UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION





Washington,
      D.C. 20549





FORM
      10-QSB/A





Amendment
      No. 1





QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
      the
      quarterly period ended September 30, 2006





Commission
      file number: 000-28153





**QPC
      Lasers, Inc.**





(Exact
      name of registrant as specified in its charter)





Nevada





(State
      of
      incorporation)





20-1568015





(I.R.S.
      Employer Identification No.)





15632
      Roxford Street, Sylmar, CA. 91342





(Address
      of principal executive offices) (Zip Code)





(818)
      986-0000





(Registrant's
      telephone number, including area code)





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





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





There
      were 37,311,506 shares of the registrant's common stock outstanding as of
      September 30, 2006.








Explanatory
      Note




OVERVIEW.
      This Amendment on Form 10-QSB/A (the “Form 10-QSB/A”) to our Quarterly Report on
      Form 10-QSB for the quarter ended September 30, 2006, initially filed with
      the
      Securities and Exchange Commission (“SEC”) on November 20, 2006 (the “Original
      Filing”), is being filed to restate our third quarter 2006 consolidated
      financial statements and other financial information primarily as a result
      of
      changes in the accounting treatment to reflect additional non-operating losses
      related to the classification of and accounting for: (1) the conversion feature
      of our subordinated convertible notes payable issued in August 2005, the
      warrants to purchase common stock associated with these notes, the amortization
      of the discount recorded with respect to the subordinated convertible note,
      (2)
      the notes payable issued to Finisar Corporation (“Finisar”) for $6,000,000 for
      the license termination, (3) the modification of warrants to purchase common
      stock held by investors in our Senior Secured Notes Payable, and (4) common
      stock issued to a consultant for services rendered in the three months ended
      June 30, 2006.




The
      information contained in this Form 10-QSB/A, including the financial statements
      and notes thereto, amends Items 1, and 2 of Part I of our Original Filing,
      in
      each case to reflect only the adjustments described herein, and no other
      information in our Original Filing is amended hereby.  Except for the
      foregoing amended information, the Original Filing, as amended, continues to
      describe conditions as of November 20, 2006, the date of the Original Filing,
      and does not reflect events occurring after November 20, 2006, or modify or
      update those disclosures that may have been affected by subsequent
      events.







INDEX
      TO
      FORM 10QSB/A




PAGEPART
                1
            FINANCIAL
                INFORMATION
            
            2Item
                1.
            Condensed
                Financial Statements
            
            2Condensed
                Consolidated Balance Sheets at September 30, 2006 (unaudited) (restated)
                and December 31, 2005
            
            2Condensed
                Consolidated Statements of Operations for the three and nine month
                periods
                ended September 30, 2006 (restated) and September 30, 2005 (unaudited)
            
            4Condensed
                Consolidated Statements of Stockholders’ Equity (unaudited)
                (restated)
            
            5Condensed
                Consolidated Statements of Cash Flows for the nine month periods
                ended
                September 30, 2006 (restated) and September 30, 2005 (unaudited)
            
            6Notes
                to Unaudited Condensed Consolidated Financial
                Statements
            
            7Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            
            33Item
                3.
            Controls
                and Procedures
            
            47PART
                II
            OTHER
                INFORMATION
            
            47Item
                1.
            Legal
                Proceedings
            
            47Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            
            48Item
                3.
            Defaults
                Upon Senior Securities
            
            48Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            
            48Item
                5.
            Other
                Information
            
            48Item
                6.
            Exhibits
            
            48SIGNATURES
            
            49







**Part
      I - Financial Information**




Item
      1.
      Financial Statements




**QPC
      LASERS, INC.**




**CONDENSED
      CONSOLIDATED BALANCE SHEETS**




**September
                30, 2006**
            
            **December
                31, 2005****(Unaudited)**
              **(Restated)****ASSETS****CURRENT
                ASSETS**Cash
            
            $
            4,294,927
            
            $
            69,440Accounts
                receivable, Commercial customers, net of allowance for doubtful accounts
                and returnsand
                discounts of $52,453 as of September 30, 2006 and $6,704 as of December
                31, 2005
            
            
            464,081
            
            
            331,332Accounts
                receivable, Government contracts, net of allowance for doubtful accounts
                and returnsand
                discounts of $-0- as of September 30, 2006 and $8,312 as of December
                31,
                2005
            
            
            235,972
            
            
            15,669Costs
                and earnings in excess of billings
            
            
            42,744
            
            
            10,774Inventory
            
            
            479,634
            
            
            419,099Prepaid
                expenses and other current assets
            
            
            271,497
            
            
            198,449Total
                Current Assets
            
            
            5,788,855
            
            
            1,044,763Capitalized
                loan fees, net of accumulated amortization of $291,001 as ofSeptember
                30, 2006 and $ 203,586 as of December 31, 2005
            
            
            52,633
            
            
            140,049Property
                and equipment, net of accumulated depreciation of $4,962,708as
                of September 30, 2006 and $ 4,056,090 as of December 31,
                2005
            
            
            3,883,516
            
            
            4,391,019Other
                assets
            
            
            88,780
            
            
            129,414**TOTAL
                ASSETS**
            
            **$**
            9,813,784
            
            $
            5,705,245




(continued)


2




**QPC
      LASERS, INC.**




**CONDENSED
      CONSOLIDATED BALANCE SHEETS (Continued)**




**September
                30, 2006**
            
            **December
                31, 2005****(Unaudited)**
              **(Restated)****LIABILITIES
                AND STOCKHOLDER’S EQUITY****CURRENT
                LIABILITIES**Accounts
                payable and other current liabilities
            
            $
            735,596
            
            $
            940,766Note
                payable-related party
            
            
            —
            
            
            343,200Current
                portion of long term debt
            
            
            974,586
            
            
            1,396,218Total
                Current Liabilities
            
            
            1,710,182
            
            
            2,680,184Long
                term debt, less current portion
            
            
            6,713,920
            
            
            1,288,506Total
                Liabilities
            
            
            8,424,102
            
            
            3,968,690**COMMITMENTS
                AND CONTINGENCIES****STOCKHOLDERS’
                EQUITY**Preferred
                stock, $.001 par value, 20,000,000 shares authorized, noneoutstanding
            
            
            —
            
            
            —Common
                stock, $.001 par value, 180,000,000 shares authorized,
                38,559,283issued
                and outstanding at September 30, 2006 and 12,787,802 at December
                31,
                2005
            
            
            38,559
            
            
            12,788Common
                stock to be issued
            
            
            —
            
            
            866Additional
                paid in capital
            
            
            50,123,854
            
            
            34,536,687Accumulated
                deficit
            
            
            (48,772,731
            )
            
            (32,813,786
            )Total
                stockholders’ equity
            
            
            1,389,682
            
            
            1,736,555**TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY**
            
            $
            9,813,784
            
            $
            5,705,245




See
      accompanying Notes to Condensed Consolidated Financial Statements




3




**QPC
      LASERS, INC.**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**For
      the Three and Nine months Ended September 30, 2006 and 2005**


**(Unaudited)**




**Three
                months ended (Unaudited)**
            
            **Nine
                months ended (Unaudited)****September
                30,****2006**
            
            **September
                30,****2005**
            
            **September
                30,****2006**
            
            **September
                30,****2005****(As
                restated)**
            
            
            
            **(As
                restated)****REVENUE**
            
            $
            930,184
            
            $
            153,621
            
            $
            1,773,094
            
            $
            676,803**COST
                OF SALES**
            
            
            690,388
            
            
            286,495
            
            
            1,465,137
            
            
            714,729**GROSS
                PROFIT**
            
            
            239,796
            
            
            (132,874
            )
            
            307,957
            
            
            (37,926
            )**OPERATING
                EXPENSES**Research
                and Development
            
            
            1,081,994
            
            
            1,149,522
            
            
            3,340,772
            
            
            3,632,791General &
                Administrative
            
            
            1,093,561
            
            
            610,245
            
            
            4,670,865
            
            
            1,727,862License
                Termination
            
            
            6,000,000
            
            
            -
            
            
            6,000,000
            
            
            -Total
                operating expenses
            
            
            8,175,555
            
            
            1,759,767
            
            
            14,011,637
            
            
            5,360,653**LOSS FROM
                OPERATIONS**
            
            
            (7,935,759
            )
            
            (1,892,641
            )
            
            (13,703,680
            )
            
            (5,398,579
            )Interest
                Income
            
            
            21,443
            
            
            2,186
            
            
            27,916
            
            
            14,280Interest
                Expense
            
            
            (336,697
            )
            
            (104,754
            )
            
            (1,947,056
            )
            
            (275,655
            )Merger
                expense
            
            
            10,123
            
            
            —
            
            
            (326,199
            )
            
            —Change
                in fair value of embedded derivative
            
            
            (97,329
            )
            
            —
            
            
            (68,703
            )
            
            -Other
                income & Other Expense
            
            
            25,170
            
            
            26,761
            
            
            58,777
            
            
            64,478**NET
                LOSS**
            
            $
            (8,313,049
            )
            $
            (1,968,448
            )
            $
            (15,958,945
            )
            $
            (5,595,476
            )**LOSS
                PER SHARE**—
                Basic and Diluted
            
            $
            (0.22
            )
            $
            (0.16
            )
            $
            (0.55
            )
            $
            (0.45
            )**WEIGHTED
                AVERAGE SHARES OUTSTANDING,**
              **BASIC
                AND DILUTED**
            
            
            38,351,320
            
            
            12,476,802
            
            
            28,889,088
            
            
            12,359,185




See
      accompanying Notes to Condensed Consolidated Financial
      Statements


4




**QPC
      LASERS, INC.**


**STATEMENT
      OF CHANGES IN STOCKHOLDERS’ EQUITY**


For
      the
      nine months ended September 30, 2006 (Unaudited) (Restated)





Common
                Stock
            
            Common
                  Stock
            
            Additional
            
            AccumulatedShares
            
            Amount
            
            to
                be Issued
            
            Paid-in
            
            Deficit
            
            TotalBALANCE-December
                31, 2005
            
            
            12,787,802
            
            $
            12,788
            
            $
            866
            
            $
            34,536,687
            
            $
            (32,813,786
            )
            $
            1,736,555Issuance
                of stock associated with stock dividend
            
            
            8,658,422
            
            
            8,659
            
            
            (866
            )
            
            (7,793
            )
            
            —
            
            
            —Shares
                issued upon reverse merger transaction
            
            
            4,166,378
            
            
            4,166
            
            
            
            
            
            (4,166
            )
            
            
            
            
            —Issuance
                of stock for cash, net, of offering costs of $2,323,942
            
            
            11,726,681
            
            
            11,726
            
            
            
            
            
            12,312,202
            
            
            
            
            
            12,323,928Value
                of warrants issued with common stock
            
            
            
            
            
            
            
            
            
            
            
            68,703
            
            
            
            
            
            68,703Issuance
                of stock upon option exercise
            
            
            17,500
            
            
            17
            
            
            
            
            
            10,983
            
            
            
            
            
            11,000Issuance
                of stock upon warrant exercise
            
            
            2,500
            
            
            3
            
            
            
            
            
            3,747
            
            
            
            
            
            3,750Issuance
                of stock for services
            
            
            1,200,000
            
            
            1,200
            
            
            
            
            
            1,498,800
            
            
            
            
            
            1,500,000Fair
                value of warrants issued for services and loan fees
            
            
            
            
            
            
            
            
            
            
            
            777,598
            
            
            
            
            
            777,598Fair
                value of vested options
            
            
            
            
            
            
            
            
            
            
            
            183,093
            
            
            
            
            
            183,093Fair
                value of modification of warrants
            
            
            
            
            
            
            
            
            
            
            
            744,000
            
            
            
            
            
            744,000Nine
                month net loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (15,958,945
            )
            
            (15,958,945
            )Balance
                September 30, 2006
            
            
            38,559,283
            
            $
            38,559
            
            $
            —
            
            $
            50,123,854
            
            $
            (48,772,731
            )
            $
            1,389,682




See
      accompanying Notes to Condensed Consolidated Financial
      Statements


5




**QPC
      LASERS, INC.**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**For
      the nine months ended September 30, 2006 and 2005**


**(Unaudited)**





**Nine
                months Ended (Unaudited)****September
                30,****2006**
            
            **September
                30,****2005****(As
                restated)****CASH
                FLOWS FROM OPERATING ACTIVITIES**Net
                Loss
            
            $
            (15,958,945
            )
            $
            (5,595,476
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            906,619
            
            
            996,642Amortization
                of loan discount
            
            
            877,461
            
            
            —Amortization
                of Capitalized Loan Fees
            
            
            87,416
            
            
            (104,319
            )License
                termination
            
            
            6,000,000
            
            
            —Gain
                on change in fair value of embedded derivatives
            
            
            68,703
            
            
            —Warrants
                issued for services and loan fees
            
            
            777,598
            
            
            —Compensation
                expense of option issuance
            
            
            183,093
            
            
            —Shares
                issued for services
            
            
            1,500,000
            
            
            —Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (353,052
            )
            
            4,051Inventory
            
            
            (60,535
            )
            
            17,626Unbilled
                revenue
            
            
            (31,970
            )
            
            (7,994
            )Other
                assets
            
            
            40,634
            
            
            —Prepaid
                Expenses
            
            
            (73,048
            )
            
            (43,191
            )Accounts
                payable and other current liabilities
            
            
            (205,170
            )
            
            132,032Deferred
                revenues
            
            
            —
            
            
            (83,387
            )Net
                cash used in operating activities
            
            
            (6,241,196
            )
            
            (4,684,016
            )**CASH
                FLOWS FROM INVESTING ACTIVITIES:**Purchase
                of property and equipment
            
            
            (399,115
            )
            
            (171,992
            )Net
                cash used in investing activities
            
            
            (399,115
            )
            
            (171,992
            )**CASH
                FLOWS FROM FINANCING ACTIVITIES:**Proceeds
                from borrowing
            
            
            —
            
            
            1,280,000Principal
                payments on debt
            
            
            (1,472,880
            )
            
            (414,072
            )Proceeds
                received from sale of common stock and unit sales allocated to common
                stock
            
            
            12,323,928
            
            
            —Preferred
                stock issued for cash, net of issuance costs
            
            
            —
            
            
            1,055,896Exercise
                of warrants
            
            
            3,750
            
            
            —Exercise
                of options
            
            
            11,000
            
            
            —Net
                cash provided by financing activities
            
            
            10,865,798
            
            
            1,921,824**NET
                INCREASE (DECREASE) IN CASH**
            
            
            4,225,487
            
            
            (2,934,184
            )**CASH —
                Beginning of period**
            
            
            69,440
            
            
            4,129,118**CASH —
                End of period**
            
            $
            4,294,927
            
            
            1,194,934**Supplemental
                Disclosures of Cash Flow Information**Cash
                paid during the period for:Interest
            
            $
            246,525
            
            
            183,985Taxes
            
            $
            —
            
            
            —




SUPPLEMENTAL
      DISCLOSURE OF NON-CASH ACTIVITIES:





During
      the nine months ended September 30, 2006, 1,200,000 common shares were issued
      in
      exchange for consulting services valued at $1,500,000.





During
      the nine months ended September 30, 2006, the Company paid to Finisar, a related
      party (shareholder), a license termination fee in exchange for a $6 million
      promissory note.




During
      the nine months ended September 30, 2006, the Company modified warrants
      with a fair value of $744,000 to holders of Senior Secured Notes Payable.





During
      the nine months ended September 30, 2006, the Company issued warrants with
      a
      fair value of $690,000 to holders of Related Party Notes Payable.





Warrants
      valued at $280,538, initially accounted for as a derivative liability, were
      reversed to Paid in Capital.




See
      accompanying Notes to Condensed Consolidated Financial
      Statements


6




**QPC
      LASERS, INC.**





**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**FOR
      THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
      (UNAUDITED)**




NOTE
      1




ORGANIZATION
      AND NATURE OF OPERATIONS





The
      Company was originally incorporated in the State of Nevada on August 31, 2004
      under the name “Planning Force, Inc.” (PFI) as a development stage company that
      planed to specialize in event planning for corporations. The Company offered
      two
      types of services: retreat training services and product launch event planning.
      This business generated minimal revenue for the Company since
      inception.




Effective
      May 1, 2006, Planning Force Inc., changed its name to QPC Lasers, Inc. On May
      12, 2006 QPC Lasers, Inc. (QLI) executed a Share Exchange Agreement by and
      among
      Julie Moran, its majority shareholder, and Quintessence Photonics Corporation
      (QPC) and substantially all of its shareholders. Under the agreement QLI issued
      one share of its common stock to the QPC shareholders in exchange for each
      share
      of QPC common stock (QPC Shares). Upon closing, QPC Shares represented at least
      87% of QLI’s common stock. Therefore, a change in control occurred and QPC also
      became a wholly owned subsidiary of QLI. Accordingly, the transaction is
      accounted for as a reverse merger (recapitalization) in the accompanying
      financial statements with QPC deemed to be the accounting acquirer and QLI
      is
      deemed to be the legal acquirer. As such the financial statements herein reflect
      the historical activity of QPC since its inception, and the historical
      stockholders’ equity of QPC has been retroactively restated for the equivalent
      number of shares received in the exchange after giving effect to any differences
      in the par value offset to paid in capital. The activity of QLI is being
      reflected from May 12, 2006 forward (see Note 8).





The
      accompanying interim financial statements are unaudited, but in the opinion
      of
      management of QLI, contain all adjustments, which include normal recurring
      adjustments necessary to present fairly the financial position at September
      30,
      2006 and the results of operations and cash flows for the nine months ended
      September 30,  2006 and 2005. The results of operations for the nine months
      ended September 30, 2006 are not necessarily indicative of the results of
      operations to be expected for the full fiscal year ending December 31, 2006.
      The
      Company has filed a Registration Statement on Form SB-2 with the Securities
      and
      Exchange Commission on September 18, 2006. The reader should refer to that
      filing for further information on the results of operations during the fiscal
      year ended December 31, 2005. The Company received a comment letter from the
      Securities and Exchange Commission in relation to this registration
      statement. Certain of the comments in that letter related to certain amounts
      reported and disclosed in the accompanying financial statements and will also
      require revision to the previously filed SB-2. We are in the process of
      responding to these comments. The ultimate resolution of such comments may
      result in changes to certain of the amounts and disclosures
      herein.




GOING
      CONCERN




The
      accompanying financial statements have been prepared in conformity with
      accounting principles generally accepted in the United States of America, which
      contemplate continuation of the Company as a going concern. However, the Company
      had a net loss of $8,208,611(restated) and utilized cash of $6,440,414 in
      operating activities during the year ended December 31, 2005, and had a working
      capital deficiency at December 31, 2005 of $3,223,421. During the nine months
      ended September 30, 2006, the Company had a net loss of $15,958,945 and utilized
      cash of $6,241,196 in operating activities. These factors raise substantial
      doubt about the Company's ability to continue as a going concern. The financial
      statements do not include any adjustments relating to the recoverability and
      classification of recorded asset amounts, or amounts and classification of
      liabilities that might result from this uncertainty.


7




Management’s
      plan to alleviate substantial doubt about the Company’s ability to continue as
      going concern is comprised of two primary components. The first component is
      to
      increase revenue to a level where the Company will generate positive cash flow
      and be able to operate without additional financing. Management believe that
      the
      earliest the Company will reach a point of cash-flow breakeven on a monthly
      basis will be in the fourth quarter of 2007. It should be noted that while
      we
      are developing Generation III technology currently and plan to release prototype
      products based on Generation III technology in the calendar year 2007, our
      cash-flow breakeven forecast is not dependent on sales of Generation III
      products. The Company is currently shipping small quantities of products based
      on Generation II technology and management believes that production and sales
      of
      these products will increase sufficiently and that the gross margin on these
      products will enable the Company to achieve positive cash flow. Management
      estimates that we will have sufficient cash to sustain operations through the
      first quarter of 2007 without any additional financing.





At
      September 30, 2006 the Company had a working capital of $4,078,673. However,
      as
      a result of the ongoing negative cash flow that the Company is currently
      experiencing, Management expects to engage in additional capital raising, most
      likely over the next 6 months. We intend to raise between $5 million and $15
      million through an offering of securities. We are engaged in preliminary
      discussions with several sources of financing including investment bankers,
      institutional funds and strategic investors. The form of the capital financing
      may be equity, secured or unsecured debt, convertible debt or convertible
      preferred stock or other alternate forms of financing. There can be no assurance
      that the Company will be able to obtain this financing.





RESTATEMENT
      OF FINANCIAL STATEMENTS





The
      Company restated its financial statements as of and for the three and nine
      months ended September 30, 2006.  In addition, certain disclosures in the
      notes to the consolidated financial statements have been revised to reflect
      the
      restatement adjustments. We
      concluded that it was necessary to restate our financial results for the interim
      period ended September 30, 2006 to reflect additional non-operating losses
      related to the classification of and accounting for: (1) the conversion feature
      of our subordinated convertible notes payable issued in August 2005, the
      warrants to purchase common stock associated with these notes, and the
      amortization of the discount recorded with respect to the subordinated
      convertible note (see Note 7 for further discussion), (2) the note payable
      issued to Finisar Corporation for $6,000,000 for the license termination, (3)
      the modification of warrants held by investors in our Senior Secured Notes
      Payable, and (4) common stock issued to a consultant for services rendered
      in
      the three months ended June 30, 2006.





**Embedded
      Derivatives**





We
      initially classified the value of the conversion features and warrants to
      purchase common stock related to the issuance of our subordinated secured
      convertible notes payable in the equity section of the balance sheet. In
      September 2006, we analyzed these instruments and determined they should be
      treated as derivative liabilities subject to FAS 133, “Accounting for Derivative
      Instruments and Hedging Activities.” In filing our Amendment No. 2 to our
      registration statement on Form SB-2, we restated our previous December 31,
      2005
      financial statements and accounted for these instruments as derivatives and
      recorded changes in the fair value of these instruments in the consolidated
      statement of operations as “gain (loss) on change in fair value of embedded
      derivatives.”





In
      December 2006, the Company reevaluated the features of these instruments, and
      determined that the initial accounting treatment was appropriate as the
      instruments are to be settled in shares and fulfill the conditions set forth
      in
      EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and
      Potentially Settled in, a Company’s Own Stock.” According to paragraphs 12
      through 32 of EITF 00-19 these instruments are not derivative liabilities,
      based
      on the analysis, principally because they are convertible into unregistered
      common shares, we have sufficient authorized shares available for conversion,
      there is a fixed maximum shares that required to be issued and there are no
      provisions that could require cash settlement. Therefore, these derivative
      instruments are accounted for in the equity section of the balance sheet. We
      have restated our balance sheet and statement of operations for the nine months
      ended September 30, 2006 to adjust for this. The December 31, 2005 financial
      statements reflect the original accounting treatment as previously audited
      and
      reported.





**License
      Termination Fee**





We
      executed an agreement effective as of September 18, 2006 with Finisar
      Corporation to terminate a previously existing license agreement dated September
      18, 2003 (“IP License Agreement”). As consideration for termination of the IP
      License Agreement, we issued to Finisar a $6,000,000 secured note payable (see
      Note 7).





Based
      on
      our historical relationship with Finisar since 2001, and their substantial
      equity ownership in our Company, we originally accounted for this transaction
      as
      a deemed distribution of equity to Finisar at September 30, 2006. Upon further
      review of this transaction, we have determined that this transaction should
      have
      been expensed in the period in which it was incurred. Accordingly, we have
      restated our results for the nine months ended September 30, 2006 to recognize
      this expense.




8





**Modification
      of Warrants**





In
      the
      second quarter of 2004, we issued 2,437,500 warrants to purchase common stock
      to
      various lenders as part of a senior secured two-year note transaction. The
      exercise price of each warrant was initially $3.75. In the second quarter of
      2005, approximately $2.1 million of the $2.4 million outstanding balance of
      the
      note was extended for an additional year. In January 2006, we adjusted the
      exercise price of 2,325,000 of these warrants upon the closing of the
      Brookstreet Tranche I offering. We have recorded a loan discount of $744,000
      in
      the nine months ended September 30, 2006 to record the difference in the value
      of the warrants immediately prior to the modification and the value of the
      warrants following modification. Interest expense includes $393,882 related
      to
      amortization of this discount.





The
      accompanying financial statements for the nine months ended September 30, 2006
      have been restated to effect the changes described above. The impact of these
      adjustments are summarized below:





**Changes
      to Statement of Operations:**




For
                the nine months ended
            
            For
                the nine months endedSeptember
                30, 2006
            
            September
                30, 2005Net
                LossAs
                previously reported
            
            $
            (9,038,663
            )
            $
            (5,809,509
            )Remove
                gain on embedded derivative
            
            
            (788,000
            )
            
            (12,000
            )Additional
                interest expense as a result of warrant modification
            
            
            (393,882
            )
            
            —Remove
                additional offering expense associated with embedded
                derivative
            
            
            —
            
            
            188,000Lower
                amortization of loan discount
            
            
            261,600
            
            
            38,033License
                Termination Fee
            
            
            (6,000,000
            )
            
            —As
                restated
            
            $
            (15,958,945
            )
            $
            (5,595,476
            )Loss
                per shareAs
                previously reported
            
            $
            (0.31
            )
            $
            (0.47
            )Recognition
                of adjustments
            
            
            (0.24
            )
            
            0.02As
                restated
            
            $
            (0.55
            )
            $
            (0.45
            )




**Changes
      to Balance Sheet:**





September
                30, 2006 Previously Reported
            
            Adjustments
            
            September
                30, 2006 As RestatedCurrent
                Liabilities
            
            $
            2,751,611
            
            $
            (1,041,429
            )(A)
            $
            1,710,182Long
                term debt less current portion
            
            
            6,160,564
            
            
            553,356
            (B)
            
            6,713,920Total
                Liabilities
            
            
            8,912,175
            
            
            (488,073
            )
            
            8,424,102Stockholders’
                EquityCommon
                stock
            
            
            38,559
            
            
            —
            
            
            38,559Additional
                paid in capital
            
            
            43,146,254
            
            
            6,977,600
            (C)
            
            50,123,854Accumulated
                deficit
            
            
            (42,283,204
            )
            
            (6,489,527
            )(D)
            
            (48,772,731
            )Total
                Stockholders’ Equity
            
            
            901,609
            
            
            488,073
            
            
            1,389,682Total
                liabilities & stockholders’ equity
            
            $
            9,813,784
            
            $
            —
            
            $
            9,813,784







(A)
            Represents
                the sum of $800,000 decrease for fair value of embedded derivative,
                additional senior secured loan discount of $431,118, less $189,689
                net
                decrease in subordinated secured convertible loan discount(B)
            Represents
                an $814,956 decrease in loan discount less $261,600 less amortization
                of
                loan discount(C)
            Represents
                the sum of $233,600 value of the loan discount, $6,000,000 license
                termination fee originally charged to paid in capital, and $744,000
                value
                of warrant modification(D)
            Represents
                the sum of $120,000 eliminate recognition of loss on embedded derivative
                2005, $122,755 lower amortization of loan discount in 2005, $188,000
                value
                of embedded derivative over loan amount charged to offering expense
                in
                2005, $261,600 lower amortization of subordinated secured loan discount,
                less $788,000 elimination of recognition of gain on embedded derivative,
                less $393,882 additional amortization of senior secured loan discount,
                and
                less $6,000,000 license termination
                fee




9




The
      net
      loss, loan discount, license termination fee, warrant modification, and loss
      on
      change in fair value of embedded derivative line items in the consolidated
      statements of cash flows for the nine months ended September 30, 2006 has been
      adjusted to reflect the restatements; however, cash flows from operating,
      investing and financing activities were unaffected by the
      restatement.





**Consultant
      Shares**





In
      addition to the adjustments presented above, the year-to-date totals reflect
      the
      following adjustment incurred in the six months ended June 30, 2006.





On
      April
      3, 2006 we entered into an agreement with a consultant to provide services
      to us
      over a one year period. As compensation for the services to be provided, we
      issued 1.2 million shares of common stock to the consultant. In accordance
      with
      EITF 96-18, "Accounting For Equity Instruments That Are Issued To Other
      Than Employees for Acquiring, or in Conjunction with Selling, Goods and
      Services," we valued the shares at grant date and determined the value of
      the shares issued based upon the current price of the sales of common stock,
      which was approximately $1.25 per share. These shares were accounted for as
      deferred compensation at the time of issuance to be expensed over the term
      of
      the contract. In September 2006, we re-evaluated the accounting treatment of
      the
      shares granted to the consultant and determined that in accordance with EITF
      00-18, "Accounting Recognition for Certain Transactions involving Equity
      Instruments Granted to Other Than Employees," the full value of the shares
      should have been expensed at June 30, 2006 since the shares were fully
      vested and non-forfeitable on the date of issuance. In order to reflect this
      change, we restated our financial statements for the period ending June 30,
      2006
      to remove the deferred compensation value of these shares on our balance sheet
      and record the expense for the full value of these shares in our consolidated
      statement of operations. This non-cash expense is included within our General
      and Administrative expenses for the nine months ended September 30, 2006.




NOTE
      2 -
  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Cash
      and Cash Equivalents





Cash
      and
      cash equivalents include unrestricted deposits and short-term investments with
      an original maturity of three months or less.





Inventory





Inventory
      is valued at lower of cost or market using the first-in, first-out
      method.


10




NOTE
      2
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)




Property
      and Equipment




Property
      and equipment are stated at cost, less accumulated depreciation. Depreciation
      is
      provided for using the straight-line method over the estimated useful lives
      of
      the assets, which range from 3 to 6 years. Leasehold improvements are amortized
      over the lesser of the remaining lease term, including renewal periods, or
      the
      useful life of the asset.





Impairment
      of Long-Lived Assets




On
      January 1, 2002, the Company adopted the provisions of SFAS No. 144, “Accounting
      for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses
      financial accounting and reporting for the disposal of long-lived assets and
      supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and
      for Long-Lived Assets to be Disposed of.” The adoption of this statement did not
      have a material effect on the Company’s results of operations or financial
      condition.




Management
      regularly reviews property, equipment and other long-lived assets for possible
      impairment. This review occurs quarterly, or more frequently, if events or
      changes in circumstances indicate the carrying amount of the asset may not
      be
      recoverable. If there is indication of impairment , then management prepares
      an
      estimate of future cash flows (undiscounted and without interest charges)
      expected to result from the use of the asset and its eventual disposition.
      If
      these cash flows are less than the carrying amount of the asset, an impairment
      loss is recognized to write down the asset to its estimated fair value.
      Management believes that the accounting estimate related to impairment of its
      property and equipment, is a “critical accounting estimate” because: (1) it
      is highly susceptible to change from period to period because it requires
      management to estimate fair value, which is based on assumptions about cash
      flows and discount rates; and (2) the impact that recognizing an impairment
      would have on the assets reported on our balance sheet, as well as net income,
      could be material. Management’s assumptions about cash flows and discount rates
      require significant judgment because actual revenues and expenses have
      fluctuated in the past and are expected to continue to do so.





Deferred
      Stock Offering Costs




The
      Company capitalizes costs incurred related to its offering of common stock
      until
      such time as the stock is issued, or the stock offering is abandoned by the
      Company. These costs include specific incremental costs directly related to
      its
      stock offering. At December 31, 2005, deferred offering costs were approximately
      $41,000 and were included in Other Assets. The offering associated with these
      costs concluded in 2006. Accordingly, these costs were charged to Additional
      Paid in Capital as of September 30, 2006.


11




NOTE
      2
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





Income
      Taxes





Current
      income tax expense is the amount of income taxes expected to be payable for
      the
      current year. A deferred income tax asset or liability is established for the
      expected future consequences of temporary differences in the financial reporting
      and tax bases of assets and liabilities. The Company considers future taxable
      income and ongoing, prudent and feasible tax planning strategies, in assessing
      the value of its deferred tax assets. If the Company determines that it is
      more
      likely than not that these assets will not be realized, the Company will reduce
      the value of these assets to their expected realizable value, thereby decreasing
      net income. Evaluating the value of these assets is necessarily based on the
      Company’s judgment. If the Company subsequently determined that the deferred tax
      assets, which had been written down, would be realized in the future, the value
      of the deferred tax assets would be increased, thereby increasing net income
      in
      the period when that determination was made.




Revenue
      Recognition




A
      portion
      of the Company’s revenues result from fixed-price contracts with U.S. government
      agencies. Revenues from fixed-price contracts are recognized under the
      percentage-of-completion method of accounting, generally based on costs incurred
      as a percentage of total estimated costs of individual contracts (“cost-to-cost
      method”). Revisions in contract revenue and cost estimates are reflected in the
      accounting period as they are identified. Provisions for the entire amount
      of
      estimated losses on uncompleted contracts are made in the period such losses
      are
      identified. No contracts were determined to be in an overall loss position
      at
      December 31, 2005 or September 30, 2006. In addition, the Company has certain
      cost plus fixed fee contracts with U.S. Government agencies that are being
      recorded as revenue is earned based on time and costs incurred. At December
      31,
      2005, there was no deferred revenue and approximately $10,774 of unbilled
      receivables related to these government contracts. At September 30, 2006 there
      was no deferred revenue and $42,744 of unbilled receivables related to these
      government contracts.


12




NOTE
      2
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





The
      Company recognizes revenues on product sales, other than fixed-price contracts,
      based on the terms of the customer agreement. The customer agreement takes
      the
      form of either a contract or a customer purchase order and each provide
      information with respect to the product or service being sold and the sales
      price. If the customer agreement does not have specific delivery or customer
      acceptance terms, revenue is recognized at the time of shipment of the product
      to the customer.





Management
      periodically reviews all product returns and evaluates the need for establishing
      either a reserve for product returns or a product warranty liability. As of
      September 30, 2006, management has concluded that neither a reserve for product
      returns nor a warranty liability is required.





Accounts
      receivable are reviewed for collectibility. When management determines a
      potential collection problem, a reserve will be established, based on
      management’s estimate of the potential bad debt. When management abandons all
      collection efforts it will directly write off the account and adjust the reserve
      accordingly.




Research
      and Development Costs




Research
      and development costs are charged to expense when incurred.




Management
      Estimates




The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      disclosure of contingent assets and liabilities at the date of the financial
      statements and the reported amounts of revenues and expenses during the
      reporting period. Actual results could differ from those
      estimates.


13




NOTE
      2
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)




Stock-Based
      Compensation




The
      Company periodically issues stock options and warrants to employees and
      non-employees in non-capital raising transactions for services and for financing
      costs. The Company accounted for stock option and warrant grants issued and
      vesting to employees up through December 31, 2005 using the guidance SFAS No
      123, "Accounting for Stock-Based Compensation". The Company adopted SFAS No.
      123R effective January 1, 2006, and is using the modified prospective method
      in
      which compensation cost is recognized beginning with the effective date (a)
      based on the requirements of SFAS No. 123R for all share-based payments granted
      after the effective date and (b) based on the requirements of SFAS No. 123R
      for
      all awards granted to employees prior to the effective date of SFAS No. 123R
      that remain unvested on the effective date. The Company accounts for stock
      option and warrant grants issued and vesting to non-employees in accordance
      with
      EITF No. 96-18: "Accounting for Equity Instruments that are Issued to Other
      Than
      Employees for Acquiring, or in Conjunction with Selling, Goods or Services” and
      EITF 00-18 “Accounting Recognition for Certain Transactions involving Equity
      Instruments Granted to Other Than Employees” whereas the value of the stock
      compensation is based upon the measurement date as determined at either a)
      the
      date at which a performance commitment is reached, or b) at the date at which
      the necessary performance to earn the equity instruments is
      complete





As
      the
      exercise price of stock options and warrants issued to employees was not less
      than the fair market value of the Company's common stock on the date of grant,
      and in accordance with accounting for such options utilizing the intrinsic
      value
      method, there was no related compensation expense recorded in the Company's
      2005
      and 2004 consolidated financial statements. The fair value of stock options
      and
      warrants issued to officers, directors and employees at not less than fair
      market value of the Company's common stock on the date of grant was estimated
      using the Black-Scholes option-pricing model, and the effect on the Company's
      results of operations was shown in a pro forma disclosure
      as if such stock options and warrants had been accounted for pursuant to SFAS
      No. 123.





In
      December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
      No.
      123 (revised 2004), "Share Based Payment" ("SFAS No. 123R"), a revision to
      SFAS
      No. 123, "Accounting for Stock-Based Compensation". SFAS No. 123R superseded
      APB
      No. 25 and amended SFAS No. 95, "Statement of Cash Flows". Effective January
      1,
      2006, SFAS No. 123R requires that the Company measure the cost of employee
      services received in exchange for equity awards based on the grant date fair
      value of the awards, with the cost to be recognized as compensation expense
      in
      the Company's financial statements over the vesting period of the
      awards.





Accordingly,
      the Company recognizes compensation cost for equity-based compensation for
      all
      new or modified grants issued after December 31, 2005. In addition, commencing
      January 1, 2006, the Company recognized the unvested portion of the grant date
      fair value of awards issued prior to adoption of SFAS No. 123R based on the
      fair
      values previously calculated for disclosure purposes over the remaining vesting
      period of the outstanding stock options and warrants.




14




NOTE
      2
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





The
      Company adopted SFAS No. 123R effective January 1, 2006, and is using the
      modified prospective method in which compensation cost is recognized beginning
      with the effective date (a) based on the requirements of SFAS No. 123R for all
      share-based payments granted after the effective date and (b) based on the
      requirements of SFAS No. 123R for all awards granted to employees prior to
      the
      effective date of SFAS No. 123R that remain unvested on the effective
      date.





For
      the
      nine months ended September 30, 2006, the value of options vesting during the
      period was $183,093 and has been reflected as compensation cost. As of September
      30, 2006, the Company has unvested options of $1,685,678 which will be reflected
      as compensation cost in future periods as the options vest.





During
      the nine months ended September 30, 2005, the Company issued 672,000 stock
      options. The pro forma disclosure related to the issuance and vesting of
      these options is as follows :





Nine
                months
              ended
              September
                30,
              2005Net
                loss as reported
            
            $
            (5,809,509
            )Stock
                based compensation
            
            
            (588,360
            )Pro
                forma loss
            
            $
            (6,397,869
            )Pro
                forma net loss per share, basic and diluted
            
            $
            (.52
            )




The
      assumptions used in calculating the fair value of the options granted during
      2005, using the Black-Scholes option pricing model were: risk free interest
      rate, 4.47%, expected life, 10 years, expected volatility 70%, no expected
      dividends.


15




NOTE
      2
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





Fair
      Value of Financial Instruments





The
      recorded values of cash, accounts receivable, accounts payable and other current
      liabilities approximate their fair values based on their short-term nature.
      The
      carrying amount of the notes payable and long term debt at December 31, 2005
      and
      September 30, 2006 approximates fair value because the related effective
      interest rates on the instruments approximate rates currently available to
      the
      Company.





Concentration
      of Credit Risk





Financial
      instruments that potentially subject the Company to concentrations of credit
      risk consist primarily of cash and cash equivalents placed with high credit
      quality institutions and account receivable due from government agencies. The
      Company places its cash and cash equivalents with high credit quality financial
      institutions. From time to time such cash balances may be in excess of the
      FDIC
      insurance limit of $100,000.





Capitalized
      Loan Fees





Capitalized
      loan fees consist of legal fees and other direct costs incurred in obtaining
      the
      loans as described in Notes 6 and 7, and are amortized over the life of the
      loans using the effective interest method.





Loss
      per Common Share





Basic
      loss per share is calculated by dividing net loss available to common
      stockholders by the weighted average number of common shares outstanding during
      the period. Weighted average number of shares outstanding have been
      retroactively restated for the equivalent number of shares received by the
      accounting acquirer as a result of the Exchange transaction as if these shares
      had been outstanding as of the beginning of the earliest period presented.
      The
      4,166,378 shares issued to the legal acquirer are in included in the weighted
      average share calculation from May 12, 2006, the date of the exchange
      agreement.





Diluted earnings
      per share is calculated assuming the issuance of common shares, if dilutive,
      resulting from the exercise of stock options and warrants. As the Company had
      a
      loss in the three and nine month periods ended September 30, 2006 and 2005,
      common share equivalents were not used to calculate diluted loss per share
      because the results would be anti-dilutive. Therefore, basic and diluted
      loss per share are the same. At September 30, 2006 and 2005, potentially
      dilutive securities consisted of outstanding common stock purchase warrants
      and
      stock options to acquire an aggregate of 11,375,047 and 5,684,181 shares,
      respectively.





Accounting
      for Derivative Instruments





Statement
      of Financial Accounting Standard (“SFAS”) No. 133, “Accounting for Derivative
      Instruments and Hedging Activities,” as amended, requires all derivatives to be
      recorded on the balance sheet at fair value. In September 2000, the Emerging
      Issues Task Force (“EITF”) issued EITF 00-19, “Accounting for Derivative
      Financial Instruments Indexed to and Potentially Settled in, a Company’s Own
      Stock,” (“EITF 00-19”) which requires freestanding contracts that are settled in
      a company’s own stock, including common stock warrants, to be designated as an
      equity instrument, asset or a liability. Under the provisions of EITF 00-19,
      a
      contract designated as an asset or a liability must be carried at fair value
      on
      a company’s balance sheet, with any changes in fair value recorded in the
      company’s results of operations. These derivatives, including embedded
      derivatives in our subordinated notes, are separately valued and accounted
      for
      on our balance sheet, and revalued at each reporting period. The net change
      in
      the value of embedded derivative liability is recorded as income or loss on
      derivative instruments in the consolidated statement of operations, included
      in
      other income.


16




NOTE
      2
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





Recent
      Accounting Pronouncements





In
      February 2006, the FASB issued SFAS 155 Accounting for Certain Hybrid Financial
      Instruments, an amendment of SFAS 133 and 140. These SFAS’s deal with derivative
      and hedging activities, accounting for transfers and servicing of financial
      instruments and extinguishment of liabilities. SFAS 155 is effective for all
      financial instruments acquired or issued in an entity’s first fiscal year
      beginning after September 15, 2006. The Company does not engage in the
      activities described in these SFAS’s and does not have any intention of engaging
      in those activities when SFAS 155 becomes effective. The Company has evaluated
      the impact of the adoption of SFAS 155, and does not believe the impact will
      be
      significant to the Company's overall results of operations or financial
      position.





In
      September 2006, the Financial Accounting Standards Board ("FASB") issued
      Statement of Financial Accounting Standards No. 157, "Fair Value Measurements"
      ("SFAS No. 157"), which establishes a formal framework for measuring fair value
      under GAAP. SFAS No. 157 defines and codifies the many definitions of fair
      value
      included among various other authoritative literature, clarifies and, in some
      instances, expands on the guidance for implementing fair value measurements,
      and
      increases the level of disclosure required for fair value
      measurements.





Although
      SFAS No. 157 applies to and amends the provisions of existing FASB and AICPA
      pronouncements, it does not, of itself, require any new fair value measurements,
      nor does it establish valuation standards. SFAS No. 157 applies to all other
      accounting pronouncements requiring or permitting fair value measurements,
      except for: SFAS No. 123(R), share-based payment and related pronouncements,
      the
      practicability exceptions to fair value determinations allowed by various other
      authoritative pronouncements, and AICPA Statements of Position 97-2 and 98-9
      that deal with software revenue recognition. SFAS No. 157 is effective for
      financial statements issued for fiscal years beginning after November 15, 2007,
      and interim periods within those fiscal years.




In
      June
      2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty
      in
      Income Taxes, an interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48
      provides criteria for the recognition, measurement, presentation and disclosure
      of uncertain tax positions that has an effect on a company's financial
      statements accounted for in accordance with SFAS No. 109, "Accounting for Income
      Taxes", as a result of positions taken or expected to be taken in a company's
      tax return. A tax benefit from an uncertain position may be recognized only
      if
      it is "more likely than not" that the position is sustainable based on its
      technical merits. The provisions of FIN 48 are effective for fiscal years
      beginning after December 15, 2006. The Company is currently evaluating the
      potential effect that the adoption of FIN 48 will have on the Company's
      financial statement presentation and disclosures.


17




NOTE
      3
      INVENTORY




Inventory
      consists of the following:




September
                30, 2006
            
            December
                31,
              2005(Unaudited)Raw
                materials
            
            $
            452,523
            
            $
            441,800Work
                in process
            
            
            49,812
            
            
            —Reserve
                for slow moving and obsolescence
            
            
            (22,701
            )
            
            (22,701
            )$
            479,634
            
            $
            419,099




NOTE
      4
  LICENSE TERMINATION




In
      August
      2001, Finisar Corporation acquired 1,756,480 shares of Series A Preferred stock
      for $5 million in our first round of equity financing. In addition to Finisar’s
      equity investment, they made a five-year term loan to us for $7 million, closing
      in two tranches between August 2001 and January 2002. The total investment
      of
      Finisar was $12 million including the preferred equity and debt. In January
      2002, $45,500 of accrued interest was added to the balance of the loan. Through
      September 18, 2003, the Company paid $1,996,225 of principal on the loan to
      Finisar. On September 18, 2003, Finisar converted the $5,049,275 remaining
      principal balance on their term loan into 1,618,883 shares of our Series B
      Preferred Stock by executing an Exchange Agreement with the Company. During
      2006, Finisar received 3,375,363 shares of common stock as a result of a stock
      dividend (see note 9). The 1,756,480 shares of Series A Preferred stock and
      1,618,883 shares of Series B Preferred were ultimately exchanged for 3,375,363
      shares of our common stock in the reverse merger transaction. As a result of
      the
      share dividend and the share exchange, Finisar ultimately held 6,750,726 shares
      of our common stock. At September 30, 2006 Finisar held 6,750,726 shares of
      our
      common stock.





Pursuant
      to the terms of the Exchange Agreement with Finisar, we granted Finisar a
      royalty free, fully paid, nonexclusive license to all of our existing and future
      intellectual property (the "IP License"). In addition, the Company granted
      Finisar favorable pricing assurances with respect to all Company products.
      Under
      terms contained in the original exchange agreement, the Company executed an
      agreement with Finisar Corporation to terminate the previously existing license
      agreement effective as of September 18, 2006. As consideration for terminating
      the IP License agreement, the Company issued to Finisar a $6,000,000 secured
      note payable (see Note 7). The value of the note was recognized as a license
      termination fee in September 2006 and is reflected in the accompanying
      consolidated statement of operations.


18




NOTE
      5
      PROPERTY AND EQUIPMENT





Property
      and equipment consist of the following:




September
                30, 2006
            
            December
                31,
              2005
            
            Useful
              Lives(Unaudited)Computer
                software
            
            $
            65,049
            
            $
            61,807
            
            
            3
                yearsFurniture
                and fixtures
            
            
            121,558
            
            
            103,180
            
            
            6
                yearsComputer
                equipment
            
            
            132,319
            
            
            118,036
            
            
            3
                yearsOffice
                equipment
            
            
            69,362
            
            
            69,362
            
            
            6
                yearsLab
                and manufacturing equipment
            
            
            4,667,367
            
            
            4,305,775
            
            
            6
                yearsLeasehold
                improvements
            
            
            3,790,569
            
            
            3,788,949
            
            
            14
                years8,846,224
            
            
            8,447,109Less
                accumulated depreciation and amortization
            
            
            (4,962,708
            )
            
            (4,056,090
            )Property
                and equipment, net
            
            $
            3,883,516
            
            $
            4,391,019




Depreciation
      and amortization expense related to property and equipment amounted to $906,619
      and $996,642 respectively for the nine months ended September 30, 2006 and
      2005.


19




NOTE
      6
      NOTE PAYABLE RELATED PARTIES




Notes
      payable related parties is as follows:




September
                30, 2006
            
            December
                31, 2005(Unaudited)Notes
                payable related parties
            
            $
            —
            
            $
            500,000Loan
                discount
            
            $
            —
            
            
            (156,800
            )$
            —
            
            $
            343,200




The
      Company was indebted to the Chairman of the Board of Directors and the Chief
      Financial Officer of Company under a $500,000 note agreement entered into in
      November 2005. The note was due January 2006, was extended to April 25, 2006,
      and was paid in April 2006. Until the note was repaid, monthly interest only
      payments were required. The interest rate was 10% per annum. The note was
      secured by all the assets of the Company. The amount outstanding at December
      31,
      2005 was $500,000. The Company paid a $25,000 loan origination fee to the
      related parties in accordance with the note agreement. As part of the original
      loan agreement, the Company granted to the note holders warrants to purchase
      320,000 shares of common stock. These warrants were valued at $0.98 per warrant
      using the Black-Scholes option pricing model. The assumptions used in the model
      were: risk free interest rate, 4.47, expected life,10 years, expected
      volatility,70%, no expected dividends. Accordingly, the Company recorded a
      loan
      discount of $313,600 which the Company amortized to interest expense over the
      original life of the loan, of which $156,800 was amortized during the year
      ending December 31, 2005. The remaining balance of $156,800 was fully amortized
      as of September 30, 2006 and is reflected as interest expense in the
      accompanying statement of operations. The Company issued 900,000 warrants to
      the
      note holders in 2006 as consideration for extending the original due date of
      the
      note from January 2006 to April 2006. The value of these warrants, approximately
      $716,000 was charged to interest expense during the nine months ended September
      30, 2006. These warrants were valued using the Black-Scholes option pricing
      model. The assumptions used in the model were: risk free interest rate, 4.59%
      and 4.67%, expected life, 5 years, expected volatility, 70%, no expected
      dividends. Different interest rates were used because the warrants were issued
      on different days.


20




NOTE
      7
      NOTES PAYABLE





As
      of
      December 31, 2005, long term debt consist of the following:




Loan
              Balance
            
            Loan
              Discount
            
            Current
              Portion
            
            Non
                current
              Portion(a)
                Senior Secured Notes
            
            $
            2,125,797
            
            $
            (506,940
            )
            $
            1,396,218
            
            $
            222,639(b)
                Subordinated Secured Convertible Notes
            
            
            1,280,000
            
            
            (214,133
            )
            
            —
            
            
            1,065,867$
            3,405,797
            
            $
            (721,073
            )
            $
            1,396,218
            
            $
            1,288,506




As
      of
      September 30, 2006 notes payable consist of the following
      (Unaudited):





Loan
              Balance
            
            Loan
              discount
            
            Current
              portion
            
            Non
                current
              Portion(a)
                Senior Secured Notes
            
            $
            1,152,917
            
            $
            (588,678
            )
            $
            564,239
            
            $
            —(b)
                Subordinated Secured Convertible Notes
            
            
            1,280,000
            
            
            (155,733
            )
            
            108,689
            
            
            1,015,578(c)
                Finisar Secured Note
            
            
            6,000,000
            
            
            -
            
            
            301,658
            
            
            5,698,342$
            8,432,917
            
            $
            (744,411
            )
            $
            974,586
            
            $
            6,713,920




21





NOTE
      7
      NOTES PAYABLE (CONTINUED)





(A)
            Senior
                Secured Notes Payable





During
      2004, the Company issued $3,250,000 of notes payable to Investors. The term
      of
      the notes are 24 months, bearing interest at 10% per annum, with no principal
      and interest payments required for the initial 3 months. The remaining 21 months
      required principal and interest payments sufficient to pay the loan in full
      at
      the end of 24 months. The notes are secured by all of the assets of the Company,
      including its intellectual property. The notes have 1 warrant for every $1.33
      of
      principal, with each warrant being exerciseable into 1 share of common stock
      at
      $3.75 per share. The warrants are fully vested and have a 6 year term. The
      Company determined there was no accounting value to be assigned to the warrants
      at the date of issuance, based on a calculation using an option pricing model.
      In January 2006, we adjusted the exercise price of 2,325,000 of these warrants
      to $1.25 upon the closing of the Brookstreet Tranche I offering. The Company
      has
      recorded the difference in the value of the warrants immediately prior to the
      modification and the value of the warrants following modification of $744,000
      as
      additional loan discount to be amortized over the remaining life of the loan.
      Interest expense includes $393,882 related to the amortization of this discount
      during the nine months ended September 31, 2006. Of the total notes above,
      $2,500,000 was subscribed to by a limited partnership of which an officer of
      the
      Company is an owner, of which $1,875,718 and $1,029,391 was outstanding as
      of
      December 31, 2005 and September 30, 2006 respectively. On October 31, 2004,
      $300,000 of the principal and $13,183 accrued interest was converted into 83,380
      shares of common stock.





During
      2005, five of the seven note holders agreed to modify the terms of their notes.
      The modifications include deferring principal payments from April 2005 to March
      2006, thereafter principal payments will commence until the notes are fully
      paid
      in May 2007. As of September30 2006, the required monthly principal and interest
      payments are $149,571. In addition, 840,000 warrants were issued to the five
      note holders who elected to defer principal payments on their loans. The
      warrants were valued at $0.71 a warrant or $596,400, using an option pricing
      model and were reflected as a loan discount amount, which is netted against
      the
      loan principal balance. The assumptions used in the model were: risk free
      interest rate, 4.41%, expected life, 4.66 years, expected volatility, 70%,
      no
      expected dividends. The loan discount fee is being amortized over the remaining
      life of the loan. Interest expense includes $89,460 and $268,380 related to
      the
      amortization of this discount during the year ended December 31, 2005 and the
      nine months ended September 30, 2006, respectively. The effective interest
      rate
      on these loans, giving effect for the modified terms and the loan discount
      is
      24.4%.





(B)
            Subordinated
                Secured Convertible Notes
                Payable




During
      2005, the Company issued $1,280,000 of subordinated, secured notes to 9 note
      holders. The terms of the notes include interest only payments for 24 months,
      thereafter the loans will be paid in full over the next twelve months. The
      loans
      are secured by all the assets of the Company but take a secondary position
      to
      the Senior Secured Notes above. The interest rate on the loans is 10%. The
      loans, at the option of the note holder, may be extended an additional three
      years, with the same terms as the original three year period. If the note
      holders elect to extend the loan, they will receive an additional 26,666
      warrants for every $100,000 loaned to the Company. The conversion feature which
      is in effect during the time the loan is outstanding, allows the note holder
      to
      convert outstanding principal and interest into common stock at a conversion
      price of $3.75. The conversion price is subject to downward revision upon the
      occurrence of certain stock offerings. The downward revision is subject to
      a
      floor of $0.90 and allows the note holder to convert at the price of the most
      recent stock offering. The conversion price was reduced to $1.25 as a result
      of
      the stock offerings discussed in Note 9.





The
      Company issued 320,000 warrants in connection with this debt offering during
      2005. The warrants were valued at $0.73 a warrant or $233,600, using an option
      pricing model and are reflected as a loan discount amount, which has been netted
      against the loan principal balance. The assumptions used in the model were:
      risk
      free interest rate, 4.41%, expected life, 5 years, expected volatility, 70%,
      no
      expected dividends. The loan discount fee is being amortized over the life
      of
      the loan. Interest expense includes $19,467 and $58,392 relating to the
      amortization of this discount during the year ended December 31, 2005 and the
      nine months ended September 30, 2006 respectively. The effective interest rate
      on these loans, giving effect for the modified terms and the loan discount
      is
      22%.





The
      Company has analyzed the terms of the conversion feature and warrants issued
      to
      the note holders and has determined that such features do not give rise to
      an
      embedded derivative as defined by SFAS 133 and EITF 00-19 as the instruments
      are
      not derivative liabilities based on the analysis principally because they are
      convertible into unregistered common shares, the Company has sufficient
      authorized shares available for conversion, there is a fixed maximum shares
      that
      required to be issued and there are no provisions that could require cash
      settlement.




22




NOTE
      7 NOTES PAYABLE (CONTINUED)




(C)
            Finisar
                Secured Note




During
      the nine months ended September 30, 2006, an agreement between Finisar and
      the
      Company to terminate the License Agreement dated September 18, 2003 became
      effective. As consideration for the termination of the license, the
      Company paid Finisar a $6 million fee by promissory note. Payment terms of
      the note require $1,000,000 of the principal together with interest thereon
      payable at the rate of 9.7% per annum, in thirty-six monthly installments,
      commencing on October 18, 2006. The remaining $5,000,000 of the principal shall
      be paid in full on September 18, 2009 and accrues interest at the rate of 9.7%
      per annum payable in arrears, on the 18th day of each calendar month commencing
      on October 18, 2006. The note is secured by substantially all of our assets
      and
      is subject to an inter-creditor agreement with the senior secured note holders
      (see A above).





NOTE
      8
      RECAPITALIZATION




On
      May
      12, 2006 QPC Lasers, Inc. (QLI) executed a Share Exchange Agreement by and
      among. Julie Moran, its majority shareholder, and Quintessence Photonics
      Corporation (QPC) and substantially all of its shareholders. Under the agreement
      QLI issued one share of its common stock to the QPC shareholders in exchange
      for
      each share of QPC common stock (QPC Shares). The transaction has been accounted
      for as a reverse merger (recapitalization) in the accompanying financial
      statements with QPC deemed to be the accounting acquirer, and. QLI deemed to
      be
      the legal acquirer. As such the historical stockholders’ equity of QPC has been
      retroactively restated for the equivalent number of shares received in the
      exchange after giving effect to any differences in the par value offset to
      additional paid in capital. Furthermore, the Series A, Series B, and Series
      C
      Preferred shares of QPC existing prior to the Share Exchange Agreement has
      been
      retroactively restated for the equivalent number of common shares received
      in
      the exchange.




23




NOTE
      8
      RECAPITALIZATION (CONTINUED)





All
      share
      and per share amounts have been retroactively restated as if the Exchange
      Agreement occurred at the beginning of the earliest period presented
      herein.





NOTE
      9
      STOCKHOLDERS’ EQUITY





Common
      Stock Issued





During
      the nine months ended September 30, 2006, the Company sold 9,436,577 shares
      of
      common stock at $1.25 per share for proceeds of $11,795,750. The cash costs
      associated with this offering was $2,334,452 resulting in net proceeds
      to the Company of $9,461,298. The underwriter also received 2,345,341
      warrants as compensation for the offering. The agreements relating to the
      purchased shares and warrants granted to the underwriter include registration
      rights; however no penalties shall accrue in the event such shares (including
      warrant shares) are not registered. The Company calculated the value of the
      warrants granted to the underwriter as $1,984,612 based on an option pricing
      model. The value of such warrants was treated as a cost of
      capital.




As
      part
      of these sales, the Company sold 572,526 units of equity instruments, at $5.00
      per unit, consisting of 2,290,104 common shares and one warrant to purchase
      common stock for $1.50 for gross proceeds of $2,862,630. The purchase and sale
      agreement of these units included a requirement that the Company register such
      shares and warrants, and that if such shares are not registered, a penalty
      of 1%
      per month would accrue. The Company determined that penalty on the registration
      rights would cause the Company to recognize a warrant liability For 60 days
      after the final closing of the Brookstreet offering until a registration has
      been filed with the Securities and Exchange Commission. As such, the Company
      determined that the fair value of warrant of $211,835 as calculated using an
      option pricing model should be established as a liability at the date of the
      agreement, and revalued the warrants at each reporting period. The Change
      in fair value of the warrants of $68,703 through September 18, 2006 is
      included in other income in the accompanying statement of operations for the
      nine months ended September 30, 2006. The Company filed a registration statement
      on September 18, 2006, and fulfilled its obligation under the share agreement.
      As such, a registration liability no longer existed to the company, and the
      value of the liability at September 18, 2006 was eliminated, increasing
      additional paid in capital by $68,703, the fair value of the warrant
      liability.




24




NOTE
      9
      STOCKHOLDERS’ EQUITY (CONTINUED)





During
      the nine months ended September 30, 2006, the Company issued 17,500 shares
      of
      common stock upon exercise of options, receiving net proceeds of $11,000. In
      addition, 2,500 shares of common stock were issued upon exercise of warrants
      for
      $3,750 of net proceeds.





The
      Company issued 1,200,000 shares of common stock to a consultant as compensation
      for services to be rendered. Fair value of the shares was determined to be
      $1.25
      a share based on the offering price per common share of the private placements
      which occurred, and was calculated to be $1,500,000. The value of these shares
      were charged to investor relations expense.





Stock
      Dividend





On
      an
      action by unanimous written consent of the QPC Board of Directors dated October
      10, 2005, QPC approved the procedure of obtaining commitments from its then
      existing preferred stockholders to ensure it had enough shareholders
      willing to exchange the shares of QPC for shares of a public reporting company
      to facilitate an anticipated reverse merger. As such, during 2005 the
      Company offered to its then existing preferred stockholders, at the
      stockholder’s election, the ability to receive one share of common stock for
      each share of preferred stock owned. In order for the stockholder to elect
      this
      offer, the stockholder gave its proxy and power of attorney to
      the management of QPC to exchange their shares pursuant to the anticipated
      reverse merger with a public company. As a result of this offer and acceptance
      by its then existing preferred stockholders, 7,160,111 shares of common stock
      was required to be issued by QPC. These shares were issued in 2006 and reflected
      as such in the accompanying statement of Stockholders' Equity.





QPC
      also
      offered to the then existing preferred C stockholders who took advantage of
      the
      offer mentioned in the above paragraph, in exchange for a signed proxy, the
      choice of adjusting the exercise price of their warrants from $3.75 to $1.25
      or
      to exchange their warrants for QPC common stock in the ratio of three shares
      of
      common stock for every four warrants held. There were 2,220,537 warrants
      outstanding prior to the offer. 1,997,788 of those warrants were exchanged
      for
      stock, leaving, 222,749 of warrants originally issued to preferred C
      stockholders. As a result of this offer, 1,498,311 shares of common stock were
      required to be issued by QPC. These shares were issued in 2006 and reflected
      as
      such in the accompanying statement of Stockholders' Equity.




The
      Company determined that the common stock to be issued to the preferred
      stockholders in exchange for their proxy should be accounted for as a stock
      dividend, with the value of the exchange being the fair value of the common
      stock to be issued. The fair value of $10,823,028 was determined based on
      the offering price of $1.25 per common share of the private placements which
      occurred subsequent to year end. As a result of the recapitalization referred
      to
      in Note 8, these financial statements reflect the dividend as a common stock
      dividend in the year ended December 31, 2005.




25




NOTE
      10
      STOCK OPTIONS AND WARRANTS





Stock
      Options





In
      July
      2001, QPC’s Board of Directors approved the 2001 Stock Option Plan (the “2001
      plan”) under which certain employees, directors, officers and independent
      contractors may be granted options to purchase up to an aggregate of 1,215,295
      shares of the Company’s common shares. In May 2004, the 2001 plan was amended to
      increase the number of options which may be granted to 2,555,295. The options
      vest over a four-year period. Upon the share exchange described in Note 1,
      these
      options were converted to options described in the next paragraph.





In
      May
      2006, QLI adopted the 2006 stock option plan (the 2006 plan) under which certain
      employees, directors, officers and independent contractors may be granted
      options to purchase up to an aggregate of 5,400,000 shares of the Company’s
      common shares. Option awards are generally granted with an exercise price equal
      to the market price of QLI stock on the date of grant. Vesting generally occurs
      on an award by award basis . The options may vest over a period not to exceed
      10
      years.





The
      fair
      value of each option award is estimated on the date of grant using the
      Black-Scholes option pricing model that uses the assumptions noted in the
      following table. Expected volatility is based on the volatilities of public
      entities which are in the same industry as QLI. For purposes of determining
      the
      expected life of the option, the full contract life of the option is used.
      The
      risk-free rate for periods within the contractual life of the options is based
      on the U. S. Treasury yield in effect at the time of the grant.





Nine
                months ended
              September
                30, 2006Expected
                volatility
            
            
            70
            %Weighted
                average volatility
            
            
            70
            %Expected
                dividends
            
            
            —Expected
                term (in years)
            
            
            10Risk
                free rate
            
            
            4.92%-5.05
            %




26




NOTE
      10
      STOCK OPTIONS AND WARRANTS (CONTINUED)





A
      summary
      of option activity as of September 30, 2006 and changes during the nine months
      then ended is presented below:





Options
            
            Shares
            
            Weighted-Average
              Exercise
                Price
            
            Weighted-Average
              Remaining
                Contractual
              Term
                (Years)
            
            Aggregate
              Intrinsic
              ValueOutstanding
                at January 1, 2006
            
            
            1,965,250
            
            $
            0.40Granted
            
            
            1,020,416
            
            $
            1.34Exercised
            
            
            (17,500
            )
            $
            0.63Forfeited
                or expired
            
            
            (49,583
            )
            $
            0.38Outstanding
                at September 30, 2006
            
            
            2,918,583
            
            $
            0.73
            
            
            8.12
            
            $
            2,605,127Exercisable
                at September 30, 2006
            
            
            1,991,916
            
            $
            0.41
            
            
            7.57
            
            $
            2,318,127




27




NOTE
      10
      STOCK OPTIONS AND WARRANTS (CONTINUED)





The
      weighted-average grant date fair value of options granted during 2005 and 2006
      was $1.01 and $0.99, respectively.





For
      the
      nine months ended September 30, 2006, the Company recorded compensation expense
      of $183,093 (Unaudited). The Company has unvested options which will require
      recognizing $1,685,678 of compensation expense in the years in which the
      unvested options vest.




Warrants




The
      Company generally issues warrants in connection with certain debt and equity
      offerings. All warrants issued immediately vest. The warrants allow the holder
      to purchase QLI common stock at an exercise price ranging from $1.25 to
      $3.75. 346,666 of the warrants outstanding allow for a modification of the
      exercise price. The modification is a downward revision subject to a floor
      of
      $0.90 and allows the warrant holder to exercise at the price of the most recent
      stock offering. The fair value of each warrant is estimated on the date of
      grant
      using the Black-Scholes option pricing model that uses the assumptions noted
      in
      the following table. Expected volatility is based on the volatilities of public
      entities which are in the same industry as QLI. For purposes of determining
      the
      expected life of the warrant, the full contract life of the warrant is used.
      The
      risk-free rate for periods within the contractual life of the warrants is based
      on the U. S. Treasury yield in effect at the time of the grant. Of the 8,456,464
      warrants outstanding at September 30, 2006, all but 572,526 warrants have a
      cashless exercise feature. The feature allows the warrant holder, at the
      election of the warrant holder, to receive an amount of stock equal to the
      stock
      the warrant holder is otherwise entitled to receive, multiplied by the amount
      the warrant is in-the-money, divided by the market price of the
      stock.





Nine
                months ended
              September
                30, 2006
            
            Year
                ended
              December
                31, 2005Expected
                Volatility
            
            
            86.6
            %
            
            70
            %Weighted
                Average Volatility
            
            
            86.6
            %
            
            70
            %Expected
                term (in years)
            
            
            3
            
            
            6Risk-free
                rate
            
            
            4.38%
                - 5.29
            %
            
            4.41
            %




28




NOTE
      10
      STOCK OPTIONS AND WARRANTS (CONTINUED)




A
      summary
      of warrant activity and changes during the nine months ended September 30,
      2006
      is presented below:





Warrants
            
            Shares
            
            Weighted-
              Average
              Exercise
              Price
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
                (Years)
            
            Aggregate
              Intrinsic
              ValueOutstanding
                at January 1, 2006
            
            
            4,514,431
            
            $
            2.53Granted
            
            
            3,944,533
            
            $
            1.30Exercised
            
            
            (2,500
            )
            $
            1.50Outstanding
                at September 30, 2006
            
            
            8,456,464
            
            $
            1.96
            
            
            3.66
            
            $
            2,778,131Exercisable
                at September 30, 2006
            
            
            8,456,464
            
            $
            1.96
            
            
            3.66
            
            $
            2,778,131


29






NOTE
      11
  INCOME TAXES




At
      December 31, 2005, the Company had available Federal and state net
      operating loss carryforwards to reduce future taxable income. The amounts
      available were approximately $20,000,000 for Federal and for state purposes.
      The
      Federal carryforward expires in 2025 and the state carryforward expires in
      2010.
      Given the Company’s history of net operating losses, management has determined
      that it is more likely than not the Company will not be able to realize the
      tax
      benefit of the carryforwards.




Accordingly,
      the Company has not recognized a deferred tax asset for this benefit. Upon
      the
      attainment of taxable income by the Company, management will assess the
      likelihood of realizing the tax benefit associated with the use of the
      carryforwards will recognize a deferred tax asset at that time.




Significant
      components of the Company’s deferred income tax assets are as
      follows:





September
                30, 2006
            
            December
                31,
              2005(Unaudited)Deferred
                income tax asset:Net
                operating loss carryforward
            
            
            9,900,000
            
            $
            6,800,000Valuation
                allowance
            
            
            (9,900,000
            )
            
            (6,800,000
            )Net
                deferred income tax asset
            
            $
            —
            
            $
            —




For
      the
      nine months ended September 30, 2006, management is evaluating the value of
      its
      carryforwards given the change of control which has occurred. Management does
      not believe the carrying value of the deferred tax asset will change materially
      for that presented above.





Reconciliation
      of the effective income tax rate to the U.S. statutory rate is as
      follows:





Nine
                Months Ended
              September
                30,
            
            Year
                Ended
              December
                31,2006
            
            2005
            
            2005
            
            2004Tax
                expense at the U.S. statutory income tax
            
            
            (34.00
            )%
            
            (34.00
            )%
            
            (34.00
            )%
            
            (34.00
            )%Increase
                in the valuation allowance
            
            
            34.00
            %
            
            34
            %
            
            34.00
            %
            
            34.00
            %Effective
                tax rate
            
            
            —
            %
            
            —
            %
            
            —
            %
            
            —
            %




30




NOTE
      12
  COMMITMENTS AND CONTINGENCIES




Operating
      Lease




On
      June
      1, 2001, the Company signed an operating lease for office, research and
      development, and manufacturing space. The lease term is 60 months beginning
      June
      1, 2001. The lease provides for two 5-year renewal terms. On August 22, 2005,
      the original lease was amended to extend the lease term to May 2016 and includes
      one 5 year renewal term for a final date of 2021. The Company also leases a
      vehicle under an operating lease. The Company has made a substantial investment
      in leasehold improvements based upon its ability to renew its lease for the
      periods shown above. The table below includes an estimate for estimated
      renewals.





The
      future minimum lease commitments are as follows as of December 31,
      2005:





Year
                Ended December 31
            
            Amount2006
            
            $
            279,5442007
            
            
            304,9572008
            
            
            304,9572009
            
            
            304,9572010
            
            
            304,957Thereafter
            
            
            1,651,851Total
                minimum lease payments
            
            $
            3,151,223




Rent
      expense for the years ended December 31, 2005 and 2004 was $321,018 and
      $322,768, respectively. For the nine months ended September 30, 2006 and 2005,
      rent expense was $225,144 and $198,991 (Unaudited), respectively.




During
      2005 and 2004, the Company subleased a portion of its leased office, research
      and development, and manufacturing space under three separate subleases. The
      three sublease terms were 24 months beginning January 8, 2003, a month-to-month
      beginning April 1, 2004, and a month-to-month that began in January 2002. The
      sublease which commenced January 8, 2003 has converted to a month-to-month
      lease
      beginning January 2006. Rental income for the nine months ended September 30,
      2006 and 2005 was $60,510 and $64,100, respectively. Rental income is included
      in other income.




31




NOTE
      12
  COMMITMENTS AND CONTINGENCIES (CONTINUED)





Employee
      Benefit Plan




The
      Company established a defined contribution plan allowing eligible employee
      income deferrals as permitted by Section 401 (k) of the Internal Revenue Code
      effective January 1, 2002. This plan covers substantially all full-time
      employees after minimum service requirements are met. The Company contributes
      a
      percentage of participants’ cash contribution subject to certain limits.


32




**Item
      2. Management’s Discussion and Analysis of Financial Condition and Results of
      Operations**





**FORWARD
      LOOKING STATEMENTS**





This
      report contains statements that involve expectations, plans or intentions (such
      as those relating to future business or financial results, new features or
      services, or management strategies). These statements are forward-looking and
      are subject to risks and uncertainties, so actual results may vary materially.
      You can identify these forward-looking statements by words such as may,” 
“should,”  “expect,”  “anticipate,”  “believe,”  
“estimate,”  “intend,”  “plan” and other similar expressions. You
      should consider our forward-looking statements in light of the risks discussed
      under the heading “Risk Factors That May Affect Results of Operations and
      Financial Condition” below, as well as our financial statements, related notes,
      and the other financial information appearing elsewhere in this report and
      our
      other filings with the Securities and Exchange Commission. *Our
      actual results could differ materially from those anticipated in these
      forward-looking statements as a result of certain factors, including but not
      limited to those set forth under “Risk factors” and elsewhere in this Form
      10QSB* We
      assume no obligation to update any forward-looking statements.




**Overview**





**Background**





Quintessence
      Photonics Corporation (“QPC”), a wholly owned subsidiary of QPC Lasers, Inc, has
      high power laser diode technology platforms that combine high beam quality
      and
      power with high efficiencies and low cost of manufacture that management
      believes are unmatched by competing laser technology. These platforms include
      a
“Surface Emitting Array” technology that permits fabrication of complete high
      power arrays on a single chip, novel processes for fabricating diodes that
      are
      intended to operate at 300% of the power of conventional chips without burning
      out, and laser diode designs that have ten times (10x) the brightness of
      conventional diode lasers. These technologies are protected by patents and
      by
      trade secrets, as appropriate.





We
      were
      incorporated in November 2000 by Jeffrey Ungar, Ph.D. and George Lintz, MBA
      (the
“Founders”). The Founders began as entrepreneurs in residence with DynaFund
      Ventures in Torrance, California and wrote the original business plan during
      their tenure at DynaFund Ventures from November 2000 to January 2001. The
      business plan drew on Dr. Ungar’s 17 years of experience in designing and
      manufacturing semiconductor lasers and Mr. Lintz’s 15 years of experience in
      finance and business; the primary objective was to build a state of the art
      wafer fabrication facility and hire a team of experts in the field of
      semiconductor laser design.





On
      May
      12, 2006 and June 13, 2006, the shareholders of QPC entered into Share Exchange
      Agreements with QPC Lasers, Inc. (“QPCI”) in which all of the shareholders of
      QPC exchanged their shares, warrants and options for shares warrants and options
      of QPCI. QPCI was a public reporting company; QPC Lasers was the resulting
      entity from the share exchange. The term “Company” refers to QPC Lasers or QPC
      as the context requires.





With
      the
      proceeds of the initial financings, the Founders recruited three scientists
      who
      had previously worked for Dr. Ungar to form the core of our chip design team.
      We
      entered into a lease on an industrial building in Sylmar, California, and
      proceeded to customize the facility, outfitting it with a unique set of
      semiconductor growth and processing equipment.





The
      founders and initial investors believed that the potential laser diode
      technology that could be developed would be robust and our success would not
      be
      dependent on a single market. Our originally targeted market was fiber optic
      telecommunications. As it became clear within the first two years of operations
      that the telecommunication market was experiencing an economic slump, we
      investigated numerous markets that could benefit from our laser diode
      technology. The Founders and the Board of Directors selected high power laser
      manufacturing for applications in the materials processing industry because
      of
      its mature market size of over one billion dollars per year. Our market research
      determined that we would have compelling competitive advantages in the materials
      processing market, printing and medical markets, and that the burgeoning
      defense/homeland security laser market had significant areas of technology
      overlap with the industrial materials processing market.


33




In
      the
      first calendar quarter of 2003, we decided on a course to: (a) pursue the
      materials processing and defense/homeland securities market as long term target
      markets (with development of our Generation III products); (b) initiate a market
      presence by offering Generation I products which are in “form, fit and function”
the same as other available products, but with higher reliability; (c) develop
      Generation II products which are form and fit the same as other available
      products, but with *much
      higher functionality* ; and
      (d) use U.S. Government development funds to subsidize the development of our
      commercial products. We released our Generation I products in the second quarter
      of 2004 and released some of our Generation II products in the fourth quarter
      of
      2005 through the third quarter of 2006. Some Generation III prototypes are
      expected during the Calendar Year 2007. Generation I & II products have been
      sold to customers in the medical, printing, and defense industries.




We
      have
      used government development funds to subsidize product development. We were
      awarded four Phase I “Small Business Innovation Research” contracts and three of
      them have progressed to Phase II contracts. In general, these types of contracts
      are cancelable and in some cases include multiple phases associated with meeting
      technical milestones. In the second quarter of 2006, we signed a sub-contract
      as
      part of a team working on a project for the Defense Advance Research Project
      Agency (“DARPA”). Our portion of the DARPA contract is $3.1 million and is to be
      carried out in two phases over three years. This contract will fund development
      of semiconductor lasers to be used for Directed Energy Weapons; and the
      technology overlaps our development of lasers for the industrial materials
      processing markets. DARPA funds very advanced technology research and
      development that could be used in the future as part of defense systems for
      the
      United States. Management believes that QPC’s contract award is very significant
      because of its size and the validation that QPC is considered a resource for
      very advanced technology.





In
      the
      second quarter of 2006, QPC was also awarded a subcontract as part of a team
      working on a project for the United States Missile Defense Agency to develop
      lasers that emit mid-infrared wavelengths. Management believes that upon
      successful development of these diode lasers, the United States will be able
      to
      use them in defense of military and commercial aircraft, as part of a system
      for
      infrared countermeasures against heat seeking missiles. We also believe that
      they will enable the creation of compact and affordable systems for detection
      of
      biochemical agents in public places. The contract is a Phase III follow-on
      contract from an earlier contract that QPC completed and demonstrated the early
      phases of feasibility of the technology. The Phase III contract amount is
      $800,000 and is to be performed over twelve months.





The
      United States Army Research Laboratory awarded a Phase II development contract
      to QPC in the first quarter of 2006 and QPC began performing under this contract
      in the second quarter of 2006. The contract is a follow-on contract from an
      earlier contract with the same customer in which QPC demonstrated its ability
      to
      develop diode lasers that emit wavelengths that are safer to the human eye
      than
      conventional high power diode wavelengths. Management believes that upon
      successful completion of the development, these lasers will be used in both
      military and commercial systems to limit accidental damage to human eyes that
      could be caused to system operators, friendly forces, and bystanders. The Army
      contract amount is $673,028 and is to be performed by March 2008.





In
      addition to U.S. Government funds, we have received development funds from
      U.S.
      prime defense contractors as well as a major foreign military contractor. The
      funds that we have received and expect to receive are for development that
      overlaps with our commercial development.





In
      the
      medical laser market QPC has received production orders and new product
      development orders from a large medical laser manufacturer. Other medical
      equipment manufacturers have also ordered from us. In the industrial market,
      QPC
      has received a substantial order for development and production of optical
      sensing lasers.





**CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES**





Our
      discussion and analysis of our financial condition and results of operations
      are
      based on our consolidated financial statements, which have been prepared in
      accordance with accounting principles generally accepted in the U.S. The
      preparation of these financial statements requires us to make estimates and
      judgments that affect the reported amounts of assets, liabilities, revenues
      and
      expenses for each period. The following represents a summary of our critical
      accounting policies, defined as those policies that we believe are the most
      important to the portrayal of our financial condition and results of operations
      and that require management's most difficult, subjective or complex judgments,
      often as a result of the need to make estimates about the effects of matters
      that are inherently uncertain.


34




Impairment
      of Long-Lived Assets





On
      January 1, 2002, the Company adopted the provisions of SFAS No. 144, *“Accounting
      for the Impairment or Disposal of Long-Lived Assets.”* SFAS No.
      144 addresses financial accounting and reporting for the disposal of long-lived
      assets and supersedes SFAS No. 121, *“Accounting
      for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
      of.* ”
The
      adoption of this statement did not have a material effect on the Company’s
      results of operations or financial condition.





Revenue
      Recognition





A
      portion
      of the Company’s revenues result from fixed-price contracts with U.S. government
      agencies. Revenues from fixed-price contracts are recognized under the
      percentage-of-completion method of accounting, generally based on costs incurred
      as a percentage of total estimated costs of individual contracts (“cost-to-cost
      method”). Revisions in contract revenue and cost estimates are reflected in the
      accounting period as they are identified. Provisions for the entire amount
      of
      estimated losses on uncompleted contracts are made in the period such losses
      are
      identified. No contracts were determined to be in an overall loss position
      at
      December 31, 2005 or September 30, 2006. In addition, the Company has certain
      cost plus fixed fee contracts with U.S. Government agencies that are being
      recorded as revenue is earned based on time and costs incurred. At December
      31,
      2005, there was no deferred revenue and approximately $10,774 of unbilled
      receivables related to these government contracts. At September 30, 2006 there
      was no deferred revenue and $42,744 of unbilled receivables related to these
      government contracts.





The
      Company recognizes revenues on product sales, other than fixed-price contracts,
      based on the terms of the customer agreement. If the customer agreement does
      not
      have specific delivery or customer acceptance terms, revenue is recognized
      at
      the time of shipment of the product to the customer. Accounts receivable are
      reviewed for collectibility quarterly. When management determines a potential
      collection problem, a reserve will be established, based on management’s
      estimate of the potential bad debt. When management abandons all collection
      efforts it will write off the account and adjust the reserve
      accordingly.





Management
      Estimates





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      disclosure of contingent assets and liabilities at the date of the financial
      statements and the reported amounts of revenues and expenses during the
      reporting period. Actual results could differ from those estimates.





Accounting
      for Derivative Instruments





Statement
      of Financial Accounting Standard (“SFAS”) No. 133, “Accounting for Derivative
      Instruments and Hedging Activities,” as amended, requires all derivatives to be
      recorded on the balance sheet at fair value. In September 2000, the Emerging
      Issues Task Force (“EITF”) issued EITF 00-19, “Accounting for Derivative
      Financial Instruments Indexed to and Potentially Settled in, a Company’s Own
      Stock,” (“EITF 00-19”) which requires freestanding contracts that are settled in
      a company’s own stock, including common stock warrants, to be designated as an
      equity instrument, asset or a liability. Under the provisions of EITF 00-19,
      a
      contract designated as an asset or a liability must be carried at fair value
      on
      a company’s balance sheet, with any changes in fair value recorded in the
      company’s results of operations. These derivatives are separately valued and
      accounted for on our balance sheet, and revalued at each reporting period.
      The
      net change in the value of embedded derivative liability is recorded as income
      or loss on derivative instruments in the consolidated statement of operations,
      included in other income.




**Sales
      & Product Releases**





QPC
      signed its first government development contract in the second quarter of 2002
      and we shipped our first commercial product in the second quarter of 2004.
      We
      hired our first salesman in the fourth quarter of 2003, added a Director of
      Worldwide Sales in the third quarter of 2004 and a Senior Vice President of
      Marketing & Sales in the second quarter of 2005. Our Marketing and Sales
      Department is headed by Dr. Paul Rudy who formerly served as Director of
      Marketing at Coherent Inc., the world’s largest publicly traded laser company.
      Dr. Rudy holds a Ph.D. in physics and has eight years of sales and marketing
      experience. QPC’s Sales Department currently has three full time personnel and a
      network of worldwide representatives and distributors.


35




We
      currently have five persons in our Sales and Marketing department, in addition
      to eight representative organizations in Europe and Asia. We currently have
      more
      than 25 customers. We are still in the qualification stage of the sales cycle
      with most of these customers. However, several customers have made repeat orders
      and one customer ordered and received production quantity and made repeat
      orders. We expect many of the customers in the qualification phase to turn
      into
      production quantity customers in the future. We have received “Non-recurring
      Engineering” funds, or “NRE” from several customers to develop custom products
      for them using our proprietary technology.




Total
      sales grew from $89,161 in 2002; to $229,079 in 2003; to $1,062,133 in 2004
      to
      $1,073,091 in 2005. Total sales for the first nine months of 2006 were
      $1,773,094.





Commercial
      sales, which were initiated in 2004, contributed $75,002 to the total revenue
      for the 2004 fiscal year. Calendar year 2005 was a transitional year for QPC
      sales for two primary reasons: (1) commercial sales contributed 55% of the
      total
      sales for the year (up from less than 10% in 2004); and (2) while absolute
      sales
      were approximately the same in 2005 as 2004, total backlog by
      January 2006 was approximately ten times greater than total backlog at the
      end of 2004.  Bookings shippable within 12 months at the end of 2004 were
      approximately $700,000 and $1,062,000 at the end of 2005.





Based
      on
      QPC’s revenue for the first nine months and the remaining backlog, management
      estimates the revenue for calendar year 2006 to be in the range of $2.5 million
      to $3 million. This would represent a substantial increase over our 2005
      revenues of $1.07 million. However, in accordance with standard business
      practices, contracts are cancelable and in some cases include multiple phases
      associated with meeting technical milestones.





In
      the
      third quarter of 2006, we received orders from new and existing customers in
      the
      medical, industrial defense and homeland security markets. The contracts covered
      standard laser products, customized laser products and advanced hardware
      developments.





**QUARTER
      ENDED SEPTEMBER 30, 2006 COMPARED TO THE QUARTER ENDED SEPTEMBER 30,
      2005**





REVENUE.
      During the quarter ended September 30, 2006, QPC had revenue of $930,184 as
      compared to revenue of $153,621 during the quarter ended September 30, 2005,
      an
      increase of approximately 506%. This increase is attributable to an increase
      in
      both commercial sales and government contracts. Continued expanded effort in
      our
      sales and marketing, new product releases, and expanded customer acceptance
      of
      previous product offerings have all contributed to the increase. Seed orders
      and
      engineering sample orders have been followed up with higher volume orders.
      Additionally, we continued to perform and bill on government contracts awarded
      to us in prior periods.





COST
      OF
      REVENUE. Cost of revenue, which consists of direct labor, overhead and material
      costs, was $690,388 for the quarter ended September 30, 2006 as compared to
      $286,495 for the quarter ended September 30, 2005.This increase is attributable
      to increased revenue from both commercial sales and government
      contracts.





GROSS
      PROFIT. Gross profit was $239,796 for the quarter ended September 30, 2006
      as
      compared to $(132,874) for the quarter ended September 30, 2005, representing
      gross margins of approximately 26% and (86)%, respectively. Costs include
      non-recurring engineering expenses and hence the aforementioned margins are
      not
      representative of more mature product shipment margins. The increase in our
      gross profits is attributable to increased efficiencies in our
      operations.





RESEARCH
      AND DEVELOPMENT COSTS. Research and development costs which consist of salaries,
      professional and technical support fees, material and overhead, totaled
      $1,081,994 for the quarter ended September 30, 2006, as compared to $1,149,522
      for the quarter ended September 30, 2005 a decrease of approximately 6%. The
      decrease in research and development costs is attributable to the shift of
      some
      of our resources from development to manufacturing as a result of increased
      orders for our products..





GENERAL
      AND ADMINISTRATIVE EXPENSES. General and administrative expenses totaled
      $1,093,561 the quarter ended September 30, 2006, as compared to $610,245 for
      the
      quarter ended September 30, 2005, an increase of approximately 79%. Of this
      increase, $171,000 was due to increased investor relations, insurance, legal
      and
      accounting costs attributable to becoming a publicly traded company with
      increased compliance obligations and investor relations needs. Approximately
      $109,000 of stock option compensation expense was recognized during the quarter
      . We expect these categories of expenses to increase in future quarters, based
      on anticipated growth of the Company; however, we do not believe that the
      percentage increase will be as great in future quarters.




36




NET
      LOSS.
      QPC had a net loss of $8,313,049 for the quarter ended September 30, 2006 as
      compared to a net loss of $1,968,448 for the quarter ended September 30, 2005.
      Of the total net less, $6,000,000 related to a license termination fee paid
      by
      promissory note. A non-cash expense of approximately $109,000 of option expense
      was recorded this quarter.





**NINE
      MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
      30,
      2005**





REVENUE.
      During the nine months ended September 30, 2006, the Company had revenue of
      $1,773,094 as compared to revenue of $676,803 during the nine months ended
      September 30, 2005, an increase of approximately 162%. This increase is
      attributable to an increase in both commercial sales and government contract
      work which are a result of our sales and marketing efforts and our increase
      in
      government contracts and product offerings. We were awarded three government
      contracts during the period for which we began to perform and bill.





COST
      OF
      REVENUE. Cost of revenue, which consists of direct labor, overhead and material
      costs, was $1,465,137 for the nine months ended September 30, 2006 as compared
      to $714,729 for the nine months ended September 30, 2005. This increase is
      attributable to increased revenue from both commercial sales and government
      contracts.





GROSS
      PROFIT. Gross profit was $307,957 for the nine months ended September 30, 2006
      as compared to $(37,926) for the nine months ended September 30, 2005,
      representing gross margins of approximately 17% and (6)%, respectively. The
      increase in our gross profits is attributable to our increase in commercial
      sales and government contracts. Since we have released new products, there
      are
      still inefficiencies in the manufacturing operations. These inefficiencies
      largely affect our commercial products rather than the government contracts.
      As
      our manufacturing operations mature, we expect to have increased efficiencies
      and as a result better margins.





RESEARCH
      AND DEVELOPMENT COSTS. Research and development costs which consist of salaries,
      professional and technical support fees, material and overhead, totaled
      $3,340,772 for the nine months ended September 30, 2006, as compared to
      $3,632,791 for the nine months ended September 30, 2005, a decrease of
      approximately 8%. The decrease in research and development costs is attributable
      to the shift of some of our resources from development to manufacturing as
      a
      result of increased orders for our products.





GENERAL
      AND ADMINISTRATIVE EXPENSES. General and administrative expenses totaled
      $4,670,865 the nine months ended September 30, 2006, as compared to $1,727,862
      for the nine months ended September 30, 2005, an increase of approximately
      170%.
      Approximately $1,500,000 of this expense was a non-cash expense attributable
      to
      equity compensation given to investor relations consultants. Additionally,
      increased investor relations, legal and accounting costs are attributable to
      becoming a publicly traded company with more compliance and investor relations
      issues. We expect these categories of expenses to increase in future periods,
      based on anticipated growth of the Company, however, we do not believe that
      the
      percentage increase will be as great in future periods. We have also expanded
      our sales team, and increased our sales and marketing efforts, and as a result
      have increased expenses in the sales and marketing areas.





NET
      LOSS.
      QPC had a net loss of $15,958,945 for the nine months ended September 30, 2006
      as compared to a net loss of $5,595,476 for the nine months ended September
      30,
      2005. Approximately $330,000 of the expenses in the nine months ended September
      30, 2006 were one-time expenses attributed to the cost of the reverse merger
      transaction. $1,500,000 of expense relates to the issuance of stock for services
      to investor relations consultants. In addition, approximately $718,000 was
      included as expense associated with warrant issuance related to the related
      party note which was extended in January 2006 and repaid in April
      2006. Approximately $183,000 of option expense was recorded this nine month
      period. In addition, the Company incurred a license termination fee of
      $6,000,000 to be paid by promissory note during the nine months ended September
      30, 2006.


37




**Liquidity
      and Capital Resources**





QPC
      lost
      $15,958,945 during the nine months ended September 30, 2006 and has a cumulative
      deficit of $48,772,731 as of September 30, 2006. Our negative cash flow is
      currently in excess of $800,000 per month. We project the Company to have
      positive cash flow from operations no sooner than the last quarter of 2007.
      Our
      cash balance at September 30, 2006 is $4,294,927.





Current
      resources and sales projections require us to raise an estimated $5 million
      of
      additional capital for use in the next 12 months for operating capital.
      Depending on market conditions, and cash needs, we expect to raise $5 to $15
      million of additional capital in the next twelve months by means of a private
      placement or other financing vehicle.





In
      addition to raising capital through private placements, we are exploring the
      possibility of engaging a corporate investor whose business areas can
      potentially leverage QPC’s technology and products. A strategic investor may be
      granted a favorable business arrangement, such as an exclusive license in a
      certain area of business as an inducement to make an investment in QPC. We
      believe that there are potential strategic investors who could leverage QPC’s
      technology to increase their own sales and contracts to much larger volumes
      than
      QPC could attain directly in the near to intermediate term.





We
      cannot
      assure you that the additional financing we need (public or private) will be
      available on acceptable terms or at all. If we issue additional equity
      securities to raise funds, the ownership percentage of our existing stockholders
      would be reduced. New investors may demand rights, preferences or privileges
      senior to those of existing holders of common stock. If we cannot raise any
      needed funds, we might be forced to make further substantial reductions in
      our
      operating expenses, which could adversely affect our ability to implement our
      current business plan and ultimately our viability as a company.





Our
      financial statements have been prepared assuming that the Company will continue
      as a going concern. The factors described above raise substantial doubt about
      our ability to continue as a going concern. Our financial statements do not
      include any adjustments that might result from this uncertainty. Our independent
      registered public accounting firm has included in their audit report for fiscal
      2005 an explanatory paragraph expressing doubt about our ability to continue
      as
      a going concern.





Financing
      History





We
      secured our first round of equity financing in August 2001, led by Finisar
      Corporation (NASDAQ: FNSR), a telecommunications component manufacturer,
      headquartered in Sunnyvale, California. Finisar invested $5 million and DynaFund
      Ventures invested $2 million in our preferred stock. Other investors, including
      small funds and individuals, invested $2.03 million in the first round of
      financing. We issued Series A Preferred Stock at a price of $2.8466 per share
      to
      the investors.





In
      addition to Finisar’s equity investment, they made a five-year term loan to us
      for $7 million, closing in two tranches between August 2001 and January 2002.
      The total investment of Finisar was $12 million including the preferred equity
      and debt. The total equity and debt capital invested in our company, as of
      January 2002, was $16 million.





In
      the
      third quarter of 2003, we raised a second round of equity financing. Finisar
      converted the $5 million remaining principal balance on their term loan into
      our
      Series B Preferred Stock and we raised an additional $2.8 million in new cash.
      The price per share of Series B Preferred Stock was $3.11898. Three of the
      five
      members of the Board of Directors at that time, founders Dr. Ungar and Mr.
      Lintz
      and independent director, Dr. Israel Ury, each purchased preferred stock in
      the
      Series B round of financing. As a condition to Finisar’s investment in Series B
      Preferred Stock, we granted a non-exclusive royalty free perpetual license
      to
      our existing and future intellectual property. The License Agreement allowed
      for
      termination by us by paying a fee on or before September 18, 2008. We
      subsequently terminated the license by issuing a promissory note in the amount
      of $6 million to Finisar as of September 18, 2006.





In
      the
      second quarter of 2004, we entered into a senior secured two-year note
      transaction with various investors and raised $3.25 million. We issued 2,437,500
      warrants to purchase common stock to the lenders as part of this transaction.
      The exercise price of these warrants was initially $3.75. In the second quarter
      of 2005, approximately $2.1 million of the $2.4 million outstanding balance
      was
      extended for an additional year. We adjusted the exercise price of 2,325,000
      warrants and issued an additional 840,000 warrants to purchase common stock
      as
      part of this transaction. The new exercise price was subject to downward
      adjustment if future financings were completed at a price lower than $3.75
      per
      share. The exercise price was ultimately fixed at $1.25 per share at the time
      of
      the Reverse Merger in May 2006. The largest participant in the note transaction,
      investing $2.5 million, was Envision Partners of which QPC’s Chief Financial
      Officer, Mr. Lintz, is a 50% partner. As of September 30, 2006 the outstanding
      principal balance of the senior secured note was $1,152,917.


38




From
      the
      fourth quarter of 2004 through the first quarter of 2005, we raised $5.9 million
      in a third round of equity financing. Investors who participated in this round
      were approximately 60 accredited investors. We issued Series C Preferred Stock
      at a price of $3.75 per share and warrants to purchase common stock with an
      exercise price of $3.75 per share. In subsequent transactions from November
      2005
      to June 2006, all but 222,749 warrants were exchanged for common stock in a
      ratio of three shares for four warrants. The exercise price of remaining
      warrants was adjusted from $3.75 to $1.25.





In
      the
      third quarter 2005, we raised $221,000 through a sale of our common stock to
      eight accredited investors at a price of $1 per share.





In
      the
      third quarter of 2005 we entered into a convertible subordinated secured note
      with various investors for $1,280,000. As of September 30, 2006 the outstanding
      principal balance was $1,280,000. We issued 320,000 warrants to purchase common
      stock to these lenders. The exercise price of the warrants and the conversion
      price of the loan is variable. The initial price was $3.75 and is to be adjusted
      downward if there are any subsequent financings of at least $1,000,000 in which
      stock is sold for less than $3.75 per share. The exercise price for the warrants
      and the conversion price for the loan was reset to $1.25 per share upon closing
      of the first $1 million of the Brookstreet offering (see below) in January
      2006.
      The “floor” or minimum price that is applicable to the exercise price of the
      warrants and the conversion price of the loan is $0.90 per share. In addition
      to
      these warrants issued at the time of the loan, we offered the lenders an
      additional 341,325 warrants on the same terms if they extend their loan for
      an
      additional three years any time during the term of the loan. To date, one lender
      has given us notice of extension of his $100,000 loan and has been issued 26,666
      additional warrants.





In
      November 2005 we offered each holder of Preferred Stock (Series A, B and C)
      a
      share dividend of one common share per share of preferred stock that they owned
      as consideration for giving management their proxy and power of attorney to
      exchange all of their securities of Quintessence Photonics Corporation for
      shares of a publicly trading company, which reports to the Securities and
      Exchange Commission pursuant to a Reverse Merger transaction. We offered
      additional incentive to the Series C investors by offering to exchange the
      warrants that they received as part of the investment in the Series C
      transaction for common stock or to lower the exercise price on the warrants
      from
      $3.75 to $1.25.





In
      November 2005, we raised $500,000 pursuant to a 10% secured note financing
      with
      Jeffrey Ungar, our Chief Executive Officer, and George Lintz, our Chief
      Financial Officer. Pursuant to these bridge notes, we issued these lenders
      warrants to purchase 320,000 shares of common stock at $1.25 per share (“Bridge
      Warrants”). In connection with extensions of the maturity date of these bridge
      notes from January 2006 to April 2006, we granted 900,000 additional Bridge
      Warrants to these lenders. The bridge notes were paid in full as of April 25,
      2006.





In
      January 2006, through a private placement offering, referred to as the
      Brookstreet Tranche I offering, we raised $2,862,630 from the sale of 572,526
      units of our securities, each unit consisting of four shares of common stock
      and
      one warrant to purchase one share of common stock at $1.50 per share (for a
      total of 2,290,104 shares of common stock and 572,526 warrants).





In
      a
      series of private placement closings between March 31, 2006 and September 30,
      2006, referred to as the Brookstreet Tranche II offering, we raised $11,795,721
      from the sale of 9,436,577 shares of common stock at a price of $1.25 per share.
      In addition, the Company issued 2,345,341 warrants to Brookstreet Securities
      as
      of September 30, 2006 in connection with the underwriting.


39




Capital
      Expenditures-





From
      January 1, 2006 to September 30, 2006 we spent approximately $399,000 on
      manufacturing equipment, computer equipment and software, furniture and
      cubicles. We expect our capital expenditures to increase based on growth of
      our
      operations, and increased orders and personnel. We are considering expanding
      our
      manufacturing area by up to 10,000 square feet. Our facility has warehouse
      space
      that is contiguous to our present manufacturing area that we are considering
      using for the manufacturing area expansion. We expect that expansion, should
      we
      choose to proceed, to cost in the range of $1 million to $2
      million.





Recent
      Accounting Pronouncements





In
      February 2006, the FASB issued SFAS 155 Accounting for Certain Hybrid Financial
      Instruments, an amendment of SFAS 133 and 140. These SFAS’s deal with derivative
      and hedging activities, accounting for transfers and servicing of financial
      instruments and extinguishment of liabilities. SFAS 155 is effective for all
      financial instruments acquired or issued in an entity’s first fiscal year
      beginning after September 15, 2006. The Company does not engage in the
      activities described in these SFAS’s and does not have any intention of engaging
      in those activities when SFAS 155 becomes effective. The Company has evaluated
      the impact of the adoption of SFAS 155, and does not believe the impact will
      be
      significant to the Company's overall results of operations or financial
      position.





In
      September 2006, the Financial Accounting Standards Board ("FASB") issued
      Statement of Financial Accounting Standards No. 157, "Fair Value Measurements"
      ("SFAS No. 157"), which establishes a formal framework for measuring fair value
      under GAAP. SFAS No. 157 defines and codifies the many definitions of fair
      value
      included among various other authoritative literature, clarifies and, in some
      instances, expands on the guidance for implementing fair value measurements,
      and
      increases the level of disclosure required for fair value
      measurements.





Although
      SFAS No. 157 applies to and amends the provisions of existing FASB and AICPA
      pronouncements, it does not, of itself, require any new fair value measurements,
      nor does it establish valuation standards. SFAS No. 157 applies to all other
      accounting pronouncements requiring or permitting fair value measurements,
      except for: SFAS No. 123(R), share-based payment and related pronouncements,
      the
      practicability exceptions to fair value determinations allowed by various other
      authoritative pronouncements, and AICPA Statements of Position 97-2 and 98-9
      that deal with software revenue recognition. SFAS No. 157 is effective for
      financial statements issued for fiscal years beginning after November 15, 2007,
      and interim periods within those fiscal years.




In
      June
      2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty
      in
      Income Taxes, an interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48
      provides criteria for the recognition, measurement, presentation and disclosure
      of uncertain tax positions that has an effect on a company's financial
      statements accounted for in accordance with SFAS No. 109, "Accounting for Income
      Taxes", as a result of positions taken or expected to be taken in a company's
      tax return. A tax benefit from an uncertain position may be recognized only
      if
      it is "more likely than not" that the position is sustainable based on its
      technical merits. The provisions of FIN 48 are effective for fiscal years
      beginning after December 15, 2006. The Company is currently evaluating the
      potential effect that the adoption of FIN 48 will have on the Company's
      financial statement presentation and disclosures.


40




***FACTORS
      THAT MAY AFFECT FUTURE PERFORMANCE***





You
      should carefully consider the following risk factors, the other information
      included herein and the information included in our other reports and
      filings.  Our business, financial condition, and the trading price of our
      common stock could be adversely affected by these and other risks.





RISKS
      OF THE BUSINESS





**Because
      we are not profitable and expect to incur additional losses, we may require
      additional financing to sustain our operations and without it we may not be
      able
      to continue operations.** At
      September 30, 2006, we had cash on hand of $4,294,927. Through September 30,
      2006, our cumulative losses of approximately $48,772,731. We have never earned
      a
      profit and we anticipate that we will continue to incur losses for at least
      the
      next 12 to 18 months. We continue to operate on a negative cash flow basis.
      Our
      independent accountants have issued a going concern qualification in their
      report on our financial statements as of and for the period ending December
      31,
      2005. We believe that we will need to raise at least an additional $5,000,000
      in
      financing in order to have sufficient financial resources to fund our operations
      for the next 12 months because we are running a cash flow deficit. We may need
      additional funds to continue our operations, and such additional funds may
      not
      be available when required.





To
      date,
      we have financed our operations through the sale of stock and certain
      borrowings. We expect to continue to depend upon outside financing to sustain
      our operations for at least the next 12 months. Our ability to arrange financing
      from third parties will depend upon our perceived performance and market
      conditions. Our inability to raise additional working capital at all or to
      raise
      it in a timely manner would negatively impact our ability to fund our
      operations, to generate revenues, and to otherwise execute our business plan,
      leading to the reduction or suspension of our operations and ultimately forcing
      us to go out of business.





**We
      have no committed sources of additional capital.** For the
      foreseeable future, we intend to fund our operations and capital expenditures
      from limited cash flow from operations, our cash on hand and the net proceeds
      from equity financings. If our capital resources are insufficient, we will
      have
      to raise additional funds. We may need additional funds to continue our
      operations, pursue business opportunities (such as expansion, acquisitions
      of
      complementary businesses or the development of new products or services), to
      react to unforeseen difficulties or to respond to competitive pressures. We
      cannot assure you that any financing arrangements will be available in amounts
      or on terms acceptable to us, if at all. If additional financing is not
      available when required or is not available on acceptable terms, we may be
      unable to fund our expansion, successfully promote our current products, license
      new products or enhance our products and services, take advantage of business
      opportunities, or respond to competitive pressures, any of which could have
      a
      material adverse effect on our business and the value of our common stock.
      If we
      choose to raise additional funds through the issuance of equity securities,
      this
      may cause significant dilution of our common stock, and holders of the
      additional equity securities may have rights senior to those of the holders
      of
      our common stock. If we obtain additional financing by issuing debt securities,
      the terms of these securities could restrict or prevent us from paying dividends
      and could limit our flexibility in making business decisions.





We
      are an
      early stage company with a limited operating history no significant
      revenues*.* We were
      formed in November 2000. Since that time, we have engaged in the formulation
      of
      a business strategy and the design and development of technologically advanced
      products. We have recorded limited revenues from various government-funded
      research programs, and we have generated only limited revenues from the sale
      of
      products. Our ability to implement a successful business plan remains unproven
      and no assurance can be given that we will ever generate sufficient revenues
      to
      sustain our business.





**We
      do not have sufficient revenues to service our debt.** As of
      September 30, 2006, we had $8,038,625 of debt secured by our fixed assets and
      intellectual property. $1,152,917 of our debt accrues interest at a rate of
      10%
      per annum and requires monthly payments until June 25, 2007. $1,280,000 debt
      accrues interest at a rate of 10% per annum and requires monthly payments until
      September 30, 2008, and may be extended at the option of the lenders under
      certain conditions. $6,000,000 debt accrues interest at a rate of 10% per annum
      and requires monthly payments until September 18, 2009. If we are unable to
      service our debt, our assets, including our patents and other intellectual
      property, may be subject to foreclosure.


41




**We
      have only limited proven commercial products** **.**
      We are currently engaged in the design and development of laser diode products
      for certain industrial and defense applications. Our most advanced technologies,
      including without limitation, our “Generation III” products, are in the design
      or prototype stage. These technologies may not be commercially viable for at
      least one year, more specifically, we expect to ship prototypes of our
      Generation III products in the calendar year 2007, if they ever become viable
      at
      all. We have received only a limited number of purchase orders for our products
      and we only have a limited number of contractual arrangements to sell our
      products. The process of qualifying laser diodes for purchase by commercial
      or
      defense customers is lengthy and unpredictable. No assurance can be given that
      any of our products will achieve commercial success.





**We
      are dependent on our customers and vulnerable to their sales and production
      cycles** **.**
      For the most part, we do not sell end-user products. We sell laser components
      that are incorporated by our customers into their products. Therefore, we are
      vulnerable to our customers’ prosperity and sales growth. Failure of our
      customers to sell their products will ultimately hurt their demand for our
      products, and thus, have a material adverse effect on our revenues.





**Unusually
      long sales cycles may cause us to incur significant expenses without offsetting
      revenue** **.**
      Customers often view the purchase of our products as a significant and strategic
      decision. Accordingly, customers typically expend significant effort in
      evaluating and testing our products before making a decision to purchase them,
      resulting in a long sales cycle, While our customers are evaluating our products
      and before they place an order, we may incur substantial expenses for sales
      and
      marketing and research and development to customize our products to the
      customer's needs. Even after evaluation, a potential customer may not purchase
      our products. As a result, these long sales cycles may cause us to incur
      significant expenses without ever receiving revenue to offset those
      expenses.





**The
      markets for our products are subject to continuing change that may impair our
      ability to successfully sell our products** **.**
      The markets for laser diode products are volatile and subject to continuing
      change. For example, since 2001, the market for telecommunications and data
      communications products has been severely depressed while a more robust market
      for defense and homeland security applications has developed during the past
      year and a half. We must continuously adjust our marketing strategy to address
      the changing state of the markets for laser diode products, we may not be able
      to anticipate changes in the market and, as a result, our product strategies
      may
      be unsuccessful.





**Our
      products may become obsolete if we are unable to stay abreast of technological
      developments** **.**
      The photonics industry is characterized by rapid and continuous technological
      development if we are unable to stay abreast of such developments, our products
      may become obsolete. We lack the substantial research and development resources
      of some of our competitors. This may limit our ability to remain technologically
      competitive.





**We
      are dependent for our success on a few key executive officers. Our inability
      to
      retain those officers would impede our business plan and growth strategies,
      which would have a negative impact on our business and the value of your
      investment.** Our
      success depends on the skills, experience and performance of key members of
      our
      management team. We are heavily dependent on the continued services of Jeffrey
      Ungar, our Chief Executive Officer, George Lintz, our Chief Financial Officer
      and Chief Operating Officer, Tim Franey, our Vice President of Manufacturing
      and
      Paul Rudy, our Senior Vice President of Marketing and Sales. We do not have
      long-term employment agreements with any of the members of our senior management
      team. Each of those individuals without long-term employment agreements may
      voluntarily terminate his employment with the Company at any time upon short
      notice. Were we to lose one or more of these key executive officers, we would
      be
      forced to expend significant time and money in the pursuit of a replacement,
      which would result in both a delay in the implementation of our business plan
      and the diversion of limited working capital. We can give you no assurance
      that
      we can find satisfactory replacements for these key executive officers at all,
      or on terms that are not unduly expensive or burdensome to our company. We
      maintain $8.0 million and $2.0 million key man insurance policies on Mr. Ungar
      and Mr. Lintz, respectively. Although we intend to issue stock options or other
      equity-based compensation to attract and retain employees, such incentives
      may
      not be sufficient to attract and retain key personnel.




42




**We
      are also dependent for our success on our ability to attract and retain
      technical personnel, sales and marketing personnel and other skilled
      management.** Our
      success depends to a significant degree upon our ability to attract, retain
      and
      motivate highly skilled and qualified personnel. Failure to attract and retain
      necessary technical personnel, sales and marketing personnel and skilled
      management could adversely affect our business. If we fail to attract, train
      and
      retain sufficient numbers of these highly qualified people, our prospects,
      business, financial condition and results of operations will be materially
      and
      adversely affected.





**Our
      business is dependent upon proprietary intellectual property
      rights** **.**
      We have employed proprietary information to design our products. We seek to
      protect our intellectual property rights through a combination of patent
      filings, trademark registrations, confidentiality agreements and inventions
      agreements. However, no assurance can be given that such measures will be
      sufficient to protect our intellectual property rights. If we cannot protect
      our
      rights, we may lose our competitive advantage. Moreover, if it is determined
      that our products infringe on the intellectual property rights of third parties,
      we may be prevented from marketing our products.





**We
      currently rely on R&D Contracts with the U.S.
      Government** **.**
      Currently, a significant part of our near term revenue is expected to be derived
      from research contracts from the U.S. Government. Changes in the priorities
      of
      the U.S. Government may affect the level of funding of programs. Changes in
      priorities of government spending may diminish interest in sponsoring research
      programs in our area of expertise.





**We
      may incur debt or issue preferred stock in the future** **.**
      In order to purchase equipment or fund operations, QPC may issue additional
      debt
      instruments or preferred stock which will have a senior claim on the assets
      of
      QPC in the event of a sale of assets. Debt service may cause a strain on cash
      flow and impair business operations.





**We
      face intense competition, including competition from companies with
      significantly greater resources than ours, and if we are unable to compete
      effectively with these companies, our market share may decline and our business
      could be harmed.** The
      laser industry is highly competitive with numerous competitors from
      well-established manufacturers to innovative start-ups. A number of our
      competitors have significantly greater financial, technological, engineering,
      manufacturing, marketing and distribution resources than we do. Their greater
      capabilities in these areas may enable them to compete more effectively on
      the
      basis of price and production and more quickly develop new products and
      technologies. In addition, new companies may enter the markets in which we
      compete, further increasing competition in the laser industry. For instance,
      larger companies such as Northrop Grumman and BAE Systems are currently
      developing laser technology to protect airliners from portable rocket launchers.
      We believe that our ability to compete successfully depends on a number of
      factors, including our innovative and advanced R & D department, strength of
      our intellectual property rights, and advanced manufacturing facility are the
      most important competitive factors and we plan to employ these elements as
      we
      develop our products and technologies, but there are many other factors beyond
      our control. We may not be able to compete successfully in the future, and
      increased competition may result in price reductions, reduced profit margins,
      loss of market share and an inability to generate cash flows that are sufficient
      to maintain or expand our development and marketing of new products, which
      would
      adversely impact the trading price of our common shares.





**If
      our facilities were to experience catastrophic loss, our operations would be
      seriously harmed.** Our
      facilities could be subject to a catastrophic loss from fire, flood, earthquake
      or terrorist activity. All of our research and development activities,
      manufacturing, our corporate headquarters and other critical business operations
      are located near major earthquake faults in Sylmar, California, an area with
      a
      history of seismic events. Any such loss at this facility could disrupt our
      operations, delay production, and revenue and result in large expenses to repair
      or replace the facility. While we have obtained insurance to cover most
      potential losses, we cannot assure you that our existing insurance coverage
      will
      be adequate against all other possible losses.





**The
      relative lack of public company experience of our management team may put us
      at
      a competitive disadvantage.** Our
      management team lacks public company experience, which could impair our ability
      to comply with legal and regulatory requirements such as those imposed by
      Sarbanes-Oxley Act of 2002. The individuals who now constitute our senior
      management have never had responsibility for managing a publicly traded company.
      Such responsibilities include complying with Federal securities laws and making
      required disclosures on a timely basis. Our senior management may not be able
      to
      implement and affect programs and policies in an effective and timely manner
      that adequately respond to such increased legal, regulatory compliance and
      reporting requirements. Our failure to do so could lead to the imposition of
      fines and penalties and further result in the deterioration of our
      business.





**New
      rules, including those contained in and issued under the Sarbanes-Oxley Act
      of
      2002, may make it difficult for us to retain or attract qualified officers
      and
      directors, which could adversely affect the management of our business and
      our
      ability to obtain or retain listing of our common stock.** We may
      be unable to attract and retain qualified officers, directors and members of
      board committees required to provide for our effective management as a result
      of
      the recent and currently proposed changes in the rules and regulations which
      govern publicly-held companies, including, but not limited to, certifications
      from executive officers and requirements for financial experts on the board
      of
      directors. The perceived increased personal risk associated with these recent
      changes may deter qualified individuals from accepting these roles. The
      enactment of the Sarbanes-Oxley Act of 2002 has resulted in the issuance of
      a
      series of new rules and regulations and the strengthening of existing rules
      and
      regulations by the SEC. Further, certain of these recent and proposed changes
      heighten the requirements for board or committee membership, particularly with
      respect to an individual’s independence from the corporation and level of
      experience in finance and accounting matters. We may have difficulty attracting
      and retaining directors with the requisite qualifications. If we are unable
      to
      attract and retain qualified officers and directors, the management of our
      business could be adversely affected.




43




**Our
      internal controls over financial reporting may not be effective, and our
      independent auditors may not be able to certify as to their effectiveness,
      which
      could have a significant and adverse effect on our
      business.** We are
      subject to various regulatory requirements, including the Sarbanes-Oxley Act
      of
      2002. We, like all other public companies, must incur additional expenses and,
      to a lesser extent, diversion of our management’s time in our efforts to comply
      with Section 404 of the Sarbanes-Oxley Act of 2002 regarding internal
      controls over financial reporting. We have not evaluated our internal controls
      over financial reporting in order to allow management to report on, and our
      independent auditors to attest to, our internal controls over financial
      reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002 and
      the rules and regulations of the SEC, which we collectively refer to as
      Section 404. We have never performed the system and process evaluation and
      testing required in an effort to comply with the management assessment and
      auditor certification requirements of Section 404, which will initially
      apply to us as of December 31, 2007. Our lack of familiarity with Section
      404 may unduly divert management’s time and resources in executing the business
      plan. If, in the future, management identifies one or more material weaknesses,
      or our external auditors are unable to attest that our management’s report is
      fairly stated or to express an opinion on the effectiveness of our internal
      controls, this could result in a loss of investor confidence in our financial
      reports, have an adverse effect on our stock price and/or subject us to
      sanctions or investigation by regulatory authorities.





**If
      we are unable to obtain adequate insurance, our financial condition could be
      adversely affected in the event of uninsured or inadequately insured loss or
      damage. Our ability to effectively recruit and retain qualified officers and
      directors could also be adversely affected if we experience difficulty in
      obtaining adequate directors’ and officers’ liability
      insurance.** Although
      we currently have property insurance, liability insurance, and employment
      practices liability insurance, we may not be able to obtain all insurance
      policies that would adequately insure our business and property against damage,
      loss or claims by third parties. To the extent our business or property suffers
      any damages, losses or claims by third parties, which are not covered or
      adequately covered by insurance, our financial condition may be materially
      adversely affected. We may be unable to maintain sufficient insurance as a
      public company to cover liability claims made against our officers and
      directors. If we are unable to adequately insure our officers and directors,
      we
      may not be able to retain or recruit qualified officers and directors to manage
      the Company.





**Economic,
      political, military or other events in the United States could interfere with
      our success or operations and harm our business.** We
      market and sell our products and services in the United States and abroad.
      The
      September 11, 2001 terrorist attacks disrupted commerce throughout the
      United States and other parts of the world. The continued threat of similar
      attacks throughout the world and the military action, or possible military
      action, taken by the United States and other nations, in Iraq or other countries
      may cause significant disruption to commerce throughout the world. To the extent
      that such disruptions further slow the global economy or, more particularly,
      result in delays or cancellations of purchase orders for our products or extends
      the sales cycles with potential customers, our business and results of
      operations could be materially adversely affected. We are unable to predict
      whether the threat of new attacks or the responses thereto will result in any
      long-term commercial disruptions or if such activities or responses will have
      a
      long-term material adverse effect on our business, results of operations or
      financial condition.


44




MARKET
      RISKS.





**Our
      common stock may be thinly traded, so you may be unable to sell at or near
      ask
      prices or at all if you need to sell your shares to raise money or otherwise
      desire to liquidate your shares.** Prior to
      the Share Exchange in May 2006, QPC’s shares were not publicly traded. Through
      this Share Exchange, QPC has essentially become public without the typical
      initial public offering procedures which usually include a large selling group
      of broker-dealers who may provide market support after going public. Thus,
      we
      will be required to undertake efforts to develop market recognition for us
      and
      support for our shares of common stock in the public market. The price and
      volume for our common stock that will develop after the Share Exchange cannot
      be
      assured. The number of persons interested in purchasing our common stock at
      or
      near ask prices at any given time may be relatively small or non-existent.
      This
      situation may be attributable to a number of factors, including the fact that
      we
      are a small company which is relatively unknown to stock analysts, stock
      brokers, institutional investors and others in the investment community that
      generate or influence sales volume, and that even if we came to the attention
      of
      such persons, they tend to be risk-averse and would be reluctant to follow
      an
      unproven company such as ours or purchase or recommend the purchase of our
      shares until such time as we became more seasoned and viable. As a consequence,
      there may be periods of several days, weeks, months, or more when trading
      activity in our shares is minimal or non-existent, as compared to a seasoned
      issuer which has a large and steady volume of trading activity that will
      generally support continuous sales without an adverse effect on share price.
      We
      cannot give you any assurance that a broader or more active public trading
      market for our common stock will develop or be sustained. While we are trading
      on the OTC Bulletin Board, the trading volume we will develop may be limited
      by
      the fact that many major institutional investment funds, including mutual funds,
      as well as individual investors follow a policy of not investing in Bulletin
      Board stocks and certain major brokerage firms restrict their brokers from
      recommending Bulletin Board stocks because they are considered speculative,
      volatile and thinly traded.





**The
      application of the “penny stock” rules to our common stock could limit the
      trading and liquidity of the Common Stock, adversely affect the market price
      of
      our common stock and increase your transaction costs to sell those
      shares.** As long
      as the trading price of our common stock is below $5 per share, the open-market
      trading of our common stock will be subject to the “penny stock” rules, unless
      we otherwise qualify for an exemption from the “penny stock” definition. The
“penny stock” rules impose additional sales practice requirements on certain
      broker-dealers who sell securities to persons other than established customers
      and accredited investors (generally those with assets in excess of $1,000,000
      or
      annual income exceeding $200,000 or $300,000 together with their spouse). These
      regulations, if they apply, require the delivery, prior to any transaction
      involving a penny stock, of a disclosure schedule explaining the penny stock
      market and the associated risks. Under these regulations, certain brokers who
      recommend such securities to persons other than established customers or certain
      accredited investors must make a special written suitability determination
      regarding such a purchaser and receive such purchaser’s written agreement to a
      transaction prior to sale. These regulations may have the effect of limiting
      the
      trading activity of our common stock, reducing the liquidity of an investment
      in
      our common stock and increasing the transaction costs for sales and purchases
      of
      our common stock as compared to other securities.





**The
      market price for our common stock may be particularly volatile given our status
      as a relatively unknown company with a small and thinly traded public float,
      limited operating history and lack of profits which could lead to wide
      fluctuations in our share price.** The
      market for our common stock may be characterized by significant price volatility
      when compared to seasoned issuers, and we expect that our share price could
      continue to be more volatile than a seasoned issuer for the indefinite future.
      The potential volatility in our share price is attributable to a number of
      factors. First, as noted above, our shares of common stock may be sporadically
      and thinly traded. As a consequence of this lack of liquidity, the trading
      of
      relatively small quantities of shares by our stockholders may disproportionately
      influence the price of those shares in either direction. The price for our
      shares could, for example, decline precipitously in the event that a large
      number of our shares of common stock are sold on the market without commensurate
      demand, as compared to a seasoned issuer which could better absorb those sales
      without adverse impact on its share price. Second, we are a speculative or
      “risky” investment due to our limited operating history and lack of profits to
      date, and uncertainty of future market acceptance for our potential products.
      As
      a consequence of this enhanced risk, more risk averse investors may, under
      the
      fear of losing all or most of their investment in the event of negative news
      or
      lack of progress, be more inclined to sell their shares on the market more
      quickly and at greater discounts than would be the case with the stock of a
      seasoned issuer. Many of these factors will be beyond our control and may
      decrease the market price of our common shares, regardless of our operating
      performance. We cannot make any predictions or projections as to what the
      prevailing market price for our common stock will be at any time.




45




In
      addition, the market price of our common stock could be subject to wide
      fluctuations in response to:





·
            quarterly
                variations in our revenues and operating expenses;·
            announcements
                of new products or services by us;·
            fluctuations
                in interest rates;·
            significant
                sales of our common stock, including “short” sales;·
            the
                operating and stock price performance of other companies that investors
                may deem comparable to us; and·
            news
                reports relating to trends in our markets or general economic
                conditions.





The
      stock
      market in general, and the market prices for penny stock companies in
      particular, have experienced volatility that often has been unrelated to the
      operating performance of such companies. These broad market and industry
      fluctuations may adversely affect the price of our stock, regardless of our
      operating performance.





Stockholders
      should be aware that, according to SEC Release No. 34-29093, the market for
      penny stocks has suffered in recent years from patterns of fraud and abuse.
      Such
      patterns include (1) control of the market for the security by one or a few
      broker-dealers that are often related to the promoter or issuer; (2)
      manipulation of prices through prearranged matching of purchases and sales
      and
      false and misleading press releases; (3) boiler room practices involving
      high-pressure sales tactics and unrealistic price projections by inexperienced
      sales persons; (4) excessive and undisclosed bid-ask differential and markups
      by
      selling broker-dealers; and (5) the wholesale dumping of the same securities
      by
      promoters and broker-dealers after prices have been manipulated to a desired
      level, along with the resulting inevitable collapse of those prices and with
      consequent investor losses. Our management is aware of the abuses that have
      occurred historically in the penny stock market. Although we do not expect
      to be
      in a position to dictate the behavior of the market or of broker-dealers who
      participate in the market, management will strive within the confines of
      practical limitations to prevent the described patterns from being established
      with respect to our securities. The occurrence of these patterns or practices
      could increase the volatility of our share price.





**Limitations
      on director and officer liability and indemnification of our officers and
      directors by us may discourage stockholders from bringing suit against a
      director.** QLI’s
      articles of incorporation and bylaws provide, with certain exceptions as
      permitted by governing state law, that a director or officer shall not be
      personally liable to us or our stockholders for breach of fiduciary duty as
      a
      director, except for acts or omissions which involve intentional misconduct,
      fraud or knowing violation of law, or unlawful payments of dividends. These
      provisions may discourage stockholders from bringing suit against a director
      for
      breach of fiduciary duty and may reduce the likelihood of derivative litigation
      brought by stockholders on our behalf against a director. In addition, QLI’s
      articles of incorporation and bylaws may provide for mandatory indemnification
      of directors and officers to the fullest extent permitted by governing state
      law.





**We
      do not expect to pay dividends for the foreseeable future, and we may never
      pay
      dividends** . We
      currently intend to retain any future earnings to support the development and
      expansion of our business and do not anticipate paying cash dividends in the
      foreseeable future. Our payment of any future dividends will be at the
      discretion of our board of directors after taking into account various factors,
      including but not limited to our financial condition, operating results, cash
      needs, growth plans and the terms of any credit agreements that we may be a
      party to at the time. In addition, our ability to pay dividends on our common
      stock may be limited by state law. Accordingly, investors must rely on sales
      of
      their Common Stock after price appreciation, which may never occur, as the
      only
      way to realize their investment.





**Our
      operating results may fluctuate significantly, and these fluctuations may cause
      our common stock price to fall.** Our
      quarterly operating results may fluctuate significantly in the future due to
      a
      variety of factors that could affect our revenues or our expenses in any
      particular quarter. You should not rely on quarter-to-quarter comparisons of
      our
      results of operations as an indication of future performance. Factors that
      may
      affect our quarterly results include:





·
            market
                acceptance of our products and technologies and those of our
                competitors;·
            speed
                of commercialization of our early stage, state-of-the-art designs
                and
                developments;·
            our
                ability to attract and retain key personnel; and·
            our
                ability to manage our anticipated growth and
                expansion.




46




**Our
      executive officers, directors and insider stockholders own or control at least
      45% of our outstanding common stock, which may limit your ability and the
      ability of our other stockholders, whether acting alone or together, to propose
      or direct the management or overall direction of our Company. Additionally,
      this
      concentration of ownership could discourage or prevent a potential takeover
      of
      our Company that might otherwise result in you receiving a premium over the
      market price for your Shares.** We
      estimate that approximately 45% of our outstanding shares of common stock is
      owned and controlled by a group of insiders, including our directors and
      executive officers. Such concentrated control of the Company may adversely
      affect the price of our common stock. Our principal stockholders may be able
      to
      control matters requiring approval by our stockholders, including the election
      of directors, mergers or other business combinations. Such concentrated control
      may also make it difficult for our stockholders to receive a premium for their
      shares of our common stock in the event we merge with a third party or enter
      into different transactions which require stockholder approval. These provisions
      could also limit the price that investors might be willing to pay in the future
      for shares of our common stock. In addition, certain provisions of Nevada law
      could have the effect of making it more difficult or more expensive for a third
      party to acquire, or of discouraging a third party from attempting to acquire,
      control of us. Accordingly, the existing principal stockholders together with
      our directors and executive officers will have the power to control the election
      of our directors and the approval of actions for which the approval of our
      stockholders is required. If you acquire Shares, you may have no effective
      voice
      in the management of the Company.





**Future
      sales of our equity securities could put downward selling pressure on our
      securities, and adversely affect the stock price. There is a risk that this
      downward pressure may make it impossible for an investor to sell his securities
      at any reasonable price, if at all.** Future
      sales of substantial amounts of our equity securities in the public market,
      or
      the perception that such sales could occur, could put downward selling pressure
      on our securities, and adversely affect the market price of our common
      stock.





Item
      3.
      CONTROLS AND PROCEDURES





(a)
      Evaluation of Disclosure Controls and Procedures.





Our
      management, with the participation of our principal executive officer and
      principal financial officer, has evaluated the effectiveness of the design
      and
      effectiveness of our disclosure controls and procedures (as defined in Rules
      13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended)
      as of the end of the period covered by this quarterly report. Based on this
      evaluation, our principal executive officer and principal financial officer
      concluded, as of the end of such period, that these disclosure controls and
      procedures are effective and designed to ensure that the information required
      to
      be disclosed in our reports filed or submitted under the Securities Exchange
      Act
      of 1934 is recorded, processed, summarized and reported within the requisite
      time periods; with the exception that we believe that there is a material
      weakness in the procedures for the accounting and recording of equity
      and derivative transactions in the financial statements. Management has hired
      a
      VP of Finance and Accounting and engaged the services of a consultant with
      significant experience in complex equity transactions to address this issue
      going forward.





(b)
      Changes in Internal Controls.





There
      was
      no change in our internal control over financial reporting (as defined in Rules
      13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended)
      identified in connection with the evaluation of our internal control performed
      during our last fiscal quarter that has materially affected, or is reasonably
      likely to materially affect, our internal control over financial
      reporting.




**Part
      II -Other information**





Item
      1
      Legal Proceedings





Not
      applicable




47




Item
      2
      Unregistered Sales of Equity Securities and Use of Proceeds





During
      the three months ended September 30, 2006, the Company sold 1,245,300 shares
      of
      restricted common stock for total gross proceeds of $1,556,625.





During
      the three months ended September 30, 2006 Brookstreet also received warrants
      to
      purchase Registrant common stock in an amount equal to 20% of the shares sold,
      at an exercise price of $1.25 per share. Based on the sale of 1,245,300 shares
      in the Offering, Brookstreet received warrants to purchase 249,060 shares of
      common stock. The value of the warrants issued to Brookstreet was
      $211,860.




During
      the three months ended September 30, 2006 the Company issued 2,500 shares of
      restricted common stock upon warrant exercise for total gross proceeds of
      $3,750.




The
      issuance of the securities describe above were exempt from the registration
      requirements of the Securities Act of 1933, as amended, under Regulation D
      and
      the rules thereunder, including Rule 506 insofar as: (1) the purchasers were
      each an accredited investor within the meaning of Rule 501(a); (2) the transfer
      of the securities were restricted by the Registrant in accordance with Rule
      502(d); (3) there were no other non-accredited investors involved in the
      transaction within the meaning of Rule 506(b); and (4) the offer and sale of
      the
      securities was not effected through any general solicitation or general
      advertising within the meaning of Rule 502(c).





Item
      3.
      Defaults Upon Senior Securities





Not
      applicable





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





Not
      applicable





Item
      5.
      Other Information





Not
      applicable





Item
      6.
      Exhibits




Exhibit
                Number
            
            Description
                of Document2.1
            
            
            Share
                Exchange Agreement by and among Quintessence Photonics Corporation
                (“Target”), QPC Lasers, Inc., the shareholders of Target, and Julie Morin
                dated May 12, 2006 (1)3.1
            
            
            Articles
                of Incorporation of QPC Lasers, Inc. as filed with the State of Nevada,
                as
                amended. (1) (2)3.2
            
            
            Bylaws
                of QPC Lasers, Inc. (1)4.1
            
            
            Registration
                Rights Agreement (2)4.2
            
            
            Form
                of Investor Warrant (2)4.3
            
            
            Form
                of Bridge Lender Warrant (2)4.4
            
            
            Form
                of Brookstreet Warrant (2)10.1
            
            
            2001
                Stock Option Plan (2)10.2
            
            
            2006
                Stock Option Plan (2)10.3
            
            
            Bridge
                Loan Agreement (2)10.4
            
            
            Real
                Property Lease (3)31.01
            
            
            Chief
                Executive Officer ’ s Certification pursuant to Section 302 of the
                Sarbanes-OxleyAct of 2002 (4)31.02
            
            
            Chief
                Financial Officer ’ s Certification pursuant to Section 302 of the
                Sarbanes-OxleyAct of 2002 (4)32.01
            
            
            Chief
                Executive Officer ’ s Certification pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002 (4)32.02
            
            
            Chief
                Financial Officer ’ s Certification pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002 (4)







(1)
            Incorporated
                by reference from the Registrant’s Form 8-K dated May 12,
                2006.




(2)
            Incorporated
                by reference from the Registrant’s Registration Statement on Form SB-2, as
                amended.(3)
            Incorporated
                by reference from the Registrant’s Registration Quarterly Report on Form
                10QSB for the period ended June 30, 2006.(4)
            Filed
                herewith.


48




**SIGNATURES**




Pursuant
      to the requirements of the Securities Exchange Act of 1934, the Registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.





Dated:
                June 15, 2007
            
            **QPC
                Lasers, Inc.**/s/
                George Lintz
              George
                LintzChief
                Operating Officer, Chief Financial Officer/s/
                Jeffrey Ungar
              
              Chief
                Executive Officer




49