using the technology conveyed in December 2002 and the additional technology conveyed in June 2004. We have paid IUT $100,000 for its initial research and
development efforts, and are scheduled to pay an additional $175,000 upon achieving certain milestones, primarily with respect to one potential product, the NeutroTest detector. As
contemplated in the contract with IUT, the research and development effort for the products contemplated is expected to cost up to $4,000,000 over several years. We have no obligation to fund any
research and development effort unless we have approved such effort.

The
technology that we acquired from IUT consists of devices and technologies based on neutron detection and gamma spectroscopy. A number of these technologies and potential products
have been under development at IUT for approximately five years, and some are available in prototype form. We are currently working on the development of a product named Neutroscan. To expand its
applications,

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we
plan to configure this technology into a form for screening packages or hand carried luggage at airports, office building and other high security locations. The further development of this product
(beyond the prototype stage) is contingent upon our ability to secure additional financing.

IUTDT
will continue to focus on products utilizing nuclear detection technologies and leveraging its experience gained at IUT in establishing relationships with governmental entities,
obtaining funding for research and development activities, increasing its portfolio of technology patents and commercializing promising products. IUTDT will work closely with IUT in completing
necessary research and development activities along with providing immediate manufacturing needs. If and when IUTDT is able to raise sufficient capital, it may establish sales operations in the United
States and will explore all available manufacturing options, as well as potential partnership agreements to meet its possible demand for its products.

Distribution Method

We operate life sciences sales offices in Columbia, Maryland and Düsseldorf, Germany. We currently market and manufacture our SOI wafers (and in
June 2004 commenced manufacturing and reclamation of silicon wafers) through our facilities in Vancouver, Washington. We also identify customers through industry sales journals, website
identification and trade shows. In addition, many customers come to us by referral from existing customers. There are a limited number of suppliers in the isotope industry and, therefore, most
customers are aware of the products and services we offer. Customers directly place the orders and we either ship directly to the customer through our sales offices or the product is shipped directly
from the supplier. We package and ship from our own manufacturing facilities using commercial courier services such as Federal Express and DHL.

Significant Customers

As of April 30, 2004, three customers accounted for approximately 34% of total net accounts receivable. Three customers accounted for approximately 46% of
total net accounts receivable at April 30, 2003. One customer (Eastern Isotopes) accounted for approximately 32% of revenues for the year ended April 30, 2004. Two customers (Eastern
Isotopes and Perkin Elmer Life Sciences) accounted for approximately 29% and 17%, respectively of revenues for the year ended April 30, 2003. Three
customers (Perkin Elmer Life Sciences, IBT SA and International Isotopes) accounted for approximately 33%, 20% and 19%, respectively of the German operation's revenues for the year ended
April 30, 2004. Four customers (Perkin Elmer Life Sciences, IBT SA, Revis LTD and International Isotopes) accounted for approximately 43%, 15%, 13% and 12%, respectively of the German
operation's revenues for the year ended April 30, 2003. Two customers accounted for approximately 49% of the German operation's accounts receivable at April 30, 2004. Two customers
accounted for approximately 52% of the German segment's accounts receivable at April 30, 2003.

Significant
reductions in sales to any of our large customers have had, and may in the future have, a material adverse effect on us by reducing our revenues and our gross margins.
Present or future customers could terminate their purchasing patterns with us or significantly change, reduce, or delay the amount of isotope or other products ordered from us.

Research and Development

Consistent with our product development strategy, we are seeking to identify and evaluate new stable and radioactive isotope products and potential markets for
economic and technical feasibility. We will, in addition, continue funding research and development to improve technologies for isotope separation, materials processing technologies and SOI
technologies. During fiscal years 2004 and 2003, research and development expenses were $569,000 and $303,000, respectively.

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During
fiscal year 2005, we expect to continue to focus our research and development efforts on the production of high chemical-purity silicon-28 silane gas,
silicon-28 trichlorosilane and silicon-28 epitaxial wafers. In addition, we are focused on refining our processes associated with the production of SOI Wafers at our plant in
Vancouver, Washington. These efforts continue the research and development we performed in fiscal years 2004 and 2003. In addition, if we are able to raise additional funding, we may commence
significant research and development activities at IUTDT for the development of commercially-marketable products using the technology we acquired from IUT in December 2002 and June 2004.
It is possible that a significant portion of these research and development activities would be outsourced and completed by IUT. These development activities will not be funded from our current
working capital (except for our commitment to fund $275,000 for these Homeland Security research and development activities in fiscal year 2005).

Isotopically-Pure Semiconductor Materials.

The majority of semiconductor devices built today use natural silicon as the starting material. Silicon has many desirable characteristics as compared to other
semiconductor materials. The semiconductor industry has invested billions of dollars to improve and optimize their manufacturing technologies for silicon-based devices. Devices fabricated on single
crystal silicon have performance characteristics that are governed by the electrical and physical characteristics of silicon including:



Carrier
mobilities, for example, govern signal transit times and, thus, place a limit on device speed. Thermal conductivity governs power dissipation, which, in turn, places an upper
limit on the packing densities achievable for devices on a chip, or on the amount of power that can safely be generated in the circuit without significantly degrading circuit performance.

The
semiconductor industry trend of adding more transistors to a single chip to increase performance, and shrinking the size of transistors to increase performance and decrease costs,
has resulted in increased power requirements and significantly higher operating temperatures. Nowhere is this trend more evident than in microprocessors. Historically, the 80286, 80386 and 80486
generations of microprocessors typically did not need external heat sinks to remove heat and function properly. High operating temperatures and thermal management were not issues outside of mainframe
or workstation computers.

Beginning
with the Pentium®, Sparc® and Alpha® microprocessors, heat sinks and fans became necessary to control the higher operating temperatures.
According to the Semiconductor Industry Association'sNational Technology Roadmap for Semiconductors, when the microprocessor's power requirements
exceed approximately 110 watts, heat sinks and fans will no longer be adequate and active cooling (refrigeration) will be required. Most of the major computer companies have already demonstrated
cryogenically cooled computers that operate up to one-third faster than their conventionally cooled counterparts. These cryogenic cooling devices can cost upwards of $400 per
microprocessor. Apple Computer recently became the first major computer manufacturer to introduce a liquid cooled personal computer to the general public.

A
significant body of research, generated over the last 20+ years, supports the thesis that isotopically-pure semiconductor materials have superior thermal conductivity
properties compared to natural, multi-isotopic materials. We believe this solution (i.e., using isotopically-pure semiconductor

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materials
to manage operating temperatures) is compatible with virtually every other heat management solution currently implemented or envisioned to date. Critically, it does not require changing a
single device design or manufacturing process because isotopically-pure semiconductor materials are essentially chemically and physically identical to naturally-occurring semiconductor
materials. For example, silicon has three naturally occurring stable isotopes:



By
purifying silicon to 99.9% silicon-28, the thermal conductivity is improved up to 60% at room temperature and over 600% at -423 degrees Fahrenheit.

In
1997, we began a program to introduce 99.9% isotopically-pure silicon-28 as a superior substitute to natural silicon for the manufacture of
semiconductor devices. Our first efforts toward developing isotopically-pure semiconductors involved securing the intellectual property rights to commercialize silicon-28 and
similar materials. These efforts culminated in our acquiring exclusive rights to two Yale University patents.See "Patents and Proprietary Rights."

We
then began acquiring sufficient quantities of pure silicon-28 to make epitaxial wafers. These wafers have been sold or given to numerous manufacturers and academic
institutions to perform additional tests to validate previous findings and to confirm the ability of pure silicon-28 to substitute for natural silicon in their manufacturing processes.
These tests support our belief that pure silicon-28 is not only a viable substitute material for natural silicon, but that the anticipated thermal conductivity property improvements are
significant.

To
expand this testing, in July 2002 Isonics qualified Globitech Incorporated to produce silicon-28 epitaxial wafers using silicon-28 trichlorosilane and
we implemented a working agreement with them to produce silicon-28 epitaxial wafers for our customers. Globitech is an epitaxial wafer manufacturer located in Sherman, Texas. In addition
to producing wafers for Isonics, we have agreed to work with Globitech to supply silicon-28 wafers to Globitech's customers, if demand develops.

In
August 2001, we entered into a marketing agreement with a major wafer manufacturer. We have since supplied silicon-28 trichlorosilane (which was produced in the
United States) to this wafer producer for the manufacture of silicon-28 epitaxial wafers. These wafers are being supplied to interested customers worldwide for evaluation in a number of
semiconductor devices. This agreement is critical in assuring that silicon-28 epitaxial wafers will be available to meet the increasingly stringent quality demands of the semiconductor
industry. Any proceeds generated under this agreement will be shared equally with the wafer manufacturer.

The
next step in our development program is to make bulk wafers composed of pure silicon-28. The manufacture of bulk wafers requires substantially more material than we could
economically acquire from our existing suppliers. We sought a domestic, economical supply of silicon-28 in a contract with Eagle-Picher Technologies, LLC ("Eagle-Picher"), and believed
that Eagle-Pichers' silicon isotope separation technology could supply the necessary silicon-28 to us. Eagle-Picher was not able to supply silicon-28, and disputes arose that
were resolved in a settlement agreement on July 24, 2002.

We
have identified other potential sources for supplying silicon-28, but those sources are not domestic. We have received silicon-28 samples from The Institute of
Stable Isotopes ("ISI"), located in Tiblisi, Republic of Georgia. Our analysis indicates that the quality of the silicon-28 appears to meet our requirements. We are optimistic about the
prospects for using the related enrichment technology from this supplier to meet our needs. We have agreed to fund (estimated to be between $50,000 and $100,000) further development of this technology
and we are looking for partners to establish a commercial enterprise for the production of silicon-28.

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In
March 2004, International SEMATECH, the organization that produces the International Technology Roadmap for semiconductors ("ITRS") designated silicon-28 as an
"emerging material". As defined by this group, an emerging material is: "Novel starting materials, structures, and processing methodologies that will enhance silicon-based CMOS technology, allowing it
to meet anticipated roadmap requirements." The group selected silicon-28 because of its potential for improved heat dissipation in semiconductor devices as compared to normal silicon. The
2003 ITRS cited two issues that, in their opinion, require "more work to understand." The first issue is the magnitude of the measured thermal conductivity of silicon-28 versus normal
silicon and the effectiveness of heat transfer within a silicon-28 epitaxial layer which the report says "may help to reduce peak temperatures in localized "hot spots' within the circuit."
The document cited three independent scientific studies, two of which found 60% improvement at room temperature and a third which found only a 7% improvement.

We
received only nominal proceeds ($221,000 and $65,000) from the sale of silicon-28 based products (mainly to universities and research groups) in fiscal years 2004 and
2003, respectively. Included in the fiscal year 2004 results was an order for $200,000 for the sale of silicon-28 as a bulk isotope. The sale of this isotope was completed in May of 2003
and was shipped to a second major wafer manufacturer to support silicon-28 epitaxial wafer production of test wafers. While we cannot forecast future orders of silicon-28
products, we are hopeful that this business will continue to grow as additional potential customers start evaluating silicon-28.

In
fiscal year 2003 we entered into an additional silicon-28 evaluation program with a major semiconductor device manufacturer and supplied silicon-28 epitaxial
wafers to them. This program remained active during fiscal 2004 and will be ongoing during our fiscal year 2005. The preliminary results have been very promising and the manufacturer is proceeding to
the evaluation phase on the current production device. We also supplied silicon-28 epitaxial wafers to a number of research organizations. In addition, we sold two kilograms of
silicon-28 as silane gas to Silex Systems, who in turn provided the silicon-28 to SUMCO, a Japanese wafer manufacturer. SUMCO is in the process of making silicon-28
epitaxial wafers for testing by several Japanese semiconductor manufacturers.

In
fiscal year 2002, we entered into silicon-28 evaluation programs with two semiconductor manufacturers, one of which manufactures semiconductor power devices, and supplied
silicon-28 epitaxial wafers to these manufacturers. We received results from the first program that were generally positive but the manufacturer involved has not yet decided to proceed
with additional testing. The power device that was evaluated by the second manufacturer was found to have power density that was too low to see any effect (either positive or negative) provided by
silicon-28.

In
May 2001, we entered into a silicon-28 Joint Development program with Advanced Micro Devices ("AMD"), a major microprocessor manufacturer, whereby we supplied AMD
with silicon-28 wafers. In fiscal year 2002, we delivered a second lot of silicon-28 epitaxial wafers to AMD and in fiscal year 2003 a third lot was delivered. AMD used our
products to make and rigorously test state-of-the-art microprocessors to accurately quantify the benefits of high thermal conductivity silicon-28 in
this application. We expect to use the results of the testing program to find the proper balance between performance and cost. The results which we have received so far are generally positive, however
AMD has decided to move all of its microprocessor products to thin-film SOI wafers from epitaxial wafers. Evaluation of silicon-28 thin-film wafers is planned, but
the timing is not defined. In addition, AMD has elected to move from 200mm to 300mm wafers, which complicates the production of test wafers.

In
fiscal year 2001, we delivered a second lot of epitaxial wafers to Cypress Semiconductor ("Cypress"), and we also sold a small quantity of silicon-28 epitaxial wafers to
two Japanese semiconductor manufacturers for their evaluation. Cypress completed one study of static random access memory using 0.25 micron technology (250 nanometers) without finding a significant
advantage using silicon-28 and planned to continue its evaluation process using 90 nanometer technology during fiscal

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year
2004. Due to problems in developing the 90 nanometer technology, this work has been delayed to our fiscal year 2005.

In
fiscal year 2000, we entered into a Cooperative Research & Development Agreement with Lawrence Berkeley Laboratory in Berkeley, California ("LBNL"), to study the
properties of various silicon isotopes. This agreement is part of a U.S. Department of Energy program to apply Russian nuclear weapons technology to commercial applications. Delays within the
Department of Energy pushed the start of this program to our fiscal year 2002. The first delivery of silicon isotopes occurred in December 2001. The second delivery occurred in
April 2003. As a result of this program Isonics has at its disposal approximately 20 kilograms of silicon-28 isotope to further its research programs. LBNL has grown small diameter
single crystals of silicon-28, silicon-29 and silicon-30 enriched isotopes. LBNL will be measuring the basic properties of these crystals, including thermal
conductivity.

Several
additional investigations into the thermal conductivity of silicon-28 have been published (some with our cooperation or funding). All of these investigations have
found an increase in thermal conductivity, but the magnitude of the increase at room temperature has ranged from approximately 10% to 60% improvement, depending on the measurement technique used. The
measurement of the thermal conductivity of thin films is not trivial and is heavily dependent on very precise experimental measurements. We believe that regardless of the actual physical number, the
best data will be derived from actual operating devices and we will continue to supply wafers of various configurations to optimize device performance.

The
adoption of silicon-28 by semiconductor manufacturers will depend on the outcome of the evaluations currently underway. Even though silicon-28 is a
one-for-one substitution for normal silicon, semiconductor companies are very conservative about changing anything in their manufacturing processes, for fear that their yields
will suffer. Typically the testing sequence at these companies is:



The
testing sequence is a time consuming process. While several companies are well into the evaluation process, we did not receive significant proceeds in our 2004 fiscal year, and we
are not aware of plans for the introduction of products based on silicon-28 wafers. Therefore we do not anticipate significant proceeds from silicon-28 product sales during
fiscal year 2005, although if any of the evaluation programs underway yield positive results, we could respond to customer demand in a relative short time frame. Our goal ultimately is to produce bulk
silicon-28 wafers (at an acceptable cost) which will produce the maximum benefit to the end user.

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In May 2002, we announced that we had delivered silicon-28 thin-film SOI wafers to a leading semiconductor manufacturer for evaluation. We have not
received the results of that evaluation process, which is still underway. Because many of the potential customers for silicon-28 are evaluating thin-film SOI wafers for future
products, we expect to continue to evaluate manufacturing technology for these wafers and work with other manufacturers in this field to deliver evaluation wafers incorporating silicon-28.

In
May 2003, we announced that we had developed our own thin-film SOI wafer technology and had accepted our first commercial order for thin-film wafers
(which as of June 30, 2004 has not yet been completed). We hope to expand this activity during fiscal year 2005 and ultimately become one of the few suppliers that offer both thin and thick
film SOI wafers but we can offer no assurance that this will come to fruition.

Patents and Proprietary Rights

We rely primarily on a combination of patents and patent applications, trade secrets, confidentiality procedures and contractual provisions to protect our
technology. Despite our efforts to protect our rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing
unauthorized use of our technology and products is difficult. In addition, the laws of many countries do not protect our rights in information, materials and intellectual property that we regard as
proprietary to as great an extent as do the laws of the United States. There can be no assurance that our means of protecting our rights in proprietary information, materials and technology will be
adequate or that our competitors will not independently develop similar information, technology or intellectual property. See "Risk Factors."

We
currently have one United States patent in our own name. We have filed several other patent applications and we have rights to several isotopically engineered innovations regarding
electronic and optical materials, which we believe may be patentable. Ongoing work in the area of isotope separation by chemical means (which is currently being performed by outside entities) also may
lead to patentable inventions.

In
April 1999, we announced that we had entered into an exclusive licensing agreement with Yale University that entitles us to exclusive intellectual property rights to patents
covering semiconductor devices derived from isotopically engineered materials. The license requires payment by us of a royalty based on a percentage of our or our sublicensees' net sales of products
derived from technology
covered by the Yale patents (#5,144,409, dated September 1, 1992, and #5,442,191, dated August 15, 1995). Each of these patents expire 17 years after issuance.

Competition

Many of our potential competitors are larger and have significantly greater financial, technical, marketing and other resources than us. Some of our competitors
may form partnerships or alliances with large pharmaceutical or electronics companies, with the resulting entity possessing greater market strength than we have. We face competition relative to many
of our products, including:

Isotopes for Life Sciences

We do not produce stable or radioactive isotopes for use in the life sciences applications mentioned here. Instead, we distribute products made for us by a
variety of producers in Russia, other countries of the former Soviet Union, Europe and North America. In many cases, we have long-term, exclusive supply relationships in place with
producers. In others, we have the advantage of relationships that have developed over upwards of 25 years.

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Competitors
for stable isotopes fall into two categories: other producers and other distributors. Our primary competition from other producers comes from the other manufacturers of
oxygen-18Rotem, CIL and Marshall Industries. To counter this, we have an exclusive supply agreement in place with our producer (which expires July 2010). Our product is
very high in quality and arguably the best in the world. We offer a very competitive and effective recycle program. As for competition with other distributors, our primary competition comes from Trace
Sciences, a privately-held company in Canada with long-standing supply relationships with several stable isotope producers.

Competitors
for radioactive isotopes fall into three categories: bulk radiochemical producers; value-added labeled compound producers; and other distributors. Our primary competition for
bulk production comes from MDS Nordion in Canada. Most other bulk producers are government-owned or university-operated. They typically sell through distributors like Isonics. We have either an
exclusive supply agreement or long-standing supply relationships with many of these organizations. In the segment of value-added producers, we have a narrow product line with an exclusive,
three-way supply agreement (which currently expires December 31, 2004) between Chemotrade, IUT and Perkin Elmer Life Sciences (the largest user of this product line). As for
competition with other distributors, the primary competitor, Tenex, is also our supply partner. While Tenex let lapse all of its exclusive supply agreements (agency agreements) with distributors on
December 31, 2001, we still have an excellent relationship with Tenex and many of its senior personnel.

Semiconductor Materials.

SOI Wafers.There are several competitors in the thick-film SOI wafer business, many of which are larger than
Isonics and have significant financial resources as compared to Isonics. SUMCO, Okmetic and SEH-Japan are our most significant competitors for thick-film SOI wafers while
SOITEC, SEH, Canon and Ibis are our most significant competitors for thin-film SOI wafers.

Silicon wafersmanufacturing and reclamation.There are a number of competitors in the test wafer and wafer
reclamation business. We compete for business primarily in North America, but have begun soliciting business from the European Union. Larger competitors, such as Silicon Quest and Exsil, provide a
wide range of products and services comparable to us and compete on a global basis. There are numerous smaller competitors which provide a more focused product or service offering and compete on a
local or regional basis. Customers select a supplier based on a combination of factors including price, delivery time, and quality.

Silicon-28.Although we have not yet identified significant competitors, numerous companies in the United States
and throughout the world are currently manufacturing semiconductor materials and are working to improve the thermal conductivity and other beneficial characteristics of semiconductor materials. Many
of these companies may be larger than us and have significantly greater financial resources at their disposal. In addition, many types of technologies can address the issue of thermal management (i.e.
better cooling technology, new designs, etc.). It remains to be seen which technologies, if any will prove to be the most cost effective and gain market acceptance.

Homeland Security

A large number of companies are involved in the homeland security industry, an industry that received a significant impetus from the events of
September 11, 2001. Many of these companies (such as InVision Technologies, Inc., Ancore Corporation, and L-3 Communications Holdings, Inc.) are significantly larger
than Isonics with greater financial resources at their disposal. We believe that the technology that we have acquired from IUT will result in better detection products, which will be attractive to the
marketplace. Given the size and importance of the homeland security market, we anticipate that even greater competition will emerge.

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Summary of Competition

Many of the areas in which we either compete or intend to compete are rapidly evolving. Competition may develop a patentable product or process that may prevent
us from competing in our intended markets. While we expect to compete primarily on the basis of product performance, proprietary position and price, in many cases the first company to introduce a
product to the market will obtain at least a temporary competitive advantage over subsequent market entrants.

Manufacturing and Supply

We obtain stable isotopes from a variety of isotope sources, primarily located in Russia or other former Soviet republics. We may invest in our own isotope
production facilities in the future upon our determining the optimum production technology for a given isotope or family of isotopes. Other facilities elsewhere in the world, including the Oak Ridge
National Laboratory in Oak Ridge, Tennessee, and private and pseudo-governmental facilities in Great Britain, Germany, the Netherlands, Australia and the Republic of South Africa also have the
potential to produce stable isotopes.

To
date, we have only been able to obtain limited quantities of silicon-28 for use in manufacturing epitaxial wafers. We believe that we will be able to obtain adequate
supplies of silicon-28, but we are unable to commit to the suppliers because of our lack of working capital.

We
have historically depended on a limited number of suppliers and processors for most of our manufacturing processes. In November 2002 we commenced manufacturing limited
quantities of our SOI wafers in our Vancouver, Washington manufacturing facility. Since then, we have improved our manufacturing processes and, in June 2004, we commenced integrating our SOI
manufacturing facilities with the manufacturing facilities we acquired from Encompass Materials Group Limited ("EMG") (an unaffiliated company in Vancouver, Washington). Prior to the acquisition, EMG
had been using its facilities for manufacturing and reclamation of non-isotopic silicon wafers. We expect to expand the historical EMG business operations and use the new facilities to
expand our SOI manufacturing and marketing operations as well.

Except
for the agreements with our supplier of oxygen-18 in Russia, we do not have any written agreements with our suppliers and processors. Although we attempt to reduce our
dependence on our suppliers, disruption or termination of any of the sources could occur, and such disruptions or terminations could have at least a temporary, materially adverse affect on our
business, financial condition and results of operations. Moreover, a prolonged inability to obtain alternative sources for processing could have a materially adverse affect on our relations with our
customers.

Government Regulation

Regulation by government authorities in the United States and other countries is a significant consideration in the research, development, production,
distribution and marketing of our products. In order to clinically test, manufacture, distribute, market and sell products, we must follow safety and other standards established by applicable
regulatory authorities. We may be subject to various laws, regulations and requirements relating to such matters as the import and export of our products, ensuring safe working conditions, laboratory
and manufacturing practices, and the use, storage and disposal of hazardous or potentially hazardous substances used in connection with our research, development and manufacturing activities. The
regulations potentially material to our business are summarized below.

We
are not currently subject to any Food & Drug Administration ("FDA") regulation because we do not currently manufacture any Diagnostic Breath Tests, drug products or other
medical devices. Our customers may, in many cases, be subject to FDA regulation. However, if we test, manufacture, market,

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distribute,
export or sell diagnostic products or medical devices in the future, we will also likely be subject to extensive regulation nationally and internationally.

The
import, export, handling, transportation, sale, storage and other activities undertaken in connection with our non-medical products are subject to, or potentially subject
to, significant
federal, state, local and foreign government controls pertaining to hazardous chemicals, import export controls and other matters. These regulations are complex, pervasive, and constantly evolving.
Our ability to effect and maintain compliance with these controls is important to our commercial success. We are not currently engaged in any activities that may require us to incur significant
expenses related to environmental compliance.

We
rely predominantly on Russian and United States freight carriers to handle and deliver all our shipments, and utilize domestic overnight courier services for shipments to our
customers. These carriers must comply with Department of Transportation and State regulations pertaining to hazardous chemicals and hazardous waste disposal. These shipments are stored in an area of
the facility designated for such materials. We believe we are in compliance, in all material respects, with applicable federal and state environmental regulatory requirements.

The
shipments from Russian manufacturing sources now enter the U.S. duty free (without tariff). If the shipments become subject to tariff, we may not be able to sell the imported
products. Furthermore, the products may cease to be commercially viable because of these increased tariff costs.

Our
facilities and employees must also comply with environmental and other regulations concerning our operations. Failure to ensure compliance with such federal, state, or local laws and
regulations could have a material adverse effect on us.

In
addition, the manufacture, distribution and export of some of our current or potential products and technology may be subject to governmental controls pertaining to materials and
technology that have potential military, nuclear power or nuclear weapons purposes. These controls include export license requirements or other restrictions. We may be unable to obtain or maintain
such licenses. Further, the failure to obtain or maintain such licenses, or comply with other restrictions that might be placed on such manufacturing and exports, may have a material adverse effect on
us and our operations.

Product Liability and Insurance

Our business exposes us to substantial product, environmental, occupational and other liability risks. These risks are inherent in product research and
development, manufacturing, marketing, distribution, and in the use of our products and operations. We have, and will attempt to renew product liability insurance (which currently expires
April 30, 2005), in order to protect ourselves from such potential exposures, however, there can be no guarantee that upon expiration of our current coverage that adequate insurance coverage
will be available, or, if available, the cost will be acceptable. Furthermore, a product liability or other claim could materially and adversely affect our business or financial condition. The terms
of our customer agreements provide that liability is limited to our standard warranty to replace non-conforming product, and liability for consequential damages caused by the improper use
of our products is limited by contractual terms. Nevertheless, one or more
third parties could file suit against us based on product liability, breach of warranty or other claims. The foregoing contract clauses might effectively limit our liability in any such actions.

Employees

As of July 14, 2004, we had 61 full-time employees. Five of our employees have Ph.D.s in scientific or engineering disciplines. We have 52
employees in our SOI and silicon wafer manufacturing and reclamation operation, four employees in our life sciences operation and five employees in our

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corporate
offices. An employee's responsibilities may also encompass areas other than his or her primary area of responsibility. We consider our relations with our employees to be good. None of our
employees are covered by a collective bargaining agreement.

ITEM 2. PROPERTIES

In August 2003, we entered into a month-to-month lease (at a rate of $2,800 per month) with the Colorado School of Mines Research
Institute to continue leasing office and storage space at our current location.

We
lease facilities (at a rate of $3,420 per month) in Vancouver, Washington, for our SOI manufacturing facility from an unaffiliated landlord. This lease expires on August 31,
2004 and we have no intention to renew such lease. Upon the expiration of our current lease, we will consolidate our equipment and related assets with the assets we acquired from EMG at the former EMG
facilities. As a result of the transaction with EMG, we assumed two facility leases. The first lease requires a minimum payment of $8,700 per month and terminates August 31, 2007 while the
second lease requires a minimum payment of $5,250 and terminates September 30, 2004. We have an option on the second lease to extend the terms for another 60 months.

We
lease 1,750 square feet (at a rate of $2,800 per month) for an administrative sales office in Columbia, Maryland that expires September 30, 2005. Chemotrade leases office space
in Düsseldorf, Germany that expires in June 2005.

ITEM 3. LEGAL PROCEEDINGS

We are not currently engaged in any material legal proceedings.

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

We held a meeting of our shareholders during the fourth quarter of the year ended April 30, 2004. On April 27, 2004, we held our annual meeting of
shareholders in Golden, Colorado. A single proposal for the election of all five members of our board of directors was submitted to a shareholder vote. The names of the directors elected to serve
until the next annual meeting of shareholders and until their successors have been elected and qualified, and the number of votes cast for and against were as follows:

Name of Director

Shares FOR

Shares WITHHELDJames E. Alexander

11,247,568

643,391Boris Rubizhevsky

11,245,438

645,521Lindsay A. Gardner

11,269,665

621,294Richard Parker

11,252,168

638,791Russell Weiss

11,253,665

637,294


Abstentions
and broker non-votes were not counted for the purposes of determining the outcome of the vote on the election of directors.

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PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

(a)Market Information.Our common stock is quoted on the Nasdaq SmallCap Market. As of
July 14, 2004, we have outstanding 202,500 Class C Warrants and 1,780,110 registered Class B Warrants. The Class B Warrants and the Class C Warrants are also quoted
on the Nasdaq SmallCap Market. Currently the trading symbols for our outstanding securities are as follows:

Common stock

"ISON"Class B Warrants

"ISONL"Class C Warrants

"ISONZ"


The
following table sets forth the closing bid prices for the common stock (quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not represent actual transactions) for the two most recent fiscal years as reported by the Nasdaq SmallCap Market.

|                    |      | Quarter Ended
July 31, 2004
|------------------- | ---- | ---------------------------
|
|Common Stock (ISON) |      |                            
|                    | High |                            
|                    | Low  |                            

|                    |      | Quarter Ended
|------------------- | ---- | -------------
|
|Common Stock (ISON) |      |              
|                    | High |              
|                    | Low  |              

|                    |      | Quarter Ended
|------------------- | ---- | -------------
|
|Common Stock (ISON) |      |              
|                    | High |              
|                    | Low  |              

(b)
and (c)Shareholders and Dividends.As of April 30, 2004 there were approximately 105
shareholders of record of our common stock. This does not include an indeterminate number of persons who hold our common stock in brokerage accounts and otherwise in "street name."

We
have never declared or paid a cash dividend on our common stock. We presently intend to retain our earnings, if any, to fund development and growth of our business and, therefore, we
do not anticipate paying cash dividends in the foreseeable future. Additionally, the certificate of designation for the Series A Convertible Preferred Stock contains restrictions on our ability
to pay dividends to holders of our common stock.

The
market price of our common stock could drop if substantial amounts of shares are sold in the public market or if the market perceives that such sales could occur. A drop in the
market price could adversely affect holders of the stock and could also harm our ability to raise additional capital by selling equity securities.

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(d)Securities Authorized for Issuance Under Equity Compensation Plans.

The
following is provided with respect to compensation plans (including individual compensation arrangements) under which equity securities are authorized for issuance as of the year
ending April 30, 2004.

|                                                           |  | Equity Compensation Plan Information(1)
|---------------------------------------------------------- |  | ---------------------------------------
|
|Equity compensation plans approved by security holders     |  | 1,745,647                              
|Equity compensation plans not approved by security holders |  | 0                                      
|Total                                                      |  | 1,745,647                              

---

(e)Recent Sales of Unregistered SecuritiesItem 701 Disclosure.

Employee and Director Offerings

Employee Offerings

Plan Name

Issued
Options/Shares

Available for Grant
or Issuance1996 Stock Option Plan

358,769 options

0 options1996 Executives Equity Incentive Plan

930,937 options
255,000 shares

741,605 options/shares1996 Equity Incentive Plan

325,941 options

614,879 options/shares1998 Employee Stock Purchase Plan

48,538 shares

151,462 shares


Dr. Walitzki

In connection with his employment by Isonics in December 2001, we issued 200,000 shares of common stock to Dr. Walitzki. These shares were subject
to certain vesting requirements, and 50,000 have vested as of April 30, 2004. At the same time, we also granted Dr. Walitzki options to purchase 204,000 shares of common stock, of which
124,000 are vested as of April 30, 2004 and are currently exercisable.

24

---





(a)   The
1998 Directors' Plan (the "Directors' Plan") authorized each person serving as a member of the Board who is not an employee of Isonics to receive options to purchase
20,000 shares of our common stock when such person accepts his position as a Director and to receive an additional option to purchase 10,000 shares when such person is re-elected as a
Director provided such person is not an employee of Isonics. The exercise price for the options is the Fair Market Value (as defined in the Executives' Plan) on the date such person becomes a director
and the options are exercisable for five years from such date. The options granted under the Directors' Plan vest immediately upon the date of the grant. In the event a Director resigns or is not
re-elected to the Board, failure to exercise the options in three months results in the options' termination prior to the expiration of their term. Although the Directors adopted the plan
in 1998, the Board formalized the plan by resolution in January 2000. The Directors' Plan is not included within any registration statement.

During
the last three fiscal years, the following persons have been granted options under the Directors' Plan:

|Name            |  | Shares Under Option  |  | Exercise Price |                | Expiration
|--------------- |  | -------------------- |  | -------------- | -------------- | ----------
|Lindsay Gardner |  | 10,000
10,000
10,000 |  | $$$            | 1.06
1.00
1.42 |           
|Richard Parker  |  | 10,000
10,000
10,000 |  | $$$            | 1.06
1.00
1.42 |           
|Russell Weiss   |  | 10,000
20,000        |  | $$             | 1.42
1.17      |           

Other Non-Plan Issuances to Officers or Directors

None

Applicable to the Offerings to the Employees, Directors, and Dr. Walitzki Offering

(b)   No
underwriters were involved in the transactions.

(c)   The
stock options and bonuses issued outside of our employee benefit plans were, for the most part, issued in consideration of services rendered and did not (therefore)
involve the offer or sale of securities. In some cases they were issued to induce the performance of services in the future.

(d)   Many
of the securities referred to in this section were not offered or sold in a manner that constituted a "sale" of securities as that term is defined in
Section 2(a)(3) of the Securities Act. Where a "sale" occurred, the transactions were exempt from registration under the Securities Act of 1933, as amended by reason of Sections 4(2) and 4(6)
of the Securities Act of 1933 or Rule 701.

(e)   There
are no conversion rights or exchange rights associated with the common stock. To the extent vested, the options are exercisable to purchase shares of common stock
as described above.

(f)    Where
proceeds were received, the proceeds were utilized for working capital purposes.

Acquisition of EMG

On June 11, 2004, we issued 731,930 shares of our restricted common stock to EMG as partial consideration for the completion of the transaction described
above. EMG represented that it, and its

25

---



two
equity holders, were accredited investors. The following sets forth the information required by Item 701 in connection with that transaction:



Series D Convertible Preferred Stock

On April 5, 2004, we committed to issue 32,950 shares of our Series D Convertible Preferred Stock and 600,000 common stock warrants to three
accredited investors in exchange for their investment of $3,295,000. In addition, we paid a due diligence fee of $210,000, reimbursement of $19,550 in expenses and issued 2,400,000 common stock
warrants to Mercator Advisory Group, LLC ("MAG"). The three accredited investors (which are all affiliated with MAG) are the Mercator Momentum Fund, LP, Mercator Momentum Fund III, LP and Monarch
Pointe Fund, Ltd. The following sets forth the information required by Item 701 in connection with that transaction:



26

---





2004 Transaction with vFinance Investments, Inc.

On February 27, 2004, we issued a warrant to purchase 150,000 shares of our restricted common stock to vFinance (3010 North Military Trail, Suite 300, Boca
Raton, FL 33431 and at 880 Third Avenue, 4th Floor, New York, NY 10022), a member of the National Association of Securities Dealers, Inc. The issuance was for payment for services
provided by vFinance. The following sets forth the information required by Item 701 in connection with that transaction:



27

---



Series C Convertible Preferred Stock

On January 27, 2004, we issued 22,000 shares of our Series C Convertible Preferred Stock and 200,000 common stock warrants to two accredited
investors in exchange for their investment of $2,200,000. In addition, we paid a due diligence fee of $185,000, reimbursement of $15,000 in expenses and issued 227,701 common stock warrants to MAG, an
affiliate of the two investors. Each common stock warrant issued in this transaction is exercisable for one share of common stock at $1.25 per share and expires on January 27, 2007. The
following sets forth the information required by Item 701 in connection with that transaction:



Investor Awareness, Inc.

On December 12, 2003 we entered into an agreement with Investor Awareness, Inc. ("Investor Awareness") to provide us with investor relations
services through July 31, 2004. In connection with this agreement, we issued a common stock warrant to acquire 50,000 shares of our restricted common stock at $1.50 per share. The common stock
warrant vested immediately and expires on December 12, 2006.



28

---





Lippert/Heilshorn &Associates, Inc.

On November 1, 2003 we entered into a twelve-month agreement with Lippert/Heilshorn to provide us with investor relations services through
October 31, 2004. In connection with this agreement, we issued a common stock warrant to acquire 120,000 shares of our restricted common stock at $1.35 per share. The common stock warrant
vested immediately and expires on November 1, 2006.



29

---





2003 Transaction with Park Capital Securities, LLC

On October 22, 2003, we extended our existing financial advisory agreement with Park Capital, a member of the National Association of Securities
Dealers, Inc. with an office at 216 East 45th Street, 9th Floor, New York, NY 10017. The agreement to extend the financial advisory agreement provided for the
issuance to Park Capital of a warrant to purchase 500,000 shares of restricted common stock in exchange for Park Capital's agreement to continue to provide financial advisory and other services to
Isonics. The following sets forth the information required by Item 701 in connection with that transaction:



2003 Transaction with vFinance Investments, Inc.

On October 22, 2003, we entered into an agreement with vFinance (3010 North Military Trail, Suite 300, Boca Raton, FL 33431 and at 880 Third Avenue,
4th Floor, New York, NY 10022), a member of the National Association of Securities Dealers, Inc. The agreement provided for the issuance to vFinance of a warrant to purchase
560,000 shares of restricted common stock in exchange for vFinance's agreement to provide financial advisory and other services to Isonics. The following sets forth the information required by Item
701 in connection with that transaction:



30

---





2003 Transaction with Investor Relations Services, Inc.



31

---





September 2003 Placement

Effective September 25, 2003, we issued 1,500,000 shares of our restricted common stock and 900,000 common stock warrants to three accredited investors
(Reback Living Trust Feb 20, 2001; Yorkshire Limited; and Southshore Capital Fund Ltd.) in exchange for their investment of $1,200,000. The following sets forth the information required by Item
701 in connection with that transaction:



(f)    Purchase of Equity Securities by Issuer and Affiliated Purchaser

During the fiscal year ended April 30, 2004 and subsequently, neither Isonics or any officer or director purchased any shares of our common stock in a
Rule 10b-18 transaction or otherwise, except for purchases made through our Employee Stock Purchase Plan. The Employee Stock Purchase Plan contemplates that each employee has the
right to withhold a portion of his or her salary and have that portion applied to purchase our common stock directly from us at a discount to the market price on June 1 and December 1 of
each year. Stephen Burden, Ph.D., Daniel Grady, Ph.D., and John Sakys (all vice presidents), are our only officers that participate in our Employee Stock Purchase Plan. (Our directors who are not
employees are not eligible to participate.) These three officers purchased (in aggregate) 2,847, 2,848 and 2,871 shares of restricted common stock on June 1, 2003, December 1, 2003 and
June 1, 2004, respectively. The purchase price on all three dates was $.91 per share.

32

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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OR PLAN OF OPERATION

(a)   Management's Discussion and Analysis of Financial Condition

The statements contained in this report that are not purely historical are forward-looking statements. "Forward looking statements" include statements regarding
our expectations, hopes, intentions, or strategies regarding the future. Forward looking statements include: statements regarding future products or products or product development; statements
regarding future selling, general and administrative costs and research and development spending, and our product development strategy; statements regarding future capital expenditures and financing
requirements; and similar forward looking statements. It is important to note that our actual results could differ materially from those in such forward-looking statements.

General Discussion

As
indicated in the risk factors and in the management's discussion and analysis which follows, we have had significant working capital shortages in the past and a lack of profitable
operations. Our revenues in the future will depend on our success in developing and selling products in the semiconductor, stable isotope and radioactive isotope markets. Consistent with our
historical experience, our annual results through April 30, 2004 have been materially affected by the size, timing, and quantity of orders and product shipments during a given quarter. In
addition, our results for fiscal year 2003 have been significantly impacted by one-time events including the July 2002 settlement of the Eagle-Picher dispute and sale of CTL as
discussed above. We cannot offer any assurance that these types of events will occur in the future.

Over
the past two years we have commenced two new operations consisting of our SOI wafer manufacturing operation in Vancouver, Washington, and our acquisition of detection technology
from IUT. In addition, in June 2004 we acquired the business and assets of EMG, which was engaged in the business of manufacturing and reclamation of silicon wafers. The start-up of
our SOI operations has required a significant cash investment and along with our manufacturing and reclamation of silicon wafers business, it will continue to do so in the future. The requirement for
significant amounts of cash for the detection technology from IUT is dependent upon our decision to move forward with the development of all the acquired technology.

33

---



Results of Operations

The following table sets forth operations data expressed as a percentage of revenues. The table and the discussion below should be read in conjunction with the
audited financial statements and the notes thereto appearing elsewhere in this report.

Year Ended
April 30,2004

2003Revenues

100.0
%
100.0
%Cost of revenues

81.8

77.5Gross margin

18.2

22.5Operating expenses:Selling, general and administrative

59.5

47.4Research and development

6.5

3.3Total operating expenses

66.0

50.7Operating loss

(47.8
)
(28.2
)Other income (expense), net

.1

15.2Loss before income tax expense

(47.7
)
(13.0
)Income tax benefit (expense)



.8Net loss

(47.7
)%
(12.2
)%


Revenues

Revenues generally decreased during the year ended April 30, 2004 as compared to the prior fiscal year, although revenues from our semiconductor materials
and products segment did reflect increases, as described in the following table:

Year Ended April 30,2004

2003Life sciencesDomestic

$
5,719,000

$
5,882,000International


2,483,000


2,972,000Semiconductor materials and products


519,000


197,000Total

$
8,721,000

$
9,051,000


As
a significant portion of our revenues are derived from a small concentration of customers (see Risk Factors), if one or more of these
customers were to discontinue or reduce their purchases of our isotope products, the result could have a material effect on both our revenues and related cash flows.

The
decrease in revenues from domestic isotope product sales for the year ended April 30, 2004 was primarily the result of a significant decrease in the sale of radioisotopes
partially offset by an increase in the sale of stable isotopes (consisting mainly of oxygen-18). The increase in the sale of stable isotopes was due to an increase in volume substantially
offset by a decrease in the unit price of oxygen-18.

While
the substantial majority of our revenues at our German subsidiary are derived from the sale of radioisotopes, we have had difficulty in the United States with our ability to enter
the radioisotope market. The difficulty arises from the fact that our potential customers have long established relationships with their suppliers (who are mostly foreign) and as a result they are
hesitant to change.

34

---



While
we continue to work towards increasing our share in the domestic radioisotope market to a meaningful number, we can offer no assurances that this will come to fruition.

The
substantial majority of our domestic isotope product sales result from the sale of oxygen-18 and while our volume continues to increase, starting in the second half of
the year ended April 30, 2004 the increases have not been as significant as the overall unit price decreases experienced in the market. As a result, in order to increase our revenues from the
sale of oxygen-18, we will need to increase our volume at a rate greater than the continuing decreases in the anticipated future market price. While we believe that we will be successful
in this endeavor in the future, we can offer no assurance that this will come to fruition.

The
decrease in revenues from international isotope product sales for the years ended April 30, 2004 was primarily the result of a significant decrease in sales of one specific
radioisotope due to a worldwide decrease in demand. It is uncertain if the demand for this radioisotope will return to previous levels.

In
general, our German subsidiary has had difficulty entering the oxygen-18 market in Europe as many of its potential customers are under long-term supply
contracts with their current suppliers and the market is relatively flat (unlike the United States which is growing at a significant rate). The quality of our product is high but we must wait until
our potential customers' current supply agreements terminate before we will be able to bid on new supply contracts. Our ability to increase the revenues in our German subsidiary (and ultimately its
gross margin) is directly related to how successful we can be in gaining market share in the European oxygen-18 market. While we anticipate that we will begin obtaining European
oxygen-18 customers in calendar 2004 (we have obtained one new customer as of July 14, 2004), the process is expected to be slow and we cannot provide any assurance that this will
come to fruition at all.

The
increase in revenues from semiconductor materials and products sales for the year ended April 30, 2004 was primarily due to a $200,000 sale of silicon-28 as a bulk
isotope in the first quarter of fiscal 2004 and an increase in the sale of SOI wafers.

As
a result of our acquisition of the business and assets of EMG in June 2004, we believe we now have the platform to not only continue and improve the EMG legacy manufacturing
and reclamation of silicon wafers business but also to launch a full scale SOI operation. As a result, we anticipate a significant increase in semiconductor materials and products sales for the year
ended April 30, 2005, however we cannot provide any assurance that this will come to fruition.

We
do not anticipate significant revenues from sales of silicon-28 based products during the year ending April 30, 2005. We are collaborating with academia and
industry to evaluate the benefits of isotopically pure silicon-28. We believe that if evaluations demonstrate the commercial feasibility of one or more products, demand could emerge in the
high-performance microprocessor segment of the semiconductor market. We can offer no assurance, however that these evaluations will demonstrate the commercial feasibility of any products,
that we will be able to commercialize any such products, or that a market will emerge for any such products.

Gross Margin

Our gross margins decreased during the year ended April 30, 2004 as compared to the prior fiscal year, both on a dollar amount and on a percentage of
revenues basis as reflected in the following table:

Year Ended April 30,2004

2003Dollar amount

$
1,583,000

$
2,037,000Percent of revenues


18.2
%

22.5
%


35

---



In
general, we anticipate that our margins will continue to decline as oxygen-18 prices decrease and until we can generate a positive margin for the semiconductor materials
and products segment. As a result of our acquisition of the business and assets of EMG in June 2004, we believe we now have the platform to not only continue and improve the EMG legacy
manufacturing and reclamation of silicon wafers business but to launch a full scale SOI operation and as a result, we anticipate that the gross margin from sales of semiconductor materials and
products (both in dollar value and as a percentage of revenues) will increase over time as sales increase and minimize the overall effect of fixed costs, but we can offer no assurances that this will
come to fruition.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses increased during the year ended April 30, 2004 as compared to the prior fiscal year, both on a dollar
amount and on a percentage of revenues basis as reflected in the following table:

Year Ended April 30,2004

2003Dollar amount

$
5,186,000

$
4,290,000Percent of revenues


59.5
%

47.4
%


The
dollar increase for the year ended April 30, 2004 is attributable primarily to an increase in the expensing of the market value of common stock warrants issued for consulting
and other professional services expenses and an increase in headcount and facility costs related to the expansion of our SOI operations partially offset by a decrease in legal costs associated with
the Eagle-Picher dispute. The percentage increase for the year ended April 30, 2004 is also attributable primarily to an increase in the expensing of the market value of common stock warrants
issued for consulting and other professional services expenses, an increase in headcount and facility costs related to the expansion of our SOI operations and a decrease in revenues partially offset
by a decrease in legal costs associated with the Eagle-Picher dispute.

As
a result of the financings we completed during the year ended April 30, 2004 and our acquisition of the business and assets of EMG in June 2004, we anticipate that we
will increase our selling, general and administrative expenses during fiscal year 2005 through anticipated increased marketing efforts for our semiconductor materials and products segment. In
addition, if we are able to obtain the necessary funding, we will increase our selling, general and administrative expenses during fiscal year 2005 in an effort to market the isotope-based trace
detection technology that we acquired from IUT. There can be no assurance that our anticipated increased selling, general and administrative expenses will result in increased revenues from product
sales.

Research and Development Expenses

Our research and development expenses increased during the year ended April 30, 2004 as compared to the prior fiscal year, both on a dollar amount and on a
percentage of revenues basis as reflected in the following table:

Year Ended April 30,2004

2003Dollar amount

$
569,000

$
303,000Percent of revenues


6.5
%

3.3
%


Both
the dollar and percentage increases for the year ended April 30, 2004 are primarily related to an increase in research and development expenses associated with our
thin-film SOI product.

36

---



Consistent
with our product development strategy, we are seeking to identify and evaluate new stable and radioactive isotope products, SOI products and potential markets for economic and
technical feasibility. In June 2004, we entered into an agreement with IUT to fund $275,000 of research and development expenses on behalf of IUTDT in fiscal 2005 and we anticipate that if we
obtain additional financing, we may incur additional research and development costs associated with the detection technology that we acquired from IUT. We will, in addition, continue funding research
and development to improve technologies for isotope separation and material processing technologies and our SOI processes. Because of the uniqueness of our business, the unique chemicals and processes
we deal with and the handling precautions required, these expenses can be significant. We cannot offer any assurance that our current or future lines of business or products resulting from our
research and development efforts will be profitable or generate significant revenues.

We
believe that the development and introduction of new product applications is critical to our future success. We expect that research and development expenses may increase assuming
sufficient cash remains available and we are able to procure necessary materials and outside services. It is likely that research and development expenditures will continue to vary as a percentage of
revenues because of the timing and amount of future revenues. Except for work being performed on our SOI thin-film product at our facilities in Vancouver, Washington, we operate no other
facilities of our own for research and development. All other research and development work is performed by outside entities, none of which we control. None of the companies that currently perform
research and development work for us does so on an exclusive basis.

Other income (expense), net

Other income(expense), net decreased during the year ended April 30, 2004 as compared to the prior fiscal year as reflected in the following table:

Year Ended April 30,2004

2003Dollar amount

$
9,000

$
1,380,000


For
the years ended April 30, 2004 and 2003, other income (expense), net includes net gains from a legal settlement, amortization of debt offering costs, gains or losses on the
sale of lines of businesses or subsidiaries, interest income and expense, and foreign currency gains and losses. The decrease is primarily attributable to the gain (net of the contingency portion of
legal fees) of $2,140,000 related to the settlement of the Eagle-Picher dispute and the gain resulting from the disposition of CTL, partially offset by the expensing of $546,000 of previously
unamortized discount related to the Series 2002A Convertible Notes to interest expense and $182,000 of previously capitalized debt offering costs as a result of the conversion of the notes to
common stock during the year ended April 30, 2003.

Income Taxes

We currently operate at a loss and expect to operate at a loss until the products currently under development begin to generate sufficient revenue. The losses
incurred in the current year are not expected to generate an income tax benefit because of the uncertainty of the realization of the deferred tax asset. As a result, we have provided a valuation
allowance against our net deferred tax asset as realization is uncertain. The income tax benefit in the year ended April 30, 2003 relates to cash received from a carry-back claim
resulting from a change in the tax laws.

37

---



Net Loss

Our net losses increased during the year ended April 30, 2004 as compared to the prior fiscal year as reflected in the following table:

Year Ended April 30,2004

2003Dollar amount

$
4,163,000

$
1,106,000


We
anticipate that losses will continue until (if ever): (i) revenues from our current operations and or newly acquired assets from EMG substantially increase or (ii) we
generate substantial revenues from products introduced as a result of our research and development projects. Included in the net loss for the year ended April 30, 2003 was a net gain of
$2,140,000 related to the settlement of the Eagle-Picher dispute.

Net
income in future years will be dependent upon our ability to increase net revenues faster than we increase our selling, general and administrative expenses, research and development
expense and other expenses. As a result of our acquisition of the business and assets of EMG in June 2004, we believe we now have the platform to not only continue and improve the EMG legacy
manufacturing and reclamation of silicon wafers business but to launch a full scale SOI operation. However, we anticipate that our operations during fiscal year 2005 will result in a loss since we are
not likely to increase our revenues from our existing products or generate additional sales from the new products we may develop in a sufficient amount (if at all) to offset our operating expenses.

Liquidity and Capital Resources

Our working capital and liquidity increased significantly during the year ended April 30, 2004 due to the private placements completed in
April 2004, January 2004 and September 2003 whereby we received $3,295,000 ($3,065,000 net of due diligence fees and related expenses), $2,200,000 ($2,000,000 net of due diligence
fees and related expenses) and $1,200,000 ($1,080,000 net of placement fees), respectively. Working capital increased $3,638,000, to $4,732,000, at April 30, 2004, from $1,094,000, at
April 30, 2003.

Our
principal source of funding for the year ended April 30, 2004 was from the private placements completed in April 2004, January 2004 and September 2003.
Our principal source of funding for the year ended April 30, 2003 was from the settlement of the Eagle-Picher dispute. We used cash in operating activities of $3,428,000 during the year ended
April 30, 2004 and provided cash from operating activities of $606,000 during the year ended April 30, 2003. Cash used in operating activities for the year ended April 30, 2004
was principally the result of a net loss of $4,163,000. Cash provided by operating activities during the year ended April 30, 2003 was principally the result of the settlement of the
Eagle-Picher dispute partially offset by operating losses.

As
a significant portion of our revenues and accounts receivable are derived from a small concentration of customers (See Significant
Customers), if one or more of these customers were to discontinue or reduce their purchases of our isotope products or fail to pay our accounts receivable, the result could
have a material effect on both our revenues and related cash flows.

Our
investing activities used cash of $43,000 and $550,000 for the years ended April 30, 2004 and 2003, respectively. Cash used in investing activities for the years ended
April 30, 2004 and 2003, resulted from purchases of property and equipment.

Financing
activities provided cash of $6,420,000 for the year ended April 30, 2004 and used cash of $39,000 for the year ended April 30, 2003. Cash provided by financing
activities for the year ended April 30, 2004 resulted primarily from the private placements of $3,295,000 ($3,065,000 net of due diligence fees and related expenses), $2,200,000 ($2,000,000 net
of due diligence fees and related

38

---



expenses)
and $1,200,000 ($1,080,000 net of placement fees) completed in April 2004, January 2004 and September 2003, respectively. Cash used in financing activities for the year
ended April 30, 2003 resulted primarily from payments on borrowings of $44,000.

At
April 30, 2004, we had $3,691,000 of cash and cash equivalents, an increase of $2,949,000, from cash and cash equivalents of $742,000 at April 30, 2003.

There
are provisions associated with the preferred stock private placement completed on July 29, 1999 that if triggered, would reduce the current conversion price and effectively
allow the preferred shares to convert to common stock at a more favorable ratio. Prior to our September 2003 financing, the preferred stock was convertible at 1.67 shares of common stock for
each share of Series A Convertible Preferred Stock outstanding. We did not believe that the financing completed in September 2003 caused any further adjustment to the conversion price,
but the holders of the Series A Convertible Preferred Stock expressed their disagreement. In November 2003, we entered into a settlement agreement with the holders of the Series A
Convertible Preferred Stock and as a result, the preferred shares are now convertible at two shares of common stock for each share of Series A Convertible Preferred Stock outstanding. As of
July 14, 2004 there were 500,308 shares of Series A Convertible Preferred Stock outstanding convertible into 1,000,616 shares of common stock based on the settlement agreement.

Our
stock was trading at prices significantly below the $1.00 per share Nasdaq minimum bid price requirement at times during calendar 2003. The volatility of our stock price, our current
price and our financial condition may result in our failing to meet Nasdaq's requirements. As a result, we could potentially be at risk of Nasdaq action to remove our securities from its SmallCap
market. We cannot give any assurance that we will be able to meet the Nasdaq requirements to maintain our SmallCap listing, or that if we do, a stable trading market will develop for our stock.

In
general, we expect that our working capital will decrease over time as we continue to use our capital and cash flows from revenues for operations, research and development, and
investing activities. We do not expect working capital to increase until we are able increase our revenues to exceed our cash out-flows (assuming we are able to increase our revenues) or
complete a financing arrangement.

At
the end of our most recent fiscal year we had sufficient working capital to finance our anticipated operations and projected negative cash flow into our 2006 fiscal year. However, on
June 11, 2004 we acquired the silicon wafer manufacturing and recycling assets of EMG. While we believe this
acquisition will now provide the platform for us to not only continue and improve the EMG legacy manufacturing and reclamation of silicon wafers business, but to also launch a full scale SOI
operation, we will need to raise significant additional capital in fiscal year 2005 if we are to successfully implement our current business plan for the acquired assets. As a result, we are currently
working with several different sources, including both strategic and financial investors, in order to raise the capital necessary to finance both our continuing operations and our newly acquired
assets from EMG.

Based
on available funds, financing opportunities, current plans and business conditions, we believe that our available cash, financing sources and amounts generated from operations will
be sufficient to meet our cash requirements for the next 12 months. The assumptions underlying this belief include, among other things, that there will be no material adverse developments in
the business or market in general. There can be no assurances however that those assumed events will occur. If our plans are not achieved, there may be further negative effects on the results of
operations and cash flows, which could have a material adverse effect on our financial position.

Contractual Cash Obligations

The following summarizes our contractual cash obligations and commercial commitments at April 30, 2004, and the effect such obligations are expected to
have on liquidity and cash flows in

39

---



future
periods. Included in the table below are purchase obligations under which we have legal obligations for payments in specific years.

|                                                                             |  | Payments Due by Period(a)
|---------------------------------------------------------------------------- |  | -------------------------
|
|Long-term debt                                                               |  | $                        
|Capital lease obligations                                                    |  |                          
|Operating lease obligations(b)                                               |  |                          
|Purchase obligations(c)                                                      |  |                          
|Other long-term obligations reflected in the balance sheet at April 30, 2004 |  |                          
|                                                                             |  |                          
|Total contractual obligations                                                |  | $                        

---

As
a result of our acquisition of the business and assets of EMG in June 2004 we have the following additional contractual cash obligations and commercial commitments related to
that business as of July 1, 2004:

|                                                                             |  | Payments Due by Period(a)
|---------------------------------------------------------------------------- |  | -------------------------
|
|Long-term debt(b)                                                            |  | $                        
|Capital lease obligations                                                    |  |                          
|Operating lease obligations(c)                                               |  |                          
|Purchase obligations (d)                                                     |  |                          
|Other long-term obligations reflected in the balance sheet at April 30, 2004 |  |                          
|                                                                             |  |                          
|Total contractual obligations                                                |  | $                        

---

Off-Balance Sheet Arrangements

In addition to the purchase obligations discussed above, see note 12 to the consolidated financial statements for a discussion of letters and lines of
credit.

40

---



Critical Accounting Policies

The material accounting policies that we believe are the most critical to an investor's understanding of our financial results and condition and require complex
management judgment have been expanded and are discussed below.

Goodwill and Intangible Assets

Effective May 1, 2002 we adopted SFAS No. 142Goodwill and Other Intangible Assets.SFAS
No. 142 addresses the methods used to amortize intangible assets and to assess impairment of those assets, including goodwill resulting from business combinations accounted for under the
purchase method. Although we adopted SFAS No. 142 effective May 1, 2002, goodwill and intangible assets other than goodwill acquired after June 30, 2001 have been amortized or not
amortized in accordance with SFAS 142. We acquired intangible assets from SEI and IUT subsequent to June 30, 2001, and have accounted for those assets in accordance with the requirements
of SFAS No. 142. Included in our assets at April 30, 2004, is goodwill related to the acquisition of Chemotrade in 1998 with a net carrying value of $1,807,000. Effective with the
adoption of SFAS No. 142, we no longer amortize this goodwill, decreasing our amortization expense by approximately $110,000 per year.

In
accordance with SFAS No. 142, we have completed our annual impairment test (as of April 30, 2004) on our life sciences reporting unit, which has recorded goodwill. In
completing our analysis of the life sciences reporting unit, we used the Discounted Cash Flow Method ("DCF Method") in which the reporting unit was valued by discounting the projected cash flows to
its present value based upon a risk adjusted discount rate. As a result of the testing, we determined that there is no impairment of goodwill. We are required to assess goodwill for impairment at
least annually, or when circumstances indicate that impairment may have occurred.

In
performing the calculation under SFAS No. 142, we made several assumptions, including the use of the DCF Method, the number of years used in the projection, the discount rate
and growth assumptions. If we had elected to use different variables, the outcome of the calculation could have been different.

We
utilized the DCF Method in order to calculate the fair value of our life sciences reporting unit. We had the option to utilize the market capitalization method but given the
complexity of our business, we determined that we couldn't reasonably bifurcate the market value of the life sciences reporting unit from our other operations based upon our market value as a whole.
In utilizing the DCF method, we based our calculation over a conservative six-year life with no projected growth over the final four years. The final four years were kept constant in order
to ensure that we did not overestimate the potential of the reporting unit. The six-year life was utilized as a result
of the fact that the life sciences reporting unit has been selling isotopes for over sixteen years and that demand for isotopes is projected to increase over the next ten years. Given the history of
the reporting unit and the projected future of the industry, we determined that it was reasonable to utilize a six-year life. Had we utilized a life of less than six years, the calculation
may have suggested that impairment was present. In addition, we discounted the projected cash flows at a rate of 12%. The 12% was deemed reasonable given the current low market interest rate and the
extremely low risk of the life sciences business offset by the higher cost of capital for a small company and the related difficulties we have had in raising necessary capital over the years. Had we
utilized a discount rate that was substantially larger than 12%, the calculation may have suggested that impairment was present.

Our
intangible assets result from the perpetual, exclusive technology license agreement with SEI that we entered into on September 14, 2001 and the isotope-based trace detection
technology we acquired from IUT in December 2002. We initially determined that the intangible assets acquired from SEI had an indefinite useful life as they were not bound by any legal time
periods or otherwise limited due to competing technologies and, therefore in accordance with SFAS No. 142 they were not

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amortized
but rather tested annually for impairment. During the year ended April 30, 2003, upon further evaluation of the uses and applications of the acquired technology and the advancement of
the development of our SOI business plan, we determined that the intangible assets no longer had an indefinite life and as a result, the assets are now being amortized over their estimated useful life
of ten years. The isotope-based trace detection technology is also being amortized over its estimated useful life of ten years (which is based upon many factors including the time it will take to
develop the technology, the expected life of the finalized product(s) and the estimated lives of similar products). We will continue to evaluate each reporting period whether events and circumstances
continue to support our assessment of a ten-year life for these intangible assets. Additionally, if indicators of impairment do arise in the future, the intangible assets will be tested
for impairment and may result in an impairment charge in the future.

Valuation of Equity Transactions

We value transactions associated with common or preferred stock that is convertible into common stock based on the market value of the underlying common stock on
the date of the signing of the agreement. We value transactions associated with common stock warrants at the appropriate measurement date utilizing the Black-Scholes pricing model, with assumptions as
to volatility (100%), risk-free interest rate (4.0%) and estimated life of the warrants based on historical information. If the assumptions used, as they relate to volatility,
risk-free interest rate and estimated life of the warrants, were materially different, the overall valuation of these transactions could change significantly.

(b)Risk Factors

An investment in and ownership of our common stock is one of high risk. You should carefully consider the risks described below before
deciding whether to exercise your Class B Warrants, your Class C Warrants, or to invest in or continue to hold our common stock. If any of the contingencies discussed in the following
paragraphs or other materially adverse events actually occurs, the business, financial condition and results of operations could be materially and adversely affected. In such case, the trading price
of our common stock could decline, and you could lose all or part of your investment.

Unless we are able to develop and sell new products profitably, we may be unable to remain competitive, furthering the likelihood that our losses and negative cash flow will
continue.

We have not operated profitably since our 1996 fiscal year. We recognized net income for the year ended April 30, 2000, only because of the gain recognized
on the sale of our depleted zinc assets to Eagle-Picher.

Our
ability to generate additional revenues (and ultimately net income) is dependent upon our ability to expand our SOI and manufacturing and reclamation of silicon wafers business and
to develop new products, including those that use stable and radioactive isotopes while marketing and selling those products profitably. We may be unable to develop products that can be profitably
marketed and sold, which may prevent us from paying creditors as debts are due, and, in turn, may materially impact our ability to continue our business operations.See
"Business."

We
are currently dependent on our continuing revenues and increasing orders to improve our operating results, and cash payments from our customers to provide working capital. To the
extent orders and deliveries are reduced because of changing customer needs or our inability to supply product, or to the extent payments from customers are reduced because of adverse financial
conditions affecting our customers, we will be adversely affected.

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It is possible that the following circumstances may develop and may adversely impact our available working capital and materially impact our ability to continue our business operations:



We
may not be able to obtain equity or debt financing on reasonable terms when we need such financing. The unavailability of additional financing, when needed, could have a material
adverse effect on our business.See "Management's Discussion and Analysis" and "Business."

We have raised capital and issued shares during the years ended April 30, 2004 and 2003, and subsequently which has resulted in dilution to our existing shareholders.
This was necessary in order to provide necessary working capital or obtain assets and services. We will likely issue more shares to raise additional capital or to obtain other services or assets, any
of which may result in substantial additional dilution.

During the course of the last two fiscal years and the current fiscal year, we have been required to raise in excess of $7,700,000 of net working capital (after
expenses) to finance our business operations and acquisitions. We have raised this capital by issuing shares of common stock, convertible preferred
stock and common stock warrants to accredited investors and as compensation to investment bankers making introductions to the accredited investors. During this same period of time, we have issued
common stock warrants and shares of common stock to several persons in exchange for their promises to perform investment banking and financial advisory services to us. In many cases, these issuances
were below the then-current market prices and can be considered dilutive to our existing shareholdersboth as a reduction of their percentage ownership in Isonics and because
of issuances at prices below the market.

There
are provisions associated with the Series A Convertible Preferred Stock private placement completed on July 29, 1999 that if triggered, would reduce the current
conversion price and effectively allow the preferred shares to convert to common stock at a more favorable ratio. As a result of various transactions (including the September 2003 financing and
the related settlement agreement), the related preferred shares are now convertible at two shares of common stock for each share of Series A Convertible Preferred Stock outstanding. As of
July 14, 2004 there were 500,308 shares of Series A Convertible Preferred Stock outstanding convertible into 1,000,616 shares of common stock.

If
we are successful in raising additional working capital, we will likely have to issue additional shares of our common stock and common stock warrants at prices that may dilute the
interests of our existing shareholders.

Operations in Russia, the Republic of Uzbekistan, and the Republic of Georgia may be disrupted because of a volatile political and economic climate beyond our control, which
could adversely affect our supply of raw materials.

Operations in Russia, the Republic of Uzbekistan, and the Republic of Georgia entail risks. The former republics of the Soviet Union including Uzbekistan and
Georgia are experiencing political, social and economic change as they obtain independence from the former central government in Moscow. Some of the republics, including Russia, Uzbekistan and
Georgia, are attempting to transition from a central-controlled economy toward a market-based economy. These changes have involved, in

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some
cases, armed conflict and the risk of continued instability has increased since the terrorist attacks on the United States of September 11, 2001. Although Uzbekistan borders Afghanistan,
the activities in Afghanistan have not impacted our supply of isotopes. Political or economic instability in these republics may continue or worsen. The price, availability, quality, quantity, ability
to export and supply of stable and radioactive isotopes could be directly affected by political, economic and military conditions in Russia, Uzbekistan and Georgia.

We
are dependent on suppliers from Russia, Uzbekistan, and Georgia for approximately 95% of both our stable isotopes and our radioisotopes. Accordingly, our operations could be
materially adversely
affected if hostilities in Russia, Uzbekistan, or Georgia should occur, if trade between Russia, Uzbekistan and/or Georgia and the United States were interrupted or ceased, if political conditions in
Russia, Uzbekistan or Georgia disrupt transportation or processing of our goods, if laws or government policies concerning foreign business operations in Russia, Uzbekistan or Georgia change
substantially, or if tariffs are introduced.See "Management's Discussion and Analysis" and "Business."

Because we depend upon few customers for a significant portion of our revenues, our business may be materially and adversely affected if we lose any one of these customers.

One customer (Eastern Isotopes) accounted for approximately 32% of revenues for the year ended April 30, 2004. Three customers (Perkin Elmer Life Sciences,
IBT SA, and International Isotopes) accounted for approximately 33%, 20% and 19%, respectively of the German operation's revenues for the year ended April 30, 2004.

While
our goal is to diversify our customer base, we expect to continue to depend upon a relatively small number of customers for a significant percentage of our revenues for the
foreseeable future. Significant reductions in sales to any of our large customers have had, and may in the future have, a material adverse effect on us by reducing our revenues and our gross margins.
Present or future customers could terminate their purchasing patterns with us or significantly change, reduce or delay the amount of isotopes or other products ordered from us. See "Management's Discussion and Analysis" and
"Business."

As
a result of our June 11, 2004 acquisition of the manufacturing and reclamation of silicon wafers business and related assets from EMG, our customer base has increased and is
anticipated to continue to increase over time as we not only expand the wafer reclaim and manufacturing business but also our SOI operations.

If demand for our product grows suddenly, we may lack the resources to meet demand or we may be required to increase our capital spending significantly.

We have experienced, and may again experience, periods of rapid growth that place a significant strain on our financial and managerial resources. Through our
marketing efforts we have increased the number and type of products we offer to our customers in our effort to replace the cash flow reduction that occurred as a result of the sale of our depleted
zinc operations, and we are continuing to look for new products to offer. Through our research and development efforts we are also attempting to develop additional products and lines of business. Our
ability to manage growth effectively, particularly given our increasing scope of operations, will require us to continue to implement and improve our management, operational and financial information
systems, and will require us to develop the management skills of our personnel and to train, motivate and manage our employees. Our failure to effectively manage growth could increase our costs of
operations and reduce our margins and liquidity, which could have a material adverse effect on our business, financial condition and results of operations.See
"Business."

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Because we are dependent upon our key personnel for our future success, if we fail to retain or attract key personnel, our business will be adversely affected.

Our future success will depend in significant part upon the continued service of our key technical, sales and senior management personnel, including James E.
Alexander, our President and Chief Executive Officer; Boris Rubizhevsky, our Senior Vice President, Isotope Production and Supply; Daniel Grady, Vice President, Life Sciences; Stephen Burden, Vice
President, Semiconductor Materials; and Hans Walitzki, Vice President, Advanced Wafer Technology. We have obtained $1,000,000 of key man life insurance on the lives of Mr. Alexander and
Mr. Rubizhevsky. Currently both Mr. Alexander and Mr. Rubizhevsky are covered by employment agreements that are renewable on an annual basis. Dr. Grady and
Dr. Burden are covered by employment agreements with an indefinite term that provides at-will employment, terminable at any time by either party. Dr. Walitzki is covered by
an employment agreement through November 2006.

We
believe that our future success will also depend upon our ability to attract and retain other qualified personnel for our operations. The failure to attract or retain such persons
could materially adversely affect our business, financial condition and results of operations.See "Management."

We may not be able to protect our intellectual property, which would reduce our competitive advantage.

We rely primarily on a combination of patents and patent applications, trade secrets, confidentiality procedures, and contractual provisions to protect our
technology. Despite our efforts to protect our technology, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing
unauthorized use of our technology and products is difficult. In addition, the laws of many countries do not protect our rights to information, materials and intellectual property that we regard as
proprietary, and that are protected under the laws of the United States. We may not be able to protect our proprietary interests, or our competitors may independently develop similar technology or
intellectual property. If either one of these situations occurs, we may lose existing customers and our business may suffer.See "Business."

The
validity of any of the patents licensed to us, or that may in the future be owned by us, may not be upheld if challenged by others in litigation. Further, our products or
technologies, even if covered by our patents, may infringe upon patents owned by others. We could incur substantial costs in defending suits brought against us, or any of our licensors, for
infringement, in suits by us against others for infringement, or in suits contesting the validity of a patent. Any such proceeding may be protracted. In any suit contesting the validity of a patent,
the patent being contested would be entitled to a presumption of validity and the contesting party would be required to demonstrate invalidity of such patent by clear and convincing evidence. If the
outcome of any such litigation were adverse to our interests, our liquidity and business operations would be materially adversely affected.

We face technological change and intense competition both domestically and internationally which may adversely affect our ability to sell our products profitably.

Although we do not believe that any entity produces a complete range of stable enriched isotopes for commercial sale, many of our competitors have significantly
greater funding than do we and may be able to develop products which are competitive with our products.See "Business."

Further,
it is possible that future technological developments may occur. The market for our isotope products and SOI wafers is characterized by rapidly evolving technology and a
continuing process development. Our future success will depend upon our ability to develop and market isotope and SOI wafer products that meet changing customer and technological needs on a cost
effective and timely basis. If we fail to remain competitive by anticipating the needs of our customers and our customers contract with other suppliers, our revenues and resulting cash flow could be
materially and adversely affected.

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We could be subject to environmental regulation by federal, state and local agencies, including laws that impose liability without fault, which could produce working capital
shortages and lessen shareholders' equity.

We could become subject to a variety of federal, state, and local environmental regulations relating to the use, storage, discharge and disposal of hazardous
chemicals used during the isotope product delivery and manufacturing process, although we do not believe that there is any such regulation directly applicable to our current operations. Regulations
that become applicable to our operations in the future could restrict our ability to expand our facilities or could require us to acquire costly equipment or to incur other significant expenses to
comply with governmental regulations. Historically, our costs of compliance with environmental regulations have not been significant.

We are controlled by only a few officers and directors and, consequently, purchasers of our shares will have very little ability to elect or control our management.

Even if all outstanding warrants and stock options are exercised and convertible securities are exchanged for common stock, our directors and officers will
beneficially own 16.3% of the outstanding shares of common stock as of July 14, 2004, and, accordingly, may have the ability to elect a majority of the directors of Isonics and otherwise
control the company. As a result, such persons, acting together, will have the ability to substantially influence all matters submitted to stockholders for approval, including the election and removal
of directors and any merger, consolidation or sale of substantially all of our assets, and to control our management and affairs. Such concentration of ownership may have the effect of delaying,
deferring or preventing a change in control, impeding a merger, consolidation or takeover or other business combination involving us or discouraging a potential acquirer from making a tender offer or
otherwise attempting to obtain control of our business, even if such a transaction would be beneficial to other stockholders.

We risk exposing ourselves to an above-policy limit product liability claim, which could adversely affect our working capital, shareholders' equity and profitability.

The use of our radioisotopes in radiopharmaceuticals and in clinical trials may expose us to potential product liability risks that are inherent in the testing,
manufacture, marketing, and sale of human diagnostic and therapeutic products. We currently have product liability insurance; however, there is a risk that our insurance would not cover completely or
would fail to cover a claim, in which case we may not have the financial resources to satisfy such claims, and the payment of claims would require us to use funds that are otherwise needed to conduct
our business and make our products.See "Business."

Our common stock is vulnerable to pricing and purchasing actions that are beyond our control and, therefore, persons acquiring our shares may be unable to resell their shares
at a profit as a result of this volatility.

The trading price of our securities has been subject to wide fluctuations in response to quarter-to-quarter variations in our operating
results, our announcements of technological innovations or new products by us or our competitors, and other events and factors. The securities markets themselves have from time to time and recently
experienced significant price and volume fluctuations that may be unrelated to the operating performance of particular companies. Announcements of delays in our testing and development schedules,
technological innovations or new products by us or our competitors and developments or disputes concerning patents or proprietary rights could have a significant and adverse impact on such market
prices. Regulatory developments in the United States and foreign countries, public concern as to the safety of products containing radioactive compounds, economic and other external factors, all
affect the market price of our securities.In addition, the

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realization of any of the risks described in these "Risk Factors" could have a significant and adverse impact on such market prices

SEC penny stock regulations may limit the ability to trade our securities on the Nasdaq Small Cap Market.

Although our common stock is currently quoted on the Nasdaq SmallCap Stock Market, our common stock has in the past been subject to additional disclosure
requirements for penny stocks mandated by the Securities Enforcement Remedies and Penny Stock Reform Act of 1990. The SEC Regulations generally define a penny stock to be an equity security that is
not traded on the Nasdaq Stock Market and has a market price of less than $5.00 per share. We have, at times in the past, been included within the SEC Rule 3a-51 definition of a
penny stock. When our common stock is considered to be a "penny stock", trading is covered by Rule 15g-9 promulgated under the Securities Exchange Act of 1934, for
non-Nasdaq and non-national securities exchange listed securities.

Under
this rule, broker-dealers who recommend such securities to persons other than established customers and accredited investors must make a special written disclosure to, and
suitability determination for, the purchaser and receive the purchaser's written agreement to a transaction prior to sale. The regulations on penny stocks limit the ability of broker-dealers to sell
our common stock and thus the ability of purchasers of our common stock to sell their securities in the secondary market. To the extent we are able to maintain our listing on the Nasdaq SmallCap Stock
Market, we will not be
subject to these penny stock rules. Reasons for being unable to maintain our listing on the Nasdaq SmallCap Stock Market include:



Our
stock has in the past traded at prices significantly below the $1.00 per share minimum maintenance requirements. The volatility of our stock price, and our financial condition may
result in our failing to meet Nasdaq's requirements in the future. As a result, we could potentially be at risk of Nasdaq action to remove our securities from its SmallCap market. We cannot give any
assurance that we will be able to meet the Nasdaq requirements to maintain our SmallCap listing, or that if we do, a stable trading market will develop for our stock or our warrants. See"Market for Common Equity and Related Stockholder Matters."

Future sales of our common stock may cause our stock price to decline.

Our stock price may decline by future sales of our shares or the perception that such sales may occur. As of July 14, 2004, approximately 5,669,000 shares
of common stock held by existing stockholders constitute "restricted shares" as defined in Rule 144 under the Securities Act. The restricted shares may only be sold if they are registered under
the Securities Act, or sold under Rule 144, or another exemption from registration under the Securities Act.

Approximately
90% of the restricted shares of our common stock are either eligible for sale pursuant to Rule 144 or have been registered under the Securities Act for resale by the
holders. We are unable to estimate the amount, timing, or nature of future sales of outstanding common stock. Sales of substantial amounts of our common stock in the public market may cause the
stock's market price to decline.See "Shares Available for Future Sale."

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We have never paid any cash dividends on our common stock and we do not anticipate paying cash dividends on our common stock in the foreseeable future.

We have never declared or paid a cash dividend on our common stock. We presently intend to retain our earnings, if any, to fund development and growth of our
business and, therefore, we do not anticipate paying cash dividends in the foreseeable future. Additionally, the certificate of designation for the Series A Convertible Preferred Stock contains
restrictions on our ability to pay dividends to holders of our common stock.

Outstanding Series A, C and D Convertible Preferred Stock, options and warrants may make it difficult for us to obtain additional capital on reasonable terms.

As of July 14, 2004 we have 500,308 shares of Series A Convertible Preferred Stock and 26,950 shares of our Series D Convertible Preferred
Stock outstanding convertible into 1,000,616 and 2,450,000 shares of our common stock, respectively, and we have 9,000 shares of our Series C Convertible Preferred Stock outstanding convertible
into up to 947,368 shares of our common stock. In addition, we had outstanding options and common stock warrants for the purchase of up to 9,950,958 shares of common stock at an average exercise price
of $1.37 per share. If all of the outstanding options and common stock warrants were to be converted, they would represent approximately 31% of our outstanding common shares on a fully diluted basis.
Future investors will likely recognize that the holders of the options, warrants and the convertible preferred stock will only exercise their rights to acquire our common stock when it is to their
economic advantage to do so. Therefore, even with lower current market prices for our common stock, the market overhang of such a large number of warrants, options, and convertible preferred stock may
adversely impact our ability to obtain additional capital because any new investors will perceive that securities offer a risk of substantial potential future dilution.

If we fail to effect and maintain registration of the common stock issued or issuable pursuant to conversion of our convertible preferred stock or certain of our outstanding
common stock purchase warrants, we may be obligated to pay the investors of those securities liquidated damages.

We have an obligation to maintain the effectiveness of certain registration statements which include certain outstanding common stock and common stock underlying
outstanding convertible preferred stock and common stock purchase warrants. If we fail to meet these contractual obligations, we may become obligated to pay investors liquidated damages. We cannot
offer any assurances that we will be able to maintain the effectiveness of the registration statement.

Provisions in our charter documents could prevent or delay a change in control, which could delay or prevent a takeover.

Our Articles of Incorporation authorize the issuance of "blank check" preferred stock with such designations, rights, and preferences, as may be determined by our
Board of Directors. Accordingly, the Board of Directors may, without shareholder approval, issue shares of preferred stock with dividend, liquidation, conversion, voting, or other rights that could
adversely affect the voting power or other rights of the holders of our common stock. Preferred stock could also be issued to discourage, delay, or prevent a change in our control, although we do not
currently intend to issue any additional series of our preferred stock. See"Isonics' Capital Stock."

Provisions
in our bylaws provide for indemnification of officers and directors to the full extent permitted by California law, which could require us to direct funds away from our
business and products.

Our
Bylaws provide for indemnification of officers and directors to the full extent permitted by California law, our state of incorporation. We may be required to pay judgments, fines,
and expenses

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incurred
by an officer or director, including reasonable attorneys' fees, as a result of actions or proceedings in which such officers and directors are involved by reason of being or having been an
officer or director. Funds paid in satisfaction of judgments, fines and expenses may be funds we need for the operation of our business and the development of our products, thereby affecting our
ability to attain profitability. This could cause our stock price to drop.

Forward-looking statements may prove to be inaccurate

In our effort to make the information in this report more meaningful, this report contains both historical and forward-looking statements. All statements other
than statements of historical fact are forward-looking statements within the meanings of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of
1934. Forward-looking statements in this report are not based on historical facts, but rather reflect the current expectations of our management concerning future results and events.

The
forward-looking statements generally can be identified by the use of terms such as "believe," "expect," "anticipate," "intend," "plan," "foresee," "likely," "will" or other similar
words or phrases.
Furthermore, statements that describe our objectives, plans, or goals are, or may be, forward-looking statements.

Forward-looking
statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Isonics to be different
from any future results, performance and achievements expressed or implied by these statements.

These
factors are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in the forward-looking statements in this annual
report. Other unknown or unpredictable factors also could have material adverse effects on the future results of Isonics.

ITEM 7. FINANCIAL STATEMENTS

The information required by this item begins on page F-1 of Part III of this Report on Form 10-KSB and is
incorporated into this part by reference.

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

None.

ITEM 8A. CONTROLS AND PROCEDURES.

(a)Evaluation of Disclosure Controls and Procedures.

As required by Rule 13a-15 under the Securities Exchange Act of 1934, within the 90 days prior to the filing date of this report,
Isonics carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures. This evaluation was carried out under the
supervision and with the participation of our principal executive officer as well as our principal financial officer, who concluded that the company's disclosure controls and procedures are effective.

Disclosure
controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the
Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated
to

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management,
including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

(b)Changes in Internal Controls.

There were no changes in our internal controls or in other factors that could significantly affect these internal controls subsequent to the date of their
evaluation.

PART III

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

(a) and (b)Identification of Directors and Executive Officers

The following table sets forth the names and ages of all the Directors and Executive Officers of Isonics, and the positions held by each such person as of
April 30, 2004. Each of the directors holds office until the next annual meeting of shareholders and until his or her successor is elected and qualified or until his or her earlier death,
resignation, or removal. Each officer serves at the discretion of the Board.

|Name                        |  | Age |  | Position                                                                
|--------------------------- |  | --- |  | ------------------------------------------------------------------------
|James E. Alexander          |  | 55  |  | President, Chief Executive Officer, Treasurer, and Chairman of the Board
|Boris Rubizhevsky(2)        |  | 53  |  | Senior Vice President, Vice Chairman and Director                       
|Daniel J. Grady             |  | 49  |  | Vice President, Life Sciences, Manager of Chemotrade                    
|Stephen J. Burden           |  | 55  |  | Vice President, Semiconductor Materials and Products                    
|John Sakys                  |  | 35  |  | Vice President, Chief Financial Officer and Secretary                   
|Hans Walitzki               |  | 48  |  | Vice President, Advanced Wafer Technology                               
|Lindsay A. Gardner(1)(2)(3) |  | 53  |  | Director                                                                
|Richard Parker(1)(2)(3)     |  | 60  |  | Director                                                                
|Russell W. Weiss(1)(2)(3)   |  | 57  |  | Director                                                                

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James E. Alexanderis our co-founder. He has served as our President, Chief Executive Officer and as a director since our
inception. Mr. Alexander has worked full-time for Isonics since January 1994. From June 1972 to December 1993, he worked in a variety of technology positions at
General Electric Corporation in the aircraft engine and nuclear power divisions, most recently as Manager of Technology Programs. Mr. Alexander received his Bachelors degree in Metallurgical
Engineering from the University of Cincinnati and performed graduate work in materials science there. He earned a Masters degree in Business Administration from Santa Clara University.

Boris Rubizhevskyis a co-founder of Isonics and has been Senior Vice President and a director since our inception.
Mr. Rubizhevsky became Vice Chairman in March 1997 and has worked exclusively for Isonics during this time. From November 1986 through December 1994, he owned and operated
SAR Marketing, a consulting firm providing business advice and services to large multinational

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corporations.
From June 1977 to May 1986, Mr. Rubizhevsky worked at General Electric Corporation as Business Development Manager in various international locations. He received
his Bachelors degree in Engineering from Stevens Institute of Technology.

Dr. Daniel J. Gradyjoined us as Vice President, Life Sciences in 1995 and became manager of our Chemotrade subsidiary in
January 2002. From March 1994 through September 1995, Dr. Grady was Vice President of Research and Development at Sopha Medical Systems, a medical diagnostic imaging
equipment manufacturer. From April 1991 until March 1994, he served as Marketing Manager, Nuclear Energy for General Electric Corporation. From May 1988 through March 1991,
Dr. Grady served as Software Engineer Manager, Nuclear Medicine for General Electric in England. From October 1984 through May 1988, he served as Clinical Applications Manager for
General Electric Nuclear Medicine. Between June 1981 and October 1984, he served as Engineering Analysis Section Head for TRW. Dr. Grady received his Bachelors and Masters degrees
and Ph.D. in Nuclear Engineering from the University of Michigan.

Dr. Stephen J. Burdenjoined us in January 1997 as Director of Research & Development. He was promoted to Vice
President, Semiconductor Materials effective January 1, 1999. From 1993 to 1997, Dr. Burden was Director of Product Development at SP3, Inc., a manufacturer of diamond-coated
tools. From 1984 to 1993, he was Manager of Advanced Materials R&D at GTE Valenite, a subsidiary of GTE Corporation, a manufacturer of cutting tools. From 1974 to 1984, Dr. Burden was employed
by General Electric Corporation in various capacities. Dr. Burden received his Ph.D. and Masters of Science degrees in Materials Science and Engineering from Drexel University, and his
Bachelors degree in Science Engineering from Northwestern University. Dr. Burden also has an MBA from the University of Michigan.

John Sakysjoined us in May 2001 as Controller. He was promoted to Vice President, Chief Financial Officer effective
September 3, 2001, and he serves as corporate Secretary. From September 2000 to April 2001 Mr. Sakys was controller of AuraServ Communications. From July 1998 to
September 2000 Mr. Sakys was Director of Financial Reporting for Media One, Inc. From December 1994 to July 1998 Mr. Sakys was an audit manager at Ernst and
Young LLP. Mr. Sakys received his Bachelors degree in Business Economics with an emphasis in accounting from the University of California at Santa Barbara and is a Certified Public Accountant.

Dr. Hans Walitzkijoined us in November 2001 as Vice President, Advanced Wafer Technology. He was employed as a vice
president, chief technology officer, and Chairman of the Board of Directors of Silicon Evolution, Inc. (of Vancouver, Washington) from its formation in February 1999 until
November 2001. Silicon Evolution filed a petition for relief under chapter 7 (liquidation) of the United States Bankruptcy Code in December 2001. Before that (from
March 1982 until February 1999), Dr. Walitzki was employed at Wacker Siltronic Corporation in Portland, Oregon and its parent Wacker Siltronic AG in Germany. Dr. Walitzki
received his Masters degree in Physics from Bonn University, Germany in 1980 and he received his Ph.D. in Physics from Bonn University in 1982.

Lindsay A. Gardnerhas served as a director since September 1993. Ms. Gardner is currently Director, Corporate Development
and Strategic Planning for Menasha Corporation. From 1991 to 2001, Ms. Gardner was President of LG Associates, a U.S.-based management consulting firm providing strategic planning and materials
management expertise to foreign company affiliates of U.S. companies in developing countries. During her tenure at LG Associates, Ms. Gardner resided in Moscow, Russia from
September 1991 to January 1994, and Beijing, China from January 1994 to April 2000. She currently resides in Appleton, Wisconsin. From 1977 to 1991, Ms. Gardner
worked for General Electric
Corporation in a variety of management and functional positions including international marketing, quality assurance and supply chain management. Ms. Gardner received a Bachelors degree in
International Economics from The George Washington University Elliott School of International Affairs and earned a Masters of Business Administration from the University of Louisville.

51

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Richard Parkerhas served as a director since August 1998. Mr. Parker previously was Vice-President of
Distribution Sales for Cypress Semiconductor and he held that position since December 1997 until his retirement which was effective December 31, 2002. Previously, Mr. Parker was
Director of Sales for Cypress from April 1984 to December 1997. Prior to joining Cypress, he held various sales and marketing management positions at Fairchild Semiconductor from 1973 to
1984. He received a Bachelors degree in Education from the University of North Dakota.

Russell W. Weisswas appointed as a director by unanimous consent of the board of directors, effective January 2004.
Mr. Weiss has 31 years of experience in the Semiconductor Industry and is currently Vice President and General Manager of the worldwide Sales Operations for KLA-Tencor. From
April 2002 through February 2003, Mr. Weiss was President and Representative Director of KLA-Tencor Japan Ltd. From 1996 through April 2002,
Mr. Weiss held various positions with KLA-Tencor. From 1991-1996 Mr. Weiss held various positions with Schlumberger with the most recent being Vice President and
General Manager of Schlumberger ATE test equipment division. Mr. Weiss received his BSEE from Missouri University and his MBA from Babson College.

(b) and
(c)Significant Employees and Family Relationships.

There
are no significant employees who are not also directors or executive officers. There were and are no family relationships among the officers, directors or any person chosen by
Isonics to become a director or officer. No arrangement exists between any of the above officers and directors pursuant to which any one of those persons was elected to such office or position. None
of our directors is also a director of another company which has a class of securities registered under Section 12 of the Securities Exchange Act of 1934, or which is subject to the reporting
requirements of Section 15(d) of that act.

(d)Involvement in Certain Legal Proceedings

Based
on information submitted by the directors and executive officers, none of the directors or executive officers is involved in, or has been involved in, legal proceedings during the
past five years that are material to an evaluation of the ability or integrity of any director or executive officer.

(e)Audit Committee Financial Expert

Not
yet required

(f)Identification of Audit Committee

We
have a separately-designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The following persons serve on our audit
committee: Lindsay A. Gardner, Richard Parker and Russell W. Weiss, each of whom is considered to be an independent director.

(g)Procedures by which security holders may recommend nominees to the board of directors.

Isonics
has a standing Nominating Committee ("Nominating Committee") to direct and oversee the process by which individuals may be nominated to our board of directors. The following
persons serve on our Nominating Committee: Lindsay A. Gardner, Russell W. Weiss, and Richard Parker. Our Nominating Committee's charter was adopted by the board of directors on January 27,
2004, and is available on our web site at www.isonics.com. Each member of the Nominating Committee must qualify as "independent" as defined under NASDAQ Marketplace Rule 4200(a)(15) and be free
of any relationship that, in the opinion of the Board, would interfere with his or her exercise of independent judgment.

The
functions performed by the Nominating Committee include identifying potential directors and making recommendations as to the size, functions and composition of the Board and its
committees. In making nominations, our Nominating Committee is required to submit candidates who have the highest

52

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personal
and professional integrity, who have demonstrated exceptional ability and judgment and who shall be most effective, in conjunction with the other nominees to the board, in collectively
serving the long-term interests of the shareholders.

The
Nominating Committee considers nominees proposed by our shareholders. To recommend a prospective nominee for the Nominating Committee's consideration, you may submit the candidate's
name by delivering notice in writing to Isonics' Nominating Committee isonics@nuvox.net or c/o Chair, Nominating Committee, via first class U.S. mail, at Isonics Corporation, 5906 McIntyre
Street, Golden, CO 80403.

A
shareholder nomination submitted to the nomination committee must include at least the following information (and can include such other information the person submitting the
recommendation desires to include), and must be submitted to Isonics by the date mentioned in the most recent proxy statement under the heading "Proposal From
Shareholders"as such date may be amended in cases where the annual meeting has been changed as contemplated in SEC Rule 14a-8(e), Question 5:



53

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Although
the information may be submitted by fax, e-mail, mail or courier, the nominating committee must receive the proposed nominee's signed consent, in original form,
within ten days of making the nomination.

When
the information required above has been received, the nominating committee will evaluate the proposed nominee based on the criteria described below, with the principal criteria
being the needs of Isonics and the qualifications of such proposed nominee to fulfill those needs.

The
process for evaluating a director nominee is the same whether a nominee is recommended by a shareholder or by an existing officer or director. The Nominating Committee will:



For
the last annual meeting of its shareholders, Isonics did not engage the services of or paid a fee to any third party or parties to identify or evaluate or assist in identifying or
evaluating potential nominees. Neither Isonics nor Isonics' Nominating Committee had received a recommended nominee from any shareholder that beneficially own more than 5% of Isonics common stock or
group of shareholders that beneficially own more than 5% of Isonics common stock.

(h)Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) Disclosure

Section 16(a) of the Securities Exchange Act of 1934 (the "1934 Act") requires our directors, executive officers and persons who own more than 10% of a
registered class of our equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other equity securities of Isonics. Officers,
directors and greater than 10% shareholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file.

To
our knowledge, based upon a review of the copies of such reports furnished to us and based upon written representations that no other reports were required, all Section 16(a)
filing requirements applicable to Isonics' officers, directors and greater than 10% beneficial owners were complied with during the fiscal year ended April 30, 2004 and subsequently.

(i)Code of Ethics

On
January 27, 2004, our Board of Directors adopted a code of ethics that applies to all of our officers and employees, including our principal executive officer, principal
financial officer, principal accounting officer and controller. Our Code of Ethics establishes standards and guidelines to assist our directors, officers, and employees in complying with both Isonics'
corporate policies and with the law and is posted at our website: www.isonics.com.

54

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ITEM 10. EXECUTIVE COMPENSATION

(a) and
(b)Summary Compensation Table

The
following table sets forth information regarding compensation awarded, paid to, or earned by the chief executive officer and the other principal officers of Isonics for the three
years ended April 30, 2004. No other executive officer earned salary and bonus compensation exceeding $100,000 during any of those years. This includes all compensation paid to each by Isonics
and any subsidiary.

|                                        |  | Annual compensation |  | Long-term Compensation  |  |                 |     |      
|--------------------------------------- |  | ------------------- |  | ----------------------- |  | --------------- | --- | -----
|
|
|
|James E. Alexander
President & CEO      |  | 2002
2003
2004      |  | 240,000
240,000
240,000 |  | 0
0
0           |     | 0
0
0
|Boris Rubizhevsky
Senior Vice President |  | 2002
2003
2004      |  | 216,000
216,000
216,000 |  | 0
0
0           |     | 0
0
0
|Stephen J. Burden,
Vice President       |  | 2002
2003
2004      |  | 137,665
144,000
144,000 |  | 0
0
35,700      | (h) | 0
0
0
|Daniel J. Grady
Vice President          |  | 2002
2003
2004      |  | 144,000
149,500
156,000 |  | 27,750
0
60,000 | (j) | 0
0
0
|John V. Sakys,
Vice President(b)        |  | 2002
2003
2004      |  | 117,947
125,000
132,492 |  | 0
0
30,000      |     | 0
0
0
|Hans Walitzski,
Vice President(c)       |  | 2002
2003
2004      |  | 69,745
160,000
160,000  |  | 0
0
0           |     | 0
0
0

---

55

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In
October 1996, we adopted an employee benefit plan under Internal Revenue Code Section 401(k). The 401(k) plan is a profit sharing plan under which both employees and
Isonics are entitled to contribute a portion of compensation and earnings, respectively, to investment funds to supplement employee retirement benefits.

56

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We
do not have written plans to pay bonuses or deferred compensation to our employees except those expressly stated in the following sections.

We
have adopted medical, dental, and life insurance plans for our employees and their dependents at our cost. In some cases, we also provide discretionary disability and other insurance
plans for the benefit of our employees.

(c)Options/SAR Grants

Stock Options and Option Plans

We grant options to executive officers, employees and consultants under the following plans (collectively the "Plans"):



Except
for the Director's Plan described below, we have not adopted any other stock option or stock appreciation rights plan.See "Compensation of
Directors."

57

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Options/SAR Grants in Last Fiscal Year

We granted stock options to the executive officers named in the compensation table (above) during the fiscal year ended April 30, 2004. We did not grant
any stock appreciation rights to any person during fiscal year 2004 or subsequently.

|                  |  | Number of Options |  | Exercise Price |      | Term
|----------------- |  | ----------------- |  | -------------- | ---- | ----
|Daniel Grady      |  | 50,000            |  | $              | 1.20 |     
|Stephen J. Burden |  | 50,000            |  | $              | 1.20 |     

We
have not granted any stock options to the executive officers named in the compensation table subsequent to April 30, 2004.

(d)Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values

No
officer exercised employee stock options during the fiscal year ended April 30, 2004 or subsequently. The following table sets forth information regarding the
year-end value of options being held by the Chief Executive Officer and the other such named officers and persons on April 30, 2004.

|Name and Principal Position             |  | Shares
acquired on
exercise (#) |  | Value
realized |  | Number of securities underlying unexercised options/stock appreciation rights at April 30, 2004
Exercisable/Unexercisable |  | Value of unexercised
in-the-money options/stock appreciation rights at April 30, 2004
Exercisable/Unexercisable
|--------------------------------------- |  | ------------------------------- |  | -------------- |  | ------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------
|James E. Alexander
President & CEO      |  | 0                               |  | 0              |  | 80,000/40,000                                                                                                             |  | $                                                                                                              
|Boris Rubizhevsky
Senior Vice President |  | 0                               |  | 0              |  | 78,750/40,000                                                                                                             |  | $                                                                                                              
|Daniel J. Grady
Vice President          |  | 0                               |  | 0              |  | 323,715/40,000                                                                                                            |  | $                                                                                                              
|Stephen J. Burden
Vice President        |  | 0                               |  | 0              |  | 230,429/40,000                                                                                                            |  | $                                                                                                              
|John V. Sakys
Vice President            |  | 0                               |  | 0              |  | 107,812/25,000                                                                                                            |  | $                                                                                                              
|Hans Walitzki
Vice President            |  | 0                               |  | 0              |  | 124,000/80,000                                                                                                            |  | $                                                                                                              

(e)Long Term Incentive Compensation Plans, and Defined Benefit and Actuarial Plans

Isonics has no long term incentive compensation plans, defined benefit plans or actuarial plans.

(f)Compensation of Directors

We reimburse directors for travel and related expenses associated with Board of Directors, meetings. In January 2000, we agreed to compensate
non-employee directors $2,000 for attending Board of Directors' meetings in person, and $500 for attending Board of Directors' meetings telephonically beginning January 1, 2000.

The
1998 Directors' Plan (the "Directors' Plan") authorized each person serving as a member of the Board who is not an employee of ours to receive options to purchase 20,000 shares of
our common stock when such person accepts his position as a Director and to receive an additional option to purchase 10,000 shares when such person is re-elected as a Director provided
such person is not an employee of Isonics. The exercise price for the options is the Fair Market Value (as defined in the Executives' Plan) on the date such person becomes a director and the options
are exercisable for five years from such date. The options granted under the Directors' Plan vest immediately upon the date of

58

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the
grant. In the event a Director resigns or is not re-elected to the Board, his or her failure to exercise the options in three months results in the options' termination prior to the
expiration of their term. Although the Directors adopted the plan in 1998, the Board formalized the plan by resolution in January 2000.

Under
the Directors' Plan the following individuals have been granted options through April 30, 2004:

Name

Shares Under Option

Exercise Price

ExpirationLindsay Gardner

10,000
10,000
10,000
10,000
10,000

$$$$$
6.25
2.19
1.06
1.00
1.42

April 26, 2005
October 10, 2005
November 12, 2006
November 19, 2007
April 27, 2009Richard Parker

10,000
10,000
10,000
10,000
10,000

$$$$$
6.25
2.19
1.06
1.00
1.42

April 26, 2005
October 10, 2005
November 12, 2006
November 19, 2007
April 27, 2009Russell Weiss

20,000
10,000

$$
1.17
1.42

January 5, 2009
April 27, 2009


We
do not have any other arrangements pursuant to which we compensate the Directors for acting in their capacities as such.

(g)Employment Agreements, Termination of Employment and Change In Control Agreements

Currently both Mr. Alexander and Mr. Rubizhevsky are covered by employment agreements that are renewable on an annual basis. We have employment
agreements with Dr. Daniel J. Grady, Dr. Stephen J. Burden, Dr. Hans Walitzki, and Mr. John V. Sakys. The agreements have an indefinite term (except for the agreement with
Dr. Walitzki which expires November 2006) and provide for at-will employment, terminable at any time by either party. The agreements provide for a rate of annual
compensation, which we will review annually. Under each agreement, Dr. Grady, Dr. Burden, Dr. Walitzki, and Mr. Sakys are entitled to participate in our standard plans and
policies. The agreements also include confidentiality and invention assignment provisions.

(h)Report on Repricing of Options/SARs

We did not reprice any options or stock appreciation rights during the fiscal year ended April 30, 2004, or subsequently.

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

(a)   and (b)Ownership of Certain Beneficial Owners and Management.

The following table sets forth information regarding the ownership of our common stock as of April 30, 2004 by: (i) each director or nominee for
director; (ii) each of the executive officers named in

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the
Summary Compensation Table; (iii) all executive officers and directors of the Company as a group; and (iv) all those known by us to be beneficial owners of more than 5% of our common
stock.

Beneficial OwnershipBeneficial Owner

Number of Shares

Percent of TotalJames E. Alexander(1)

2,041,167

13.1
%Boris Rubizhevsky(2)

1,522,955

9.8
%Stephen J. Burden(3)

401,594

2.6
%Daniel J. Grady(4)

418,167

2.7
%Hans Walitzki(5)

404,000

2.6
%Lindsay Gardner(6)

302,775

2.0
%Richard Parker(7)

52,927

0.3
%John Sakys(8)

134,087

0.9
%Russell W. Weiss(9)

30,000

0.2
%All executive officers and directors as a group (9 persons).

5,307,672

31.5
%The address for all of the above directors and executives officers is: 5906 McIntyre Street, Golden, CO 80403Richard and Ana Grossman, Orin Hirschman, Adam
Smith Capital Management, LLC, Adam Smith
Investment Partners, LP, Diamond Capital
Management Inc., Adam Smith Investments, Ltd.,
Adam Smith & Company, Inc.(10)

1,373,336

8.2
%Mercator Advisory Group, LLC(11)

1,704,000

9.9
%


---

60

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The
Series A Convertible Preferred Stock consisted of 1,830,000 shares issued with a liquidation preference of $1.50 per share and a right to convert the shares based on a one for
one basis. As of April 30, 2004, 866,334 shares of Series A Convertible Preferred Stock have been converted into common stock. The conversion right of the preferred stock is currently
two shares of common stock for each share of Series A Convertible Preferred Stock (an effective conversion rate of $.75 per share). The Series A Convertible Preferred Stock is entitled
to dividends or distributions equal to the amount of the dividend or distribution per share of common stock payable at such time multiplied by the number of shares of common stock then obtainable upon
conversion of such Series A Convertible

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Preferred
Stock. On May 3, 2004, 463,358 shares of Series A Convertible Preferred Stock were converted into 926,716 shares of common stock.

The
Redemption Trigger Date for the Series A Convertible Preferred Stock was the business day immediately following the thirtieth consecutive trading day that the average closing
price during such trading days (or, if no closing price is reported, the average of the bid and ask prices) of the shares of common stock was above $8.00 per share (which minimum price shall be
proportionally adjusted for stock splits, stock dividends, reverse stock splits and any other subdivision or combination of the common stock). As we have met the Redemption Trigger Date, we may redeem
all or any part of the Series A Convertible Preferred Stock at our election at any time and from time to time. The Series A Convertible Preferred Stock is convertible into common stock
at the option of the holder until and
unless we choose to redeem such shares and, until converted, at any meeting of our shareholders, each share of Series A Convertible Preferred Stock is entitled to the number of votes equal to
the number of shares of common stock into which the Series A Convertible Preferred Stock is then convertible.

The
Series C Convertible Preferred Stock consisted of 22,000 shares with a liquidation preference of $100 per share and a right to convert the shares into common stock (in the
range of 1,760,000 to 2,315,790) based on the then existing conversion price. As April 30, 2004, there have been 13,000 shares of Series C Convertible Preferred Stock converted into
1,368,421 shares of common stock. Subject to the prior rights of holders of all classes of stock at the time outstanding, the Series C Convertible Preferred Stock is entitled to dividends or
distributions equal to the amount of the dividend or distribution per share of common stock or Series A Convertible Preferred Stock payable at such time multiplied by the number of shares of
common stock then obtainable upon conversion of such Series C Convertible Preferred Stock. See note (11) to the Beneficial Ownership table, above.

The
Series D Convertible Preferred Stock consisted of 32,950 shares with a liquidation preference of $100 per share and a right to convert the shares into common stock at the rate
of $1.10 per share. As of April 30, 2004, there have been zero shares of Series D Convertible Preferred Stock converted into common stock. Subject to the prior rights of holders of all
classes of stock at the time outstanding, the Series D Convertible Preferred Stock is entitled to dividends or distributions equal to the amount of the dividend or distribution per share of
common stock or Series A Convertible Preferred Stock payable at such time multiplied by the number of shares of common stock then obtainable upon conversion of such Series D Convertible
Preferred Stock. See note (11) to the Beneficial Ownership table, above. On May 20, 2004, 6,000 shares of Series D Convertible Preferred Stock were converted into 545,455 shares
of common stock.

(c)No Change of Control Arrangements.

We know of no plans or arrangement that will result in a change of control at Isonics.

(d)Equity Compensation Plan Information

|Plan Category                                              |  | Number of Securities to be Issued upon Exercise of Outstanding, Options, Warrants and Rights |  | Weighted-average Exercise Price of Outstanding Options, Warrants and Rights |      | Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans (excluding securities reflected in column (a)
|---------------------------------------------------------- |  | -------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------- | ---- | ------------------------------------------------------------------------------------------------------------------------------------------
|Equity Compensation Plans Approved by Security Holders     |  | 1,745,647                                                                                    |  | $                                                                           | 1.39 |                                                                                                                                           
|Equity Compensation Plans Not Approved by Security Holders |  | 0                                                                                            |  |                                                                             | 0    |                                                                                                                                           
|Total                                                      |  | 1,745,647                                                                                    |  | $                                                                           | 1.39 |                                                                                                                                           

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ITEM 12. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.

We provide the following information regarding transactions among officers, directors and significant shareholders of Isonics during the most recent two fiscal
years and during the subsequent fiscal year.

Pledging of Shares in Connection with Issuance of Series 2002A 4% Convertible Notes

In connection with the issuance of our Series 2002A 4% Convertible Notes on March 20, 2002, James E. Alexander (president, chief executive officer
and a director of Isonics) and Boris Rubizhevsky (senior vice president and a director of Isonics) each pledged 500,000 common shares in order to secure our $1,000,000 obligation while we filed and
obtained effectiveness for a Form S-3 registration statement for the benefit of the lenders as selling security holders. In consideration for pledging their shares, we issued both
James E. Alexander and Boris Rubizhevsky a warrant to purchase 100,000 shares of common stock. Each warrant vested immediately, is exercisable at $1.25 per share and expires on March 20, 2007.
The pledge agreement terminated in June 2002 when we fulfilled our registration obligations.

Corporate Loans to Officers

We have not made any corporate loans to our officers, directors, or shareholders in fiscal years 2004, 2003 or subsequently. The Sarbanes-Oxley Act of 2002
prohibits any loans to corporate officers or directors.

Corporate Loans from Officers and Employees

During the years ended April 30, 2004 and 2003, we have been required to borrow money from certain executive officers in order to finance certain
receivables.

On
December 23, 2003, we borrowed $40,000 from James E. Alexander, our President and Chief Executive Officer. We repaid the loan in full, plus interest at 12% per annum, on
January 30, 2004.

On
September 9, 2003, we borrowed $100,000 from Stephen Burden, our Vice President of Semiconductor Materials and Products. We repaid the loan in full, plus interest at 12% per
annum, on September 11, 2003. On November 19, 2003 we borrowed an additional $100,000 from Dr. Burden. The loan bore interest at a rate of 12% per annum and was due the earlier of
one year or the collection of certain accounts receivable, as defined. This loan was repaid in full, plus interest in January 2004.

On
August 26, 2003 and July 30, 2003, we borrowed $120,000 and $80,000, respectively from Daniel Grady, our Vice President of Life Sciences. We repaid the loans in full,
plus interest at 12% per annum, on September 11, 2003 and August 4, 2003, respectively. On November 18, 2003, we borrowed an additional $120,000 from Dr. Grady. The loan
bore interest at a rate of 12% per annum and was due the earlier of one year or the collection of certain accounts receivable, as defined. This loan was repaid in full, plus interest in
January 2004.

We
did not borrow any additional funds from our officers or directors during the years ended April 30, 2004 or 2003, or subsequently. When funds are owed to our executive
officers, we have agreed to keep them advised with respect to our cash receipts and expenditures.

63

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ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.

|Exhibit
Number |  | Title                                                                                                                       
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------
|1.01           |  | Intentionally omitted                                                                                                       
|3.01           |  | Registrant's Amended and Restated Articles of Incorporation.(1)                                                             
|3.02           |  | Registrant's Bylaws.(1)                                                                                                     
|3.03           |  | Certificate of Determination of Preferences and Rights of the Series A preferred stock (see exhibit 10.18).                 
|3.04           |  | Certificate Of Determination Of Preferences And Rights Of Series B Convertible Preferred Stock(11)                          
|3.05           |  | Certificate of Amendment to Articles of Incorporation(13)                                                                   
|4.01           |  | Specimen Common Stock Certificate.(1)                                                                                       
|4.02           |  | Certificate of Determination of Preferences and Rights of the Series C preferred stock(16)                                  
|4.03           |  | Certificate of Determination of Preferences and Rights of the Series D preferred Stock(17)                                  
|4.04           |  | Intentionally omitted                                                                                                       
|4.05           |  | Form of warrant Agreement between the Registrant and Continental Stock Transfer & Trust Company.(8)                         
|4.06           |  | Specimen Class B Warrant Certificate (see exhibit 10.27).                                                                   
|4.07           |  | Specimen Class C Warrant Certificate (see exhibit 10.27).                                                                   
|4.08           |  | Amendment No. 1 to warrant Agreement between the Registrant and Continental Stock Transfer & Trust Company.(7)              
|5.01           |  | Opinion as to the Validity of the Securities (not applicable to Form 10-KSB)                                                
|10.01          |  | Registrant's 1996 Stock Option Plan.(1)(2)                                                                                  
|10.02          |  | Intentionally omitted                                                                                                       
|10.03          |  | Registrant's 1996 Executives Equity Incentive Plan.(1)(2)                                                                   
|10.04          |  | Registrant's 1996 Equity Incentive Plan.(1)(2)                                                                              
|10.05          |  | Intentionally omitted                                                                                                       
|10.06          |  | Option Agreement between the Registrant and Yale University.(1)                                                             
|10.07          |  | Intentionally omitted                                                                                                       
|10.08          |  | Letter from Yale University to Registrant dated February 10, 1996.(1)                                                       
|10.09          |  | Form of Indemnity Agreement entered into by Registrant with each of its directors and investors.(2)                         
|10.10          |  | Agreement dated June 7, 2004 between Isonics Corporation, Isonics Vancouver, Inc., and Encompass Materials Group Limited(18)
|10.11          |  | Registration Rights Agreement between Isonics Corporation and Encompass Materials Group Limited(18)                         
|               |  |                                                                                                                             

64

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|10.12 |  | Intentionally omitted                                                                                                                                                                                                                                                                               
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.13 |  | Intentionally omitted                                                                                                                                                                                                                                                                               
|10.14 |  | Intentionally omitted                                                                                                                                                                                                                                                                               
|10.15 |  | Agreement effective December 4, 2002, between Isonics and Institut fur Umwelttechnologien GmbH ("IUT") of Berlin, Germany, by which Isonics has acquired the exclusive, world-wide rights to detection technologies for explosives, chemical weapons,
illegal drugs and other chemical compounds(15)
|10.16 |  | Intentionally omitted                                                                                                                                                                                                                                                                               
|10.17 |  | Letter from Yale University to Registrant dated January 28, 1997.(1)                                                                                                                                                                                                                                
|10.18 |  | Certificate of Determination of Preferences and Rights of the Series A preferred stock.(4)                                                                                                                                                                                                          
|10.19 |  | Share Purchase and Assignment Agreement dated December 23, 2002 between Isonics Corporation and Institut fur Umwelttechnologien GmbH.(3)                                                                                                                                                            
|10.20 |  | Intentionally omitted                                                                                                                                                                                                                                                                               
|10.21 |  | Intentionally omitted                                                                                                                                                                                                                                                                               
|10.22 |  | Form of Registration Rights Agreement.(4)                                                                                                                                                                                                                                                           
|10.23 |  | Intentionally omitted.                                                                                                                                                                                                                                                                              
|10.24 |  | Intentionally omitted.                                                                                                                                                                                                                                                                              
|10.25 |  | Intentionally omitted.                                                                                                                                                                                                                                                                              
|10.26 |  | Intentionally Omitted.                                                                                                                                                                                                                                                                              
|10.27 |  | Amended and Restated warrant Agreement effective as of January 15, 2001, between the Registrant and Continental Stock Transfer and Trust Company, Inc.(8)                                                                                                                                           
|10.28 |  | Stock Purchase Agreement dated February 1, 2001, by and between Isonics Corporation and Interpro Zinc, LLC.(9)                                                                                                                                                                                      
|10.29 |  | [Joint R&D Project Agreement, dated April 21, 1999, by and between Silex Systems Limited and Isonics Corporation.](10)                                                                                                                                                                              
|10.30 |  | Intentionally omitted                                                                                                                                                                                                                                                                               
|10.31 |  | Sponsored Research Agreement, dated December 15, 1999, by and between Isonics Corporation and Southern Methodist University.(10)                                                                                                                                                                    
|10.32 |  | Stevenson-Wydler Cooperative Research and Development Agreement, dated November 9, 1999, by and between Ernest Orlando Lawrence Berkeley National Laboratory and Isonics Corporation (with attached Project Letter Agreement).(10)                                                                  
|10.33 |  | Intentionally omitted                                                                                                                                                                                                                                                                               
|10.34 |  | Agreement between Isonics Corporation and Silicon Evolution, Inc. dated September 14, 2001(12)                                                                                                                                                                                                      
|10.35 |  | Technology License Agreement dated September 14, 2001, between Silicon Evolution, Inc. and Isonics Corporation(12)                                                                                                                                                                                  
|      |  |                                                                                                                                                                                                                                                                                                     

65

---



|10.36  |  | Form of employment agreement to be entered into pursuant to the agreement between Isonics Corporation and certain persons previously associated with Silicon Evolution, Inc. dated September 14, 2001(12)
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.37  |  | [Form of lease agreement to be entered into pursuant to the agreement between Isonics Corporation and Silicon Evolution, Inc. dated September 14, 2001](12)                                              
|10.38  |  | Amended and Restated Warrant Agreement dated July 26, 2001.(11)                                                                                                                                          
|10.39  |  | Consulting Agreement dated October 15, 2001, with Wells Investment Group(13)                                                                                                                             
|10.40  |  | Form of Registration Rights Agreement between Isonics and various accredited investors in connection with the March 22, 2002, convertible promissory note financing.(14)                                 
|10.41  |  | Form of Series 2002A 4% Convertible Promissory Note due March 1, 2003 between Isonics and various accredited investors in connection with the March 22, 2002, convertible promissory note financing.(14) 
|10.42  |  | Form of Warrant Agreement expiring March 20, 2005 between Isonics and various accredited investors in connection with the March 22, 2002, convertible promissory note financing.(14)                     
|14.0   |  | Code of Ethics                                                                                                                                                                                           
|21.1   |  | List of subsidiaries.                                                                                                                                                                                    
|23.10* |  | Consent of independent accountants                                                                                                                                                                       
|23.11  |  | Consent of Arter & Hadden (see exhibit 5.01) (not applicable to Form 10-KSB)                                                                                                                             
|31*    |  | Certification pursuant to Rule 13a-14(a)                                                                                                                                                                 
|32*    |  | Certification pursuant to 18 U.S.C. §1350                                                                                                                                                                

---

66

---



ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

(a)Audit Fees.

Our principal accountant, Grant Thornton LLP, billed us aggregate fees in the amount of approximately $143,000 for the fiscal year ended April 30, 2004 and
approximately $114,000 for the fiscal year ended April 30, 2003. These amounts were billed for professional services that Grant Thornton LLP provided for the audit of our annual financial
statements, review of the financial statements included in our report on 10-QSB, review of our securities offerings and other services typically provided by an accountant in connection
with statutory and regulatory filings or engagements for those fiscal years.

(b)Audit-Related Fees.

Grant Thornton LLP billed us aggregate fees in the amount of $0 for the fiscal years ended April 30, 2004 and 2003 for assurance and related services that
were reasonably related to the performance of the audit or review of our financial statements.

(c)Tax Fees

Grant Thornton LLP billed us aggregate fees in the amount of approximately $14,000 for the fiscal year ended April 30, 2004 and approximately $12,000 for
the fiscal year ended April 30, 2003, for tax compliance, tax advice, and tax planning.

(d)All Other Fees

Grant Thornton LLP billed us aggregate fees in the amount of $19,000 and $0 for the fiscal years ended April 30, 2004 and 2003, respectively for other
fees.

67

---



(e)Audit Committee's Pre-Approval Practice

Section 10A(i) of the Securities Exchange Act of 1934 prohibits our auditors from performing audit services for us as well as any services not
considered to be "audit services" unless such services are pre-approved by the audit committee of the Board of Directors, or unless the services meet certainde
minimisstandards. The audit committee's charter (as amended January 27, 2004) provides that the audit committee must:



The
audit committee considers at each of its meetings whether to approve any audit services or non-audit services. In some cases, management may present the request; in other
cases, the auditors may present the request. At its annual meeting in April 2004 it approved Grant Thornton LLP performing our audit for the 2004 fiscal year, as well as tax services for the
2003 and 2004 fiscal years.

The
percentage of the fees for audit, audit-related, tax and other services were as set forth in the following table:

Percentage of total fees paid to Grant Thornton LLPFiscal Year 2003

Fiscal Year 2004Audit fees

91
%
82
%Audit-related fees

0
%
0
%Tax fees

9
%
8
%All other fees

0
%
10
%


68

---





SIGNATURES

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

July 28,
2004

| |  | ISONICS CORPORATION,a California Corporation
| |  | --------------------------------------------
| |  | By:                                         

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

|Date          |  | Name and Title                                                                |  | Signature            
|------------- |  | ----------------------------------------------------------------------------- |  | ---------------------
|              |  |                                                                               |  |                      
|July 28, 2004 |  | James E. Alexander
Principal Executive Officer
Chairman of the Board
Director |  | /s/JAMES E. ALEXANDER
|July 28, 2004 |  | Boris Rubizhevsky
Vice Chairman Director                                      |  | /s/BORIS RUBIZHEVSKY 
|July 28, 2004 |  | Lindsay A. Gardner
Director                                                   |  | /s/LINDSAY A. GARDNER
|July 28, 2004 |  | Richard Parker
Director                                                       |  | /s/RICHARD PARKER    
|July 28, 2004 |  | Russell Weiss
Director                                                        |  | /s/RUSSELL WEISS     
|July 28, 2004 |  | John Sakys
Principal Financial and Accounting Officer                         |  | /s/JOHN SAKYS        

69

---





ISONICS CORPORATION AND SUBSIDIARIES        Index to Financial Statements

|                                                        |                                                 | Page
|------------------------------------------------------- | ----------------------------------------------- | ----
|Report of Independent Registered Public Accounting Firm |                                                 | F-2 
|Consolidated Financial Statements                       |                                                 |     
|                                                        | Consolidated Balance Sheets                     |     
|                                                        | Consolidated Statements of Operations           |     
|                                                        | Consolidated Statements of Stockholders' Equity |     
|                                                        | Consolidated Statements of Cash Flows           |     
|                                                        | Notes to Consolidated Financial Statements      |     

F-1

---





Report of Independent Registered Public Accounting Firm

Board of Directors
Isonics Corporation and Subsidiaries

We
have audited the accompanying consolidated balance sheets of Isonics Corporation and Subsidiaries as of April 30, 2004 and 2003, and the related consolidated 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 audits.

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

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Isonics Corporation and Subsidiaries as of April 30,
2004 and 2003, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/
Grant Thornton LLP

Denver,
Colorado
June 11, 2004

F-2

---





Isonics Corporation and Subsidiaries    CONSOLIDATED BALANCE SHEETS  (In thousands, except share amounts)

|                                                        |                                                                                                                          | April 30,                                                                         |                                                                           
|------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------- | --------------------------------------------------------------------------
|
|ASSETS                                                  |                                                                                                                          |                                                                                   |                                                                           
|CURRENT ASSETS:                                         |                                                                                                                          |                                                                                   |                                                                           
|                                                        | Cash and cash equivalents                                                                                                |                                                                                   | $                                                                         
|                                                        | Accounts receivable (net of allowances of $16 and $29, respectively)                                                     |                                                                                   |                                                                           
|                                                        | Inventories                                                                                                              |                                                                                   |                                                                           
|                                                        | Prepaid expenses and other current assets                                                                                |                                                                                   |                                                                           
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|LONG-TERM ASSETS:                                       |                                                                                                                          |                                                                                   |                                                                           
|                                                        | Property and equipment, net                                                                                              |                                                                                   |                                                                           
|                                                        | Goodwill                                                                                                                 |                                                                                   |                                                                           
|                                                        | Intangible assets, net                                                                                                   |                                                                                   |                                                                           
|                                                        | Other assets                                                                                                             |                                                                                   |                                                                           
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|TOTAL ASSETS                                            |                                                                                                                          | $                                                                                 | 8,681                                                                     
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|LIABILITIES AND STOCKHOLDERS' EQUITY                    |                                                                                                                          |                                                                                   |                                                                           
|CURRENT LIABILITIES:                                    |                                                                                                                          |                                                                                   |                                                                           
|                                                        | Current portion of obligation under capital leases                                                                       |                                                                                   | $                                                                         
|                                                        | Accounts payable                                                                                                         |                                                                                   |                                                                           
|                                                        | Accrued liabilities                                                                                                      |                                                                                   |                                                                           
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|OBLIGATION UNDER CAPITAL LEASES, net of current portion |                                                                                                                          |                                                                                   | 32                                                                        
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|TOTAL LIABILITIES                                       |                                                                                                                          |                                                                                   | 970                                                                       
|STOCKHOLDERS' EQUITY:                                   |                                                                                                                          |                                                                                   |                                                                           
|                                                        | Preferred Stock; 10,000,000 shares authorized                                                                            |                                                                                   |                                                                           
|                                                        |                                                                                                                          | Series A Convertible Preferred Stockno par value; shares issued and outstanding: |                                                                           
|                                                        |                                                                                                                          |                                                                                   | 2004 and 2003963,666; liquidation preference: 2004 and 2003$1,445,499   
|                                                        |                                                                                                                          | Series C Convertible Preferred Stockno par value; shares issued and outstanding: |                                                                           
|                                                        |                                                                                                                          |                                                                                   | 20049,000; 2003zero; liquidation preference: 2004$900,000; 2003zero   
|                                                        |                                                                                                                          | Series D Convertible Preferred Stockno par value; shares issued and outstanding: |                                                                           
|                                                        |                                                                                                                          |                                                                                   | 200432,950; 2003zero; liquidation preference: 2004$3,295,000; 2003zero
|                                                        | Common stockno par value; 40,000,000 shares authorized; shares issued and outstanding: 200415,344,913; 200312,113,533 |                                                                                   |                                                                           
|                                                        | Additional paid in capital                                                                                               |                                                                                   |                                                                           
|                                                        | Deferred compensation                                                                                                    |                                                                                   |                                                                           
|                                                        | Accumulated deficit                                                                                                      |                                                                                   |                                                                           
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|                                                        |                                                                                                                          |                                                                                   |                                                                           
|TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY              |                                                                                                                          | $                                                                                 | 8,681                                                                     
|                                                        |                                                                                                                          |                                                                                   |                                                                           

See Notes to Consolidated Financial Statements.

F-3

---



Isonics Corporation and Subsidiaries    CONSOLIDATED STATEMENTS OF OPERATIONS  (In thousands, except per share amounts)

|                                             |                                                        | Year Ended
April 30,              |       
|-------------------------------------------- | ------------------------------------------------------ | --------------------------------- | ------
|
|Revenues                                     |                                                        | $                                 | 8,721 
|Cost of revenues                             |                                                        |                                   | 7,138 
|                                             |                                                        |                                   |       
|                                             |                                                        | Gross margin                      |       
|Operating expenses:                          |                                                        |                                   |       
|                                             | Selling, general and administrative                    |                                   |       
|                                             | Research and development                               |                                   |       
|                                             |                                                        |                                   |       
|                                             |                                                        | Total operating expenses          |       
|                                             |                                                        |                                   |       
|Operating loss                               |                                                        |                                   | (4,172
|Other income (expense):                      |                                                        |                                   |       
|                                             | Gain on legal settlement, net                          |                                   |       
|                                             | Amortization of debt offering costs                    |                                   |       
|                                             | Interest and other income                              |                                   |       
|                                             | Interest expense                                       |                                   |       
|                                             | Foreign exchange                                       |                                   |       
|                                             |                                                        |                                   |       
|                                             |                                                        | Total other income (expense), net |       
|                                             |                                                        |                                   |       
|Loss before income tax benefit               |                                                        |                                   | (4,163
|Income tax benefit                           |                                                        |                                   |      
|                                             |                                                        |                                   |       
|NET LOSS                                     |                                                        | $                                 | (4,163
|                                             |                                                        |                                   |       
|DEEMED DIVIDENDS ON PREFERRED STOCK          |                                                        | $                                 | (2,862
|                                             |                                                        |                                   |       
|NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS |                                                        | $                                 | (7,025
|                                             |                                                        |                                   |       
|Net loss per sharebasic and diluted         |                                                        |                                   |       
|                                             | Net loss per share attributable to common stockholders |                                   | $     
|                                             | Shares used in computing per share information         |                                   |       

See
Notes to Consolidated Financial Statements

F-4

---





Isonics Corporation and Subsidiaries        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY        (In thousands, except share amounts)

|                         |                                                                                                   | Preferred Stock |         | Common Stock |       |        |            |           |   |        |       |   |      
|------------------------ | ------------------------------------------------------------------------------------------------- | --------------- | ------- | ------------ | ----- | ------ | ---------- | --------- | - | ------ | ----- | - | -----
|
|
|BALANCES, April 30, 2002 |                                                                                                   | 963,666         |         | $            | 745   |        | 10,824,812 |           |   | 10,354 |       |   | 3,912
|                         | Conversion of Series 2002A Convertible Notes into common stock                                    |                 |        |              |       |       |            | 1,000,000 |   |        | 1,000 |   |      
|                         | Fair value of common stock issued for services                                                    |                 |        |              |       |       |            | 32,500    |   |        | 36    |   |      
|                         | Fair value of common stock issued for the acquisition of isotope-based trace detection technology |                 |        |              |       |       |            | 250,000   |   |        | 273   |   |      
|                         | Common stock issued under Employee Stock Purchase Program                                         |                 |        |              |       |       |            | 6,221     |   |        | 5     |   |      
|                         | Fair value of common stock warrants issued for services                                           |                 |        |              |       |       |            |          |   |        |      |   |      
|                         | Amortization of deferred compensation                                                             |                 |        |              |       |       |            |          |   |        |      |   |      
|                         | Net loss                                                                                          |                 |        |              |       |       |            |          |   |        |      |   |      
|                         |                                                                                                   |                 |         |              |       |        |            |           |   |        |       |   |      
|BALANCES, April 30, 2003 |                                                                                                   | 963,666         |         |              | 745   |        | 12,113,533 |           |   | 11,668 |       |   | 4,362
|                         | Exercise of common stock warrants                                                                 |                 |        |              |       |       |            | 225,000   |   |        | 281   |   |      
|                         | Issuance of common stock in financing transaction                                                 |                 |        |              |       |       |            | 1,500,000 |   |        | 1,080 |   |      
|                         | Issuance of convertible preferred stock and common stock warrants in financing transactions:      |                 |         |              |       |        |            |           |   |        |       |   |      
|                         |                                                                                                   | Series C        |         | 22,000       |       |        | 1,790      |           |  |        |       |  |      
|                         |                                                                                                   | Series D        |         | 32,950       |       |        | 1,864      |           |  |        |       |  |      
|                         | Deemed dividends on preferred stock                                                               |                 |        |              |       | 2,862  |            |          |   |        |      |   |      
|                         | Conversion of Series C Convertible Preferred Stock into common stock                              |                 | (13,000 | )            |       | (1,648 | )          | 1,368,421 |   |        | 1,648 |   |      
|                         | Fair value of common stock issued for services                                                    |                 |        |              |       |       |            | 100,000   |   |        | 97    |   |      
|                         | Fair value of common stock warrants issued for services                                           |                 |        |              |       |       |            |          |   |        |      |   |      
|                         | Fair value of common stock issued as employee compensation                                        |                 |        |              |       |       |            | 30,000    |   |        | 36    |   |      
|                         | Common stock issued under Employee Stock Purchase Program                                         |                 |        |              |       |       |            | 7,959     |   |        | 7     |   |      
|                         | Amortization of deferred compensation                                                             |                 |        |              |       |       |            |          |   |        |      |   |      
|                         | Net loss                                                                                          |                 |        |              |       |       |            |          |   |        |      |   |      
|                         |                                                                                                   |                 |         |              |       |        |            |           |   |        |       |   |      
|BALANCES, April 30, 2004 |                                                                                                   | 1,005,616       |         | $            | 5,613 |        | 15,344,913 |           | $ | 14,817 |       | $ | 6,732
|                         |                                                                                                   |                 |         |              |       |        |            |           |   |        |       |   |      

See Notes to Consolidated Financial Statements

F-5

---



Isonics Corporation and Subsidiary        CONSOLIDATED STATEMENTS OF CASH FLOWS        (In thousands)

|                                                 |                                                                                           | Year Ended
April 30,                                                                                  |                                  
|------------------------------------------------ | ----------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------- | ---------------------------------
|
|CASH FLOWS FROM OPERATING ACTIVITIES:            |                                                                                           |                                                                                                       |                                  
|                                                 | Net loss                                                                                  |                                                                                                       | $                                
|                                                 | Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |                                                                                                       |                                  
|                                                 |                                                                                           | Depreciation and amortization                                                                         |                                  
|                                                 |                                                                                           | Amortization of debt discount and debt offering costs                                                 |                                  
|                                                 |                                                                                           | Gain on sale of subsidiary                                                                            |                                  
|                                                 |                                                                                           | Fair value of common stock and warrants issued for services and amortization of deferred compensation |                                  
|                                                 |                                                                                           | Changes in operating assets and liabilities:                                                          |                                  
|                                                 |                                                                                           |                                                                                                       | Accounts receivable              
|                                                 |                                                                                           |                                                                                                       | Inventories                      
|                                                 |                                                                                           |                                                                                                       | Prepaid expenses and other assets
|                                                 |                                                                                           |                                                                                                       | Accounts payable                 
|                                                 |                                                                                           |                                                                                                       | Accrued liabilities              
|                                                 |                                                                                           |                                                                                                       |                                  
|                                                 |                                                                                           |                                                                                                       |                                  
|CASH FLOWS FROM INVESTING ACTIVITIES:            |                                                                                           |                                                                                                       |                                  
|                                                 | Purchases of property and equipment                                                       |                                                                                                       |                                  
|                                                 | Proceeds from sale of subsidiary net of cash disposed                                     |                                                                                                       |                                  
|                                                 |                                                                                           |                                                                                                       |                                  
|                                                 |                                                                                           |                                                                                                       |                                  
|CASH FLOWS FROM FINANCING ACTIVITIES:            |                                                                                           |                                                                                                       |                                  
|                                                 | Principal payments under capital lease obligations                                        |                                                                                                       |                                  
|                                                 | Payments on borrowings                                                                    |                                                                                                       |                                  
|                                                 | Proceeds from the issuance of preferred stock and related warrants                        |                                                                                                       |                                  
|                                                 | Proceeds from issuance of common stock                                                    |                                                                                                       |                                  
|                                                 |                                                                                           |                                                                                                       |                                  
|                                                 |                                                                                           |                                                                                                       |                                  
|                                                 |                                                                                           |                                                                                                       |                                  
|                                                 |                                                                                           |                                                                                                       |                                  
|Cash and cash equivalents at beginning of period |                                                                                           |                                                                                                       | 742                              
|                                                 |                                                                                           |                                                                                                       |                                  
|Cash and cash equivalents at end of period       |                                                                                           | $                                                                                                     | 3,691                            
|                                                 |                                                                                           |                                                                                                       |                                  

See
Notes to Consolidated Financial Statements

F-6

---





Isonics Corporation and Subsidiaries        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Organization and Principles of Consolidation

Isonics Corporation develops and markets products worldwide based on isotopes for applications in the energy, medical research, diagnostic, pharmaceutical and
semiconductor industries. The consolidated financial statements (the "financial statements") include our accounts and those of our wholly-owned subsidiary, Chemotrade GmbH ("Chemotrade") and our 85%
interest in IUT Detection Technologies, Inc. ("IUTDT"). All significant intercompany accounts have been eliminated in consolidation.

Realization of Assets and Liquidity

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America,
which contemplates our continuation as a going concern. However, we have sustained substantial losses from operations in recent years, and such losses have continued into the unaudited quarter ending
July 31, 2004. In view of this matter, recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon our continued operations, which
in turn is dependent upon our ability to meet our financing requirements on a continuing basis, to maintain present financing and to succeed in our future operations.

As
of April 30, 2004 we had cash and cash equivalents of $3,691,000 and working capital of $4,732,000. In addition, on June 11, 2004 we acquired the silicon wafer
manufacturing and recycling assets of EnCompass Materials Group, Ltd. ("EMG") (See Note 19). While we believe this acquisition will now provide the platform for us to not only continue
and improve the EMG legacy manufacturing and reclamation of silicon wafers business, but to also launch a full scale silicon-on-insulator ("SOI") operation, we will need to
raise significant additional capital in fiscal year 2005 if we are to successfully implement our current business plan for the acquired assets. As a result, we are currently working with several
different sources, including both strategic and financial investors, in order to raise the capital necessary to finance both our continuing operations and our newly acquired assets from EMG.

Based
on available funds, financing opportunities, current plans and business conditions, we believe that our available cash, financing sources and amounts generated from operations will
be sufficient to meet our cash requirements for the next 12 months. The assumptions underlying this belief include, among other things, that there will be no material adverse developments in
the business or market in general. There can be no assurances however that those assumed events will occur. If our plans are not achieved, there may be further negative effects on the results of
operations and cash flows, which could have a material adverse effect on our financial position.

Cash Equivalents

Cash equivalents include investments purchased with a maturity of less than ninety days. Cash balances held in foreign bank accounts were $478,000 and $543,000 at
April 30, 2004 and 2003, respectively.

Accounts Receivable

The majority of our accounts receivable are due from customers of our life sciences segment. Credit is extended based on evaluation of a customers' financial
condition and, generally, collateral is not required. Accounts receivable are generally due within 30 days and are stated at amounts due from

F-7

---



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

Inventories

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

Property and Equipment

Property and equipment are stated at cost. Depreciation is computed using the straight-line method over three to seven years. Leasehold improvements
are amortized over the shorter of their estimated useful lives or the lease term.

Goodwill

Goodwill recorded on our consolidated balance sheet resulted from the acquisition of Chemotrade in 1998. Goodwill is not amortized, but instead is tested for
impairment at the reporting unit level annually or more frequently if the presence of certain circumstances indicates that impairment may have occurred. During the fourth quarter of the years ended
April 30, 2003 and 2004, we completed our annual impairment test and concluded there was no impairment to our goodwill. Absent any impairment indicators, we expect to perform our next
impairment test during the fourth quarter of the year ending April 30, 2005.

Long-Lived Assets

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

Prior
to the adoption of SFAS No. 142Goodwill and Other Intangible Assets, all intangible assets were evaluated for impairment
using the methods described in the preceding paragraph. After the adoption of SFAS No. 142, amortizable intangible assets continue to use these methods. We determined that no impairment
indicators were present during the years ended April 30, 2004 and 2003, and

F-8

---



accordingly
no impairment tests were performed for property and equipment or amortizable intangible assets.

Income Taxes

We account for income taxes using an asset and liability approach for financial accounting and reporting purposes. A valuation allowance is provided when deferred
tax assets are not expected to be realized.

Revenue Recognition

Revenue from product sales is recognized upon shipment. Product returns and warranty costs have not been material in any period.

Use of Estimates in the Financial Statements

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, we are required to make estimates
and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as revenues and
expenses during the reporting period. These estimates are based upon management's best findings, after considering past and current events and assumptions about future events. Actual results could
differ from those estimates.

Fair Values of Financial Instruments

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

Translation of Foreign Currencies

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

Accounting for Stock-Based Compensation

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

F-9

---



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

Year Ended April 30,2004

2003Net loss attributable to common stockholders, as reported

$
(7,025
)
$
(1,106
)Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects


(412
)

(305
)Adjusted net loss attributable to common stockholders

$
(7,437
)
$
(1,411
)


Year Ended April 30,2004

2003Basic and diluted net loss per share attributable to common stockholdersAs reported

$
(.53
)
$
(.09
)Adjusted

$
(.56
)
$
(.12
)


Net Income (Loss) Per Share

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

As
of April 30, 2004, a total of 10,570,958 outstanding stock options and common stock warrants, and 963,666, 9,000 and 32,950 outstanding shares of Series A, C and D
Convertible Preferred Stock, respectively were excluded from the diluted net income (loss) per share calculations, as the inclusion would be anti-dilutive. As of April 30, 2003, a
total of 5,232,840 outstanding stock options and common stock warrants, and 963,666 outstanding Series A Convertible Preferred Stock shares were excluded from the diluted computation, as the
inclusion would be anti-dilutive.

Recently Issued Accounting Standards

In May 2003, the Financial Accouting Standards Board ("FASB") issued SFAS No. 150,Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for classifying and measuring certain financial instruments that have
characteristics of both liabilities and equity. The guidance in SFAS No. 150 became effective June 1, 2003, for all financial instruments created or modified after May 31, 2003,
and otherwise became effective as of July 1, 2003. In November 2003, the FASB deferred for an indefinite period the application of the guidance in SFAS No. 150 to noncontrolling
interests that are classified as equity in the financial statements of a subsidiary but would be classified as a liability in the parent's financial statements under SFAS No. 150. The deferral
is limited to mandatorily redeemable noncontrolling interests

F-10

---



associated
with finite-lived subsidiaries. The adoption of SFAS No. 150 did not have a material impact on our financial statements.

In
January 2003, the FASB issued Interpretation No. 46 (FIN 46),Consolidation of Variable Interest Entities.
FIN 46 addresses when a company should consolidate in its financial statements the assets, liabilities and activities of a variable interest entity ("VIE"). It defines VIE's as entities that
either do not have any equity investors with a controlling financial interest, or have equity investors that do not provide sufficient financial resources for the entity to support its activities
without additional subordinated financial support. FIN 46 also requires disclosures about VIE's that a company is not required to consolidate, but in which it has a significant variable
interest. The consolidation requirements of FIN 46 applied immediately to variable interest entities created after January 31, 2003. The Company has not obtained an interest in a VIE
subsequent to that date. A modification to FIN 46 (FIN 46(R)) was released in December 2003. FIN 46(R) delayed the effective date for VIEs created before February 1,
2003, with the exception of special-purpose entities, until the first fiscal year or interim period ending after March 15, 2004. FIN 46(R) delayed the effective date for special-purpose
entities until the first fiscal year or interim period after December 15, 2003. We are not the primary beneficiary of any SPEs at April 30, 2004. We adopted FIN 46(R) for
non-SPE entities on April 30, 2004 and it did not have a material impact on our financial statements.

We
have reviewed all other recently issued, but not yet effective, accounting pronouncements and do not believe any such pronouncements will have a material impact on our financial
statements.

NOTE 2FINANCIAL STATEMENT COMPONENTS

Inventories consist of the following (in thousands):

April 30,2004

2003Finished goods

$
407

$
312Work in process


508


414Materials and supplies


70


22$
985

$
748


Prepaid
expenses and other current assets consists of the following (in thousands):

April 30,2004

2003Prepaid investment banking services (see Notes 7 and 8)

$
92

$
161Prepaid insurance





32Other


51


53$
143

$
246


F-11

---



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

April 30,2004

2003Office furniture and equipment

$
304

$
272Production equipment


648


631Leasehold improvements


30


29982


932Accumulated depreciation and amortization


(511
)

(317
)$
471

$
615


Depreciation
expense for the years ended April 30, 2004 and 2003 was $194,000 and $102,000, respectively.

Intangible
assets consists of the following (in thousands):

April 30,2004

2003Silicon Evolution, Inc. technology license agreement

$
590

$
590Isotope-based trace detection technology (see Note 5)


273


273863


863Accumulated amortization


(157
)

(71
)$
706

$
792


Amortization
expense for the years ended April 30, 2004 and 2003 was $86,000 and $71,000, respectively. Amortization expense associated with these intangible assets is anticipated
to be approximately $86,000 per year over the remaining useful life of these assets.

Accrued
liabilities consist of the following (in thousands):

April 30,2004

2003Compensation

$
103

$
74Customer advances and deposits


67


224Other


86


98$
256

$
396


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

Year Ended April 30,2004

2003Deemed dividends associated with beneficial conversion feature on Series C and D Convertible Preferred Stock

$
2,862

$
Common stock issued for intangible assets

$


$
273Capital lease obligations for property and equipment (see Note 10)

$


$
154Series 2002A Convertible Notes converted into common stock

$


$
1,000


F-12

---



Supplemental
disclosures of cash flow information (in thousands):

Year Ended April 30,2004

2003Cash paid during the period for:Interest

$
21

$
24Income taxes

$


$



NOTE 3GAIN ON LEGAL SETTLEMENT WITH EAGLE-PICHER TECHNOLOGIES, LLC

On December 1, 1999, we sold our depleted zinc business to Eagle-Picher Technologies, LLC ("Eagle-Picher") for $8,230,000, including $1,500,000 due in
equal installments on November 30, 2000, 2001 and 2002. During the year ended April 30, 2001, we entered into a dispute with Eagle-Picher relating to, among other things, nonpayment of
the additional payments related to the alleged nonperformance of our former depleted zinc supplier under the terms of the supply agreement transferred to Eagle-Picher, Eagle Picher's failure to supply
us the required amount of silicon-28 to be used in our research and development activities and the validity of Eagle-Picher's exercise of the related common stock warrants into 3,130,435
shares of common stock under the net exercise provision of the warrant agreement.

As
we were unable to come to a resolution, we filed for binding arbitration on March 26, 2001 claiming damages against Eagle-Picher of $75,500,000. Eagle-Picher claimed damages of
$10,000,000 for alleged misrepresentations regarding the status of the depleted zinc business at the time of sale.

On
July 24, 2002, we entered into a settlement agreement whereby Eagle-Picher paid us $2,500,000 as full consideration for settlement of the dispute. Neither Isonics nor
Eagle-Picher acknowledged fault or liability in connection with the dispute. In addition, as a result of the settlement, no shares of our common stock were ultimately issued to Eagle-Picher. In
connection with the settlement, we recognized legal expense of $360,000 as satisfaction of the contingency portion of our legal fees, resulting in a net gain of $2,140,000.

NOTE 4SALE OF CHEMOTRADE LEIPZIG GMBH

On July 31, 2002, we sold our 75% interest in Chemotrade Leipzig GmbH ("CTL") to the 25% shareholder for 50,000 Euros (approximately
$48,000). In accordance with the sales agreement, the transaction was effective as of May 1, 2002, with the new 100% shareholder controlling the operations from that point forward. We
recognized a gain of $30,000, which is recorded as interest and other income in the accompanying consolidated statements of operations. The carrying amount of the major classes of assets and
liabilities that were disposed in the transaction were: cash and cash equivalents $77,000, accounts receivable $201,000, prepaid expenses and other current assets $215,000, accounts payable $225,000,
and accrued liabilities $268,000. CTL was previously included in our life sciences business segment before the disposition.

NOTE 5ACQUISITION OF ISOTOPE-BASED TRACE DETECTION TECHNOLOGY

In December 2002 we acquired certain isotope-based trace detection technology to be used to detect explosives and chemical and biological weapons from
Institut of Umwelttechnologien GmbH ("IUT"), an entity in which we hold a 6% ownership interest. We issued to IUT 250,000 shares of restricted common stock for the isotope-based trace detection
technology. In addition, we granted IUT

F-13

---



a
15 percent ownership interest in our newly created subsidiary, IUTDT, that will own and commercialize the trace detection technology. Although legally formed, IUTDT has not yet been
capitalized and as a result there has been no minority interest recorded in the accompanying consolidated balance sheets. The restricted common stock was valued at $273,000 based upon the closing
price of our common stock on December 4, 2002. We have determined that these intangible assets have a finite life and as a result, we are amortizing them over their estimated useful life of ten
years. We incurred amortization expense of $27,000 and $12,000 during the years ended April 30, 2004 and 2003, respectively.

In
December 2002, we acquired an option (at a cost of $50,000), to purchase an additional 29.1% of IUT from an unaffiliated party for an exercise price of $450,000. The option
expired unexercised on February 28, 2003.

In
June 2004, we entered into an agreement with IUT whereby we acquired additional technology and agreed to fund $275,000 of research and development expenses on behalf of IUTDT
during the year ending April 30, 2005. The research and development work will be completed by IUT and will be funded in steps based upon the completion of various milestones.

NOTE 6CONSULTING AGREEMENT WITH INVESTOR RELATIONS SERVICES, INC.

On December 18, 2001 we entered into a one-year consulting agreement with Investor Relations Services, Inc. ("IRSI") whereby we issued
500,000 shares of restricted common stock for consulting services consisting of financial advisory, strategic business planning and investor and public relations services. The shares of restricted
common stock vested immediately and were considered full payment for services (including IRSI expenses) to be performed during the first six months of calendar 2002. The restricted common stock was
valued at $515,000 based upon the closing price of our common stock on December 18, 2001 and was amortized ratably to consulting expense over the six-month period beginning
January 1, 2002. During the last six months of calendar 2002 IRSI was to act as an advisor but to the extent that we requested IRSI to incur any expenses on our behalf, we would have been
required to reimburse IRSI for such costs.

On
July 1, 2002 we amended the agreement whereby we issued 250,000 shares of restricted common stock (valued at $247,500 based upon the fair market value of the stock) so that
IRSI would continue to perform consulting services consisting of financial advisory, strategic business planning and investor and public relations services. The shares of restricted common stock
vested immediately and were considered full payment for services (including IRSI expenses) to be performed during the last six months of calendar 2002. In August 2002, the contract was
terminated due to nonperformance by IRSI and as a result, effective as of July 1, 2002, the 250,000 shares of restricted common stock were cancelled and returned to the "authorized, unissued"
category.

During
October 2002 and again in August 2003, IRSI disputed our termination of the agreement based upon nonperformance and requested to mediate the matter. On
September 18, 2003, we settled the dispute in its entirety by issuing to IRSI 100,000 shares of our restricted common stock (valued at $97,000 based upon the fair market value of the stock).
The value of the restricted common stock was expensed to selling, general and administrative expenses during the year ended April 30, 2004.

F-14

---





NOTE 7INVESTMENT BANKING AGREEMENTS WITH VFINANCE, INC.

On June 10, 2002 we entered into an agreement with vFinance, Inc. ("vFinance") whereby we issued 25,000 shares of restricted common stock (valued at
$26,500 based upon the fair market value of the stock) and 200,000 common stock warrants (valued at $176,000 using the Black-Scholes pricing model) for investment banking, market making and consulting
services. The common stock warrants vested immediately, are exercisable at $2.32 per share and expire on June 10, 2006. The agreement was cancelable by either party upon 30 days
notification. The value of both the restricted common stock (which vested immediately) and the common stock warrants was being amortized to consulting expense over the twelve-month period (the
expected life) of the agreement. During the year ended April 30, 2003 a dispute arose between the two parties whereby vFinance claimed that it was entitled to additional cash payments along
with the shares of restricted common stock and common stock warrants in order to perform the required services under the new agreement. We determined that vFinance was not entitled to cash payments
and refused to make such payment. It was doubtful that this dispute would be resolved and thus the value of the future services to be provided over the remaining life of the new agreement was expected
to be minimal. As a result of the uncertainty of future benefit under this agreement, we expensed the entire $202,500 of value associated with the restricted common stock and common stock warrants to
consulting services during the year ended April 30, 2003. The agreement expired in June 2003 and no additional cash payments were made.

On
October 22, 2003, we entered into a non-exclusive investment banking agreement with vFinance whereby we issued a common stock warrant (valued at $369,600 using the
Black-Scholes pricing model of which $92,000 is included in prepaid expenses and other current assets in the accompanying consolidated balance sheet as of April 30, 2004) to purchase 560,000
shares of our restricted common stock at $1.25 per share. The common stock warrant vested immediately, expires on April 30, 2006 and is considered full payment for services to be provided
through June 30, 2004. The common stock warrant is being expensed to selling, general and administrative expenses ratably over the eight-month period beginning November 1, 2003.

NOTE 8CONSULTING AGREEMENTS WITH PARK CAPITAL SECURITIES, LLC

In November 2002, we entered into an agreement with Park Capital Securities, LLC ("Park Capital") whereby we issued a common stock warrant (valued at
$261,000 using the Black-Scholes pricing model) to purchase 300,000 shares of common stock at $1.00 per share, for investment banking and consulting services. The common stock warrant vested
immediately, expires in November 2005 and was expensed to consulting services over the life of the agreement. We recognized consulting services expense of $161,000 and $100,000 related to this
agreement during the years ended April 30, 2004 and 2003, respectively. The agreement terminated on December 31, 2003.

On
October 22, 2003, we extended our existing financial advisory agreement with Park Capital through December 31, 2004. In connection with this agreement, we issued a
common stock warrant (valued at $355,000 using the Black-Scholes pricing model) to purchase 500,000 shares of our restricted common stock at $1.25 per share. The common stock warrant vested
immediately and expires on October 21, 2006. During 2004 Park Capital elected to terminate its business and as a result we expensed the entire value of the common stock warrant to selling,
general and administrative expenses during the year ended April 30, 2004.

F-15

---



NOTE 9INVESTOR RELATIONS AGREEMENT

On November 1, 2003 we entered into a twelve-month agreement with Lippert/Heilshorn & Associates, Inc. ("Lippert/Heilshorn") to provide us
with investor relations services through October 31, 2004. In connection with this agreement, we agreed to make monthly payments of $10,500 and we issued a common stock warrant to acquire
120,000 shares of our restricted common stock at $1.35 per share. The common stock warrant (valued at $76,800 using the Black-Scholes pricing model) vested immediately and expires on
November 1, 2006. In April 2004, we terminated the investor relations services agreement and as a result we expensed the entire value of the common stock warrant to selling, general and
administrative expenses during the year ended April 30, 2004.

NOTE 10EQUIPMENT FINANCING AGREEMENT

In October 2002, we entered into an agreement with Fidelity Capital ("Fidelity") whereby Fidelity agreed to provide up to $1,000,000 in equipment
financing. This agreement was subsequently terminated with no new additional financings but as of April 30, 2004, principal amounts still
outstanding under this facility were $86,000. Included in property and equipment, net as of April 30, 2004 and 2003 is equipment under capital leases with a cost basis of $154,000.

The
following represents the minimum lease payments remaining under capital leases as of April 30, 2004 (in thousands):

Year ending April 30,2005

$
612006


33Total minimum lease payments


94Less: amount representing interest


8Present value of minimum lease payments


86Less: current portion of obligation under capital leases


54Long term obligation under capital leases

$
32


NOTE 11INCOME TAXES

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

April 30,2004

2003Deferred tax assetsAccruals and expenses deductible in future periods

$
1,441

$
817Net operating loss and credit carryforwards


3,715


2,633Total deferred tax assets


5,156


3,450Valuation allowance


(4,858
)

(3,359
)298


91Deferred tax liabilitiesAmortization and depreciation


(298
)

(91
)$


$



F-16

---



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

April 30,2004

2003CurrentFederal

$


$
(70
)State





Foreign








(70
)DeferredFederal





State





Foreign








$


$
(70
)


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

April 30,2004

2003Expected benefit at federal statutory rate

$
(1,415
)
$
(400
)State taxes net of federal benefit


(129
)

(36
)Foreign income taxed at different rates


25


6Other items


20


62Change in valuation allowance


1,499


298$


$
(70
)


The
federal net operating loss carryforward of approximately $7,539,000 as of April 30, 2004 expires on various dates through 2024. In addition, Chemotrade has a net operating
loss carryforward of approximately $2,000,000 which under current German tax law will not expire until utilized.

We
have established a full valuation allowance against the deferred tax assets because it is uncertain whether we will utilize these benefits due to continuing operating losses.

NOTE 12DEBT AND LETTER OF CREDIT

We currently have no lending facilities with any financial institutions, except for a line of credit available to Chemotrade in the amount of 100,000 Euros
(approximately $120,000) and a letter of credit guarantee relating to imports and exports for $50,000. The line of credit carries an interest rate of 10.1% on all outstanding amounts and currently has
no expiration date while the letter of credit expires February 28, 2005. There were no amounts outstanding under the line of credit as of April 30, 2004 and 2003, respectively.

F-17

---



NOTE 13STOCKHOLDERS' EQUITY

Common Stock

On September 25, 2003, we completed a private placement to accredited investors whereby we sold 300,000 units for $1,200,000 ($1,080,000 net of placement
fees). Each unit consisted of five shares of common stock and three common stock warrants. Each common stock warrant is exercisable for one share of our common stock at $1.25 per share until
December 31, 2005. In accordance with the securities purchase agreement, we gained effectiveness on a registration statement associated with the common stock and the common stock underlying the
common stock warrants on December 31, 2003.

Series D Convertible Preferred Stock

On April 5, 2004 we completed a financing arrangement whereby we issued 32,950 shares of our Series D Convertible Preferred Stock and 600,000 common
stock warrants to accredited investors who are affiliated with Mercator Advisory Group, LLC ("MAG") for $3,295,000. In addition, we paid MAG $230,000 in due diligence fees and related expenses and
issued them a common stock warrant to acquire 2,400,000 shares of our common stock. The common stock warrants issued in this transaction are exercisable for one share of common stock with one third
each at $1.10, $1.20 and $1.30, respectively and expire on April 5, 2007. The Series D Convertible Preferred Stock is convertible at $1.10 per share. On May 20, 2004, 6,000 shares
of Series D Convertible Preferred Stock were converted into 545,455 shares of common stock.

In
accordance with the securities purchase agreement, we gained effectiveness on a registration statement associated with the common stock and the common stock underlying the common
stock warrants on April 23, 2004.

We
have allocated the net proceeds received between the Series D Convertible Preferred Stock and related warrants to acquire 3,000,000 shares of common stock based on the relative
fair value of each instrument. In addition, in accordance with EITF 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments" we have calculated the
intrinsic value of the conversion option by using the effective conversion price based on the proceeds allocated to the convertible instrument. As a result, we determined that the value of the
beneficial conversion feature contained in our Series D Convertible Preferred Stock to be $1,864,000, which has been reported as a deemed dividend for the year ended April 30, 2004 given
that the preferred shares were convertible at the date of issuance.

The
Series D Convertible Preferred Stock is non-voting and has a liquidation preference equal to $100 per share. In addition, the holders of the Series D
Convertible Preferred stock are entitled to receive dividends (if declared) subject to the prior rights of holders of all classes of stock at the time outstanding.

Series C Convertible Preferred Stock

On January 27, 2004 we completed a financing arrangement whereby we issued 22,000 shares of our Series C Convertible Preferred Stock and 200,000
common stock warrants to accredited investors who are affiliated with MAG for $2,200,000. In addition, we paid MAG $200,000 in due diligence fees and related expenses and issued them a common stock
warrant to acquire 227,701 shares of our common stock. Each common stock warrant issued in this transaction is exercisable for one share of common stock at $1.25 per share and expires on
January 27, 2007. The Series C Convertible Preferred Stock is convertible (or has since been converted) at a price to be determined as 80% of the market price (which is defined as the
average of the lowest three inter-day trading prices of our common stock

F-18

---



for
the five consecutive trading days immediately preceding the conversion date) of our common stock on the day of conversion, but not greater than $1.25 per share nor less than $0.95 per share
(equating to a range of 1,760,000 to 2,315,790 shares of common stock). During the year ended April 30, 2004, 13,000 shares of Series C Convertible Preferred Stock were converted (at
$.95 per share) into 1,368,421 shares of common stock.

In
accordance with the securities purchase agreement, we gained effectiveness on a registration statement associated with the common stock and the common stock underlying the common
stock warrants on March 8, 2004.

We
have allocated the net proceeds received between the Series C Convertible Preferred Stock and related warrants to acquire 427,701 shares of our common stock based on the
relative fair value of each instrument. In addition, in accordance with EITF 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments" we have calculated
the intrinsic value of the conversion option by using the effective conversion price based on the proceeds allocated to the convertible instrument. As a result, we determined that the value of the
beneficial conversion feature contained in our Series C Convertible Preferred Stock to be $998,000, which has been reported as a deemed dividend for the year ended April 30, 2004 given
that the preferred shares were convertible at the date of issuance.

The
Series C Convertible Preferred Stock is non-voting and has a liquidation preference equal to $100 per share. In addition, the holders of the Series C
Convertible Preferred stock are entitled to receive dividends (if declared) subject to the prior rights of holders of all classes of stock at the time outstanding.

In
conjunction with pursuing the financing agreement with MAG, we were simultaneously working with vFinance as an alternate source of funding. In order to compensate vFinance for their
services, on February 27, 2004 we issued them a common stock warrant (valued at $84,000 using the Black-Scholes pricing model) to purchase 150,000 shares of our restricted common stock at $1.25
per share. The common stock warrant vested immediately and expires April 30, 2006.

Series A Convertible Preferred Stock

On April 30, 2004 we had 963,666 shares of Series A Convertible Preferred Stock outstanding with a liquidation preference of $1.50 per share. The
Series A Convertible Preferred Stock is entitled to dividends or distributions equal to the amount of the dividend or distribution per share of common stock payable at such time multiplied by
the number of shares of common stock then obtainable upon conversion of such Series A Convertible Preferred Stock. Subsequent to year-end, on May 3, 2004, 463,358 shares of
Series A Convertible Preferred Stock were converted into 926,716 shares of common stock.

The
Redemption Trigger Date for the Series A Convertible Preferred Stock was the business day immediately following the thirtieth consecutive trading day that the average closing
price during such trading days (or, if no closing price is reported, the average of the bid and ask prices) of the shares of common stock was above $8.00 per share (which minimum price shall be
proportionally adjusted for stock splits, stock dividends, reverse stock splits and any other subdivision or combination of the common stock). As we have met the Redemption Trigger Date, we may now
redeem all or any part of the Series A Convertible Preferred Stock at our election at any time and from time to time. The Series A Convertible Preferred Stock is convertible into common
stock at the option of the holder until and unless we choose to redeem such shares and, until converted, at any meeting of our shareholders, each share of Series A Convertible Preferred Stock
is entitled to the number of votes equal to the

F-19

---



number
of shares of common stock into which the Series A Convertible Preferred Stock is then convertible.

Under
the terms of the Series A Convertible Preferred Stock private placement, the related shareholders had anti-dilution rights if we issued or sold common stock
after July 29, 1999 for a per share consideration less than the current exercise price of the related warrants. The 3,085,622 common stock warrants associated with this private placement
expired unexercised on July 29, 2002.

There
are provisions associated with the Series A Convertible Preferred Stock that if triggered, would reduce the current conversion price and effectively allow the preferred
shares to convert to common stock at a more favorable ratio. Prior to our September 2003 financing, the preferred stock was
convertible at 1.67 shares of common stock for each share of Series A Convertible Preferred Stock outstanding. We did not believe that the financing completed in September 2003 (see Common Stock) caused any further adjustment to the conversion price, but the holders of the Series A Convertible Preferred Stock expressed their
disagreement. In November 2003, we entered into a settlement agreement with the holders of the Series A Convertible Preferred Stock and as a result, the preferred shares are now
convertible at two shares of common stock for each share of Series A Convertible Preferred Stock outstanding.

Series 2002A Convertible Notes

On March 20, 2002 we completed a financing arrangement whereby we issued $1,000,000 in Series 2002A Convertible Notes along with 200,000 detachable
common stock warrants. As a result of allocating the proceeds between the convertible notes and the detachable warrants on a relative fair value basis, we recorded a discount to the convertible notes
of $190,000. In addition, after applying the provisions of EITF 98-5 "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios
and EITF 00-27 Application of EITF Issue 98-5 to Certain Convertible Instruments", we determined that the conversion feature on the $1,000,000 convertible notes had an
intrinsic value of $430,000, which was recorded as an additional discount to the convertible notes. The discount to the convertible notes was being amortized to interest expense over the life of the
convertible notes. During the year ended April 30, 2003, the $1,000,000 of convertible notes were converted to 1,000,000 shares of common stock. As a result of the conversion of the notes to
common stock, we expensed the entire remaining discount amount of $546,000 to interest expense during the year ended April 30, 2003.

In
connection with completing the financing arrangement, we paid the investment banker $100,000 and issued them 100,000 common stock warrants (valued at $102,000 using the Black-Scholes
pricing model). The common stock warrants are exercisable at $1.25 per share and expire on March 20, 2005. The total debt offering costs had been capitalized and were being amortized to expense
over the life of the convertible notes. As a result of the conversion of the notes to common stock, we expensed the entire remaining debt offering costs of $182,000 to other income (expense) during
the year ended April 30, 2003.

Stock Option and Purchase Plans

1996 Stock Option Plan

Our 1996 Stock Option Plan authorized the grant of incentive and nonqualified stock options to our key employees, directors or consultants. The options generally
expire ten years from the date of grant. In September 1997, the Board of Directors terminated the 1996 Stock Option Plan. As of

F-20

---



April 30,
2004, there remain 358,769 options outstanding and zero shares available for grant under the 1996 Stock Option Plan.

Directors' Stock Option Plan

The 1998 Directors' Plan provides that each person serving as a member of the Board, who is not an employee of Isonics, receive options to purchase 20,000 shares
of common stock when such person accepts his position as a director and to receive an additional option to purchase 10,000 shares when such person is re-elected as a director provided such
person is not an employee of Isonics at the time of election. The exercise price for the options is the quoted market price on the date of grant and the options are exercisable for five years from
such date. The options granted under the directors' plan vest immediately. In the event a director resigns or is not re-elected to the Board, failure to exercise the options within three
months results in the options' termination. As of April 30, 2004, options to purchase a total of 130,000 shares were outstanding under the directors' plan.

Executive and Incentive Stock Option Plans

In November 1996 (and modified subsequently), the Board of Directors adopted the Executives' Incentive and Incentive Stock Option Plans authorizing the
granting of up to 1,000,000 and 500,000 incentive and nonqualified stock options respectively, to our key employees, directors or consultants. Effective November 13, 2001, our shareholders
approved an increase in the authorized shares for the Executive and Incentive Stock Option Plans to 2,000,000 and 1,000,000, respectively. Incentive stock options are granted at a price not less than
fair market value, and nonqualified stock options are granted at a price not less than 85% of the fair market value. Options are exercisable when vested, typically over four to five years and expire
five to ten years after the date of grant. As of April 30, 2004, options to purchase a total of 1,256,878 shares were outstanding and 1,356,484 shares were available for grant under the
Executive and Incentive Stock Option Plans.

Employee Stock Purchase Plan

The employee stock purchase plan has reserved 200,000 shares of our common stock for sale to all permanent employees who have met minimum employment criteria.
Employees who do not own 5% or more of the outstanding shares are eligible to participate through payroll deductions. At the end of each offering period, shares are purchased by the participants at
85% of the lower of the fair market value of our common stock at the beginning or the end of the offering period. As of April 30, 2004, 48,538 shares have been issued under the plan.

F-21

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SFAS No. 123 Disclosures

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

For
purposes of the pro forma disclosures, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted
average assumptions for the years ended April 30, 2004 and 2003, respectively; no expected dividends, volatility of 100%; risk-free interest rate of 4.0%; and expected lives of four
to eight years. A summary of the status of our stock option plans as of April 30, 2004 and 2003, and changes during the years ended on these dates is presented below.

Number of
Shares

Weighted
Average
Exercise
PriceOutstanding, April 30, 2002

1,568,473

$
1.69Granted

275,000

$
.98Exercised




Canceled

(53,243
)
$
4.60Outstanding, April 30, 2003

1,790,230

$
1.50Granted

230,000

$
1.18Exercised




Canceled

(274,583
)
$
1.46Outstanding, April 30, 2004

1,745,647

$
1.39


The
weighted average fair value of options granted during the years ended April 30, 2004 and 2003 was $.95 and $.79, respectively.

The
following information applies to options outstanding at April 30, 2004:

Range of
Exercise Price

Number
Outstanding

Weighted Average
Exercise Price

Weighted Average
Remaining
Contractual
Life (Years)

Number
Exercisable

Weighted Average
Exercise price$0.58

207,340

$
0.58

2

207,340

$
0.58$1.00-$1.44

1,196,878

$
1.08

6

809,378

$
1.12$1.69-$2.19

191,429

$
1.75

5

166,429

$
1.75$3.50

80,000

$
3.50

3

80,000

$
3.50$5.50-$6.25

70,000

$
5.71

1

70,000

$
5.711,745,647

$
1.39



1,333,147

$
1.50


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Warrants

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

Number of
Shares

Weighted
Average
Exercise
PriceOutstanding, April 30, 2002

6,178,232

$
2.35Warrants issued for services

520,000


1.51Expired

(3,255,622
)

3.04Outstanding, April 30, 2003

3,442,610


1.57Warrants issued for services

1,380,000


1.27Warrants issued in connection with financings

4,327,701


1.22Exercised

(225,000
)

1.25Expired

(100,000
)

1.88Outstanding, April 30, 2004

8,825,311

$
1.35


The
outstanding warrants as of April 30, 2004, are summarized as follows:

Number
Outstanding

Weighted
Average
Exercise
Price

Expiration
DateClass B Warrants

1,780,110

$
1.50

12-31-2005Class C Warrants

202,500

$
2.50

12-31-2005Other Warrants

6,842,701

$
1.28


(1)8,825,311

$
1.35


---

NOTE 14BUSINESS SEGMENTS AND FOREIGN OPERATIONS

We
currently have two reportable segments: life sciences and semiconductor materials and products. Our life sciences segment sells stable and radioisotopes in elemental and simple compound forms for
use in life sciences applications. Our semiconductor materials and products segment sells SOI wafers and is involved in several research and development projects including silicon-28.
Reconciling items consist primarily of corporate expenses that have not been allocated to a specific reportable segment.

F-23

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

2004

2003Segment revenues:Life sciences

$
8,202

$
8,854Semiconductor materials and products


519


197Total

$
8,721

$
9,051Segment operating (loss) incomeLife sciences

$
486

$
1,099Semiconductor materials and products


(1,213
)

(1,009
)Reconciling amounts


(3,445
)

(2,646
)Total

$
(4,172
)
$
(2,556
)Total assets:Life sciences

$
4,066

$
3,807Semiconductor materials and products


1,037


1,193Reconciling amounts


3,578


747Total

$
8,681

$
5,747


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

2004

2003Net revenuesUnited States

$
6,238

$
6,079Germany


2,483


2,972Total

$
8,721

$
9,051Operating (loss) incomeUnited States

$
(4,206
)
$
(2,652
)Germany


34


96Total

$
(4,172
)
$
(2,556
)Total assetsUnited States

$
5,914

$
2,956Germany


2,767


2,791Total

$
8,681

$
5,747


NOTE 15EMPLOYEE BENEFIT PLAN

We have a profit sharing plan qualified under section 401(k) of the Internal Revenue Code. The plan is a defined contribution plan, covering substantially
all of our employees. Company contributions to the plan aggregated approximately $32,000 and $30,000 for the years ended April 30, 2004 and 2003, respectively.

NOTE 16CONCENTRATIONS

As of April 30, 2004, three customers accounted for approximately 34% of total net accounts receivable. Three customers accounted for approximately 46% of
total net accounts receivable at

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April 30,
2003. One customer (Eastern Isotopes) accounted for approximately 32% of revenues for the year ended April 30, 2004. Two customers (Eastern Isotopes and Perkin Elmer Life
Sciences) accounted for approximately 29% and 17%, respectively of revenues for the year ended April 30, 2003. Three customers (Perkin Elmer Life Sciences, IBT SA and International Isotopes)
accounted for approximately 33%, 20% and 19%, respectively of the German operation's revenues for the year ended April 30, 2004. Four customers (Perkin Elmer Life Sciences, IBT SA,
Revis LTD and International Isotopes) accounted for approximately 43%, 15%, 13% and 12%, respectively of the German operation's revenues for the year ended April 30, 2003. Two customers
accounted for approximately 49% of the German operation's accounts receivable at April 30, 2004. Two customers accounted for approximately 52% of the German segment's accounts receivable at
April 30, 2003.

NOTE 17RELATED PARTY TRANSACTIONS

On January 1, 2002, we entered into a one-year consulting agreement with HS-CONSULT GMBH ("HSC") primarily to assist Chemotrade in
buying and selling isotope products. HSC primarily consists of our former managing director of Chemotrade and an additional former key employee of Chemotrade. The consulting agreement expired on
December 31, 2002 and required a monthly payment of 5,500 Euros for the services to be provided. In connection with the agreement we also issued a common stock warrant (valued at $44,000 using
the Black-Scholes pricing model) to purchase 50,000 shares of restricted common stock at $1.20 per share. The common stock warrant vested and was exercisable immediately. The common stock warrant
expires on December 31, 2004 and was amortized to consulting expense over the life of the agreement. The consulting agreement was renewed for terms of one year on January 1, 2004 and
2003 and requires monthly payments of 5,500 Euros.

On
December 23, 2003, we borrowed $40,000 from James E. Alexander, our President and Chief Executive Officer. We repaid the loan in full, plus interest at 12% per annum, on
January 30, 2004.

On
September 9, 2003, we borrowed $100,000 from Stephen Burden, our Vice President of Semiconductor Materials and Products. We repaid the loan in full, plus interest at 12% per
annum, on September 11, 2003. On November 19, 2003 we borrowed an additional $100,000 from Stephen Burden. The loan bore interest at a rate of 12% per annum and was due the earlier of
one year or the collection of certain accounts receivable, as defined. The loan was repaid in full, plus interest in January 2004.

On
August 26, 2003 and July 30, 2003, we borrowed $120,000 and $80,000, respectively from Daniel Grady, our Vice President of Life Sciences. We repaid the loans in full,
plus interest at 12% per annum, on September 11, 2003 and August 4, 2003, respectively. On November 18, 2003, we borrowed an additional $120,000 from Daniel Grady. The loan bore
interest at a rate of 12% per annum and was due the earlier of one year or the collection of certain accounts receivable, as defined. The loan was repaid in full, plus interest in January 2004.

On
January 1, 2002 we extended our cooperation agreement on a month-to-month basis with Interpro Zinc, LLC ("Interpro") to continue leasing office,
laboratory and storage space at our current location. We incurred rental expense to Interpro of $8,000 and $57,000 for the years ended April 30, 2004 and 2003, respectively. Our lease with
Interpro expired effective July 31, 2003.

NOTE 18COMMITMENTS

In August 2003, we entered into a month-to-month lease (at a rate of $2,800 per month) with the Colorado School of Mines Research
Institute to continue leasing office and storage space at our current location.

F-25

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We
rent additional office facilities under operating leases expiring through September 2005. Rent expense for operating leases was $249,000 and $232,000 for the years ended
April 30, 2004 and 2003, respectively. Future minimum annual operating lease commitments are as follows (in thousands):

Year ending April 30,2005

$
752006


19$
94


In
December 2003 we extended our production, marketing and sales agreement with our supplier of Oxygen18 through July 2010. The agreement requires the purchase
of certain quantities at prices to be determined as a percentage of the then prevailing market price. Under the terms of the agreement, we estimate that our purchase obligation (based on estimates of
future market prices) is approximately $30,000,000 through the end of the agreement.

As
of April 30, 2004 we had commitments outstanding for capital expenditures of approximately $700,000.

NOTE 19SUBSEQUENT EVENT

On June 11, 2004, we acquired the silicon wafer manufacturing and recycling assets of EMG for approximately $3,551,000. The purchase price consisted of a
$1,700,000 promissory note (secured by the assets acquired and certain other assets owned by us relating to our SOI business) payable over 33 months with an interest rate of 6%, 731,930 shares
of our restricted common stock (valued at $1,171,000 based upon the fair market value of the common stock), payment of approximately $380,000 to satisfy certain of EMG's obligations and assumption of
approximately $300,000 of certain future obligations. In addition, we assumed operating leases (that expire in various years through fiscal 2011) with future commitments of approximately $1,200,000.
We are currently in the process of completing our valuation of the assets acquired and the related purchase accounting associated with this transaction. We anticipate that this will be completed
during our quarter ended October 31, 2004.

In
conjunction with this acquisition, in May 2004 we established our wholly owned subsidiary Isonics Vancouver, Inc. ("Isonics Vancouver"). Isonics Vancouver is a
Washington based entity that now conducts our SOI and manufacturing and reclamation of silicon wafer operations.

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