TTC Technology (SMTR) 10QSB/A 2006 Q2 Quarterly report (small business) (amended)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB/A

(Mark One)

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

ACT OF 1934

For the quarterly period ended January 31, 2006.

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from ___________ to ____________

Commission file number 0-24209

SMARTIRE SYSTEMS INC.

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

Yukon Territory, Canada	Not applicable
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

#150 - 13151 Vanier Place

Richmond, British Columbia, Canada V6V 2J1

(Address of principal executive offices, including area code)

604-276-9884

(Issuer's telephone number)

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

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS

Check whether the issuer has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ]

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date.

The number of shares outstanding of our common stock at February 28, 2006 was 293,121,513.

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

STATEMENT REGARDING THIS REPORT

This Form 10-QSB/A for the period ended January 31, 2006 includes comparative figures that have been restated from prior annual and quarterly fiscal periods.

Based on extensive discussions with the Staff of the Securities and Exchange Commission we have amended our Form 10-QSBs filed for the periods ended April 30, 2005, October 31, 2005 and January 31, 2006. We have also amended our Form 10-KSB/A filed for the year ended July 31, 2005.

We have received comments from the staff of the SEC related to our accounting treatment of our outstanding convertible debentures that have warrants, conversion features and related registration rights with respect to the Statement of Financial Accounting Standards (“SFAS”) No. 133 and Emerging Issues Task Force (“EITF”) 00-19. As a result of the comments received from, and our subsequent discussions with, the staff of the SEC, the warrants, and registration rights agreements have been in this form 10-QSB/A accounted for as derivative instrument liabilities, rather than as equity, and the conversion options related to the debentures held by Cornell Capital Partners, LP, its affiliates and certain other investors, together with other embedded derivative instruments, have been in this form 10-QSB/A, bifurcated from the debt hosts and accounted for separately as derivative instrument liabilities. The impact of this amendment on the previously filed financial statements for the period ended January 31, 2006, is as follows. The effect of the (non-cash) charges related to accounting separately for these derivative instrument liabilities on our consolidated statement of operations for the three and six months ended January 31, 2006 was an increase in our net interest and financing expense for $211,733 which resulted in an increase in net loss of $211,733 for each respective period. Basic and diluted net loss per share for the three and six months ended January 31, 2006 remain unchanged at $0.01 and $0.08 respectively. The effect on our consolidated balance sheet as of January 31, 2006, was an increase in our derivative financial instrument liability of $7,061,963, a decrease in our additional paid-in capital of $6,843,906 and an increase in our accumulated deficit of $218,057.

We also received further comments from the staff of the SEC relating to our accounting for the gain recorded upon the extinguishment of our $2.5 million, 5% convertible debenture, with respect to guidance in EITF 00-27, Issue 12(b). As a result of these comments and our subsequent discussions with the SEC, we have amended this Form 10-QSB/A, the conversion prices used in the calculation of the accounting gain to reflect that of the closing bid price of our common stock on the date of extinguishment. The impact of this amendment on the previously filed financial statements for the period ended January 31, 2006, is as follows. The effect of the amended accounting for the (non-cash) gain on extinguishment of debt on our consolidated balance sheet as of January 31, 2006 was an increase in our additional paid in capital and accumulated deficit of $6,324 for each respective period. There was no impact to the statement of operations for the amended accounting related to the gain on extinguishment of debt for the three and six months ended January 31, 2006.

In all other material respects, this Amended Quarterly Report on Form 10-QSB/A is unchanged from the Quarterly Report on Form 10-QSB previously filed by the Company on March 17, 2006.

INDEX			PAGE NUMBER
PART I.	FINANCIAL INFORMATION		1
	ITEM 1.	FINANCIAL STATEMENTS	1
		CONSOLIDATED BALANCE SHEETS - JANUARY 31, 2006 (UNAUDITED - AS RESTATED)
		AND JULY 31, 2005	2
		CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED - AS RESTATED) - FOR THE
		THREE AND SIX MONTHS ENDED JANUARY 31, 2006 AND JANUARY 31,
		2005	3
		CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
		COMPREHENSIVE INCOME - FOR THE SIX MONTHS ENDED JANUARY 31,
		2006 (UNAUDITED - AS RESTATED) AND YEAR ENDED JULY 31, 2005	4
		CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED - AS RESTATED) - SIX
		MONTHS ENDED JANUARY 31, 2006 AND JANUARY 31, 2005	5
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - SIX
		MONTHS ENDED JANUARY 31, 2006 AND JANUARY 31, 2005	6
	ITEM 2.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
		AND RESULTS OF OPERATIONS	13
	ITEM 3.	CONTROLS AND PROCEDURES	19
PART II.	OTHER INFORMATION		19
	ITEM 1.	LEGAL PROCEEDINGS	19
	ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	19
	ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	20
	ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	20
	ITEM 5.	OTHER INFORMATION	20
	ITEM 6.	EXHIBITS	21
		SIGNATURES	22

PART I - FINANCIAL INFORMATION

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

THIS QUARTERLY REPORT ON FORM 10-QSB/A, INCLUDING EXHIBITS HERETO, CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE FORWARD-LOOKING STATEMENTS ARE TYPICALLY IDENTIFIED BY THE WORDS "ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FORECASTS," "PLANS," "ESTIMATES," "MAY," "FUTURE," "STRATEGY," OR WORDS OF SIMILAR MEANING. VARIOUS FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN THE FORWARD-LOOKING STATEMENTS, INCLUDING THOSE DESCRIBED IN "RISK FACTORS" IN OUR JULY 31, 2005 FORM 10-KSB/A. WE ASSUME NO OBLIGATIONS TO UPDATE THESE FORWARD-LOOKING STATEMENTS TO REFLECT NEW INFORMATION, ACTUAL RESULTS, CHANGES IN ASSUMPTIONS, OR CHANGES IN OTHER FACTORS, EXCEPT AS REQUIRED BY LAW.

ITEM 1. FINANCIAL STATEMENTS

The unaudited consolidated financial statements of SmarTire Systems Inc. and its wholly owned subsidiaries, SmarTire USA Inc., SmarTire Europe Limited and SmarTire Technologies Inc. ("we," "us," "our," and "SmarTire") as of January 31, 2006 and for the three and six months ended January 31, 2006 and January 31, 2005 are attached hereto. Our consolidated financial statements are stated in United States Dollars and are prepared in accordance with United States Generally Accepted Accounting Principles.

It is the opinion of management that the interim financial statements for the three and six months ended January 31, 2006 includes all adjustments necessary in order to ensure that the financial statements are not misleading.

Consolidated Financial Statements

Unaudited

(Expressed in United States dollars)

In accordance with United States Generally Accepted Accounting Principles

SMARTIRE SYSTEMS INC.

Periods ended January 31, 2006 and 2005

-1-

SMARTIRE SYSTEMS INC.

Consolidated Balance Sheets

(Expressed in United States dollars)

(Prepared in accordance with U.S. generally accepted accounting principles)

		January 31, 2006			July 31, 2005
		(Unaudited - as restated - note 1)
Assets
Current assets:
Cash and cash equivalents	$	2,278,619		$	10,059,763
Short term investments (note 2(a))		3,299,084			-
Receivables, net of allowance for doubtful accounts
of $63,400 (July 31, 2005 - $50,750)		553,319			275,789
Inventory		2,674,351			2,798,747
Prepaid expenses		465,946			158,188
		9,271,319			13,292,487
Capital assets		775,017			716,763
Deferred financing costs (note 3)		1,906,864			18,209,280
Other assets		521,076			1,066,013
	$	12,474,276		$	33,284,543
Liabilities and Stockholders' Equity (Deficiency)
Current liabilities:
Accounts payable and accrued liabilities	$	855,126		$	915,334
Current portion of convertible debentures		310,960			4,866,584
		1,166,086			5,781,918
Convertible debentures, net of equity portion of $11,787,252
(July 31, 2005 - $10,111,082) (note 4)		19,693,610			17,118,667
Accrued interest on convertible debentures		756,164			-
Preferred shares, net of equity portion of $3,997,220, subject to
mandatory redemption (July 31, 2005 - $3,999,999)		2,780			1
Derivative financial instruments (note 5)		7,061,963			-
Stockholders' equity (deficiency):
Share capital (note 7)
Common shares, without par value:
Unlimited shares authorized
289,646,656 shares issued and outstanding		67,303,418			66,695,717
(July 31, 2005 - 278,562,884)
Additional paid-in capital		12,865,403			18,697,821
Deficit		(97,202,002	)		(75,138,474	)
Accumulated other comprehensive income		826,854			128,893
		(16,206,327	)		10,383,957
	$	12,474,276		$	33,284,543

Subsequent event (note 12)
See accompanying notes to consolidated financial statements.
Approved on behalf of the Board
/s/Robert Rudman	/s/Martin Gannon
Robert Rudman, Director	Martin Gannon, Director

-2-

SMARTIRE SYSTEMS INC.

Consolidated Statements of Operations

(Expressed in United States dollars)

(Prepared in accordance with U.S. generally accepted accounting principles)

(Unaudited)

	Three Months Ended						Six Months Ended
		January 31, 2006		��	January 31, 2005			January 31, 2006			January 31, 2005
		(as restated - note 1)						(as restated - note 1)
Revenue	$	839,615		$	390,909		$	1,432,481		$	692,078
Cost of goods sold (including January 31, 2005
inventory write-down of $200,000)		638,847			489,819			1,062,535			710,255
		200,768			(98,910	)		369,946			(18,177	)
Expenses:
Depreciation and amortization		343,252			380,283			715,080			740,420
Engineering, research and development (note 2(b)(ii))		550,863			495,665			517,418			997,350
General and administrative (note 2(b)(ii))		686,370			800,911			526,803			1,380,042
Marketing (note 2(b)(ii))		365,195			410,726			781,403			907,513
		1,945,680			2,087,585			2,540,704			4,025,325
Loss from operations	$	(1,744,912	)	$	(2,186,495	)	$	(2,170,758	)	$	(4,043,502	)
Other earnings (expenses):
Interest income		61,656			1,307			135,102			1,791
Net interest and financing expense (note 3)		(1,669,366	)		(1,990,097	)		(19,300,802	)		(2,575,118	)
Loss on settlement of debt (note 8)		(214,274	)		-			(214,274	)		-
Derivative instrument (income/loss)		(211,733	)		-			(211,733	)		-
Foreign exchange gain (loss)		(73,376	)		71,345			(301,063	)		128,989
	$	(2,107,093	)	$	(1,917,445	)	$	(19,892,770	)	$	(2,444,338	)
Loss for the period		(3,852,005	)		(4,103,940	)		(22,063,528	)		(6,487,840	)
Basic and diluted loss per share	$	(0.01	)	$	(0.02	)	$	(0.08	)	$	(0.03	)
Weighted average number of common shares used in
the computation of basic and diluted loss per share		288,516,221			226,846,422			285,575,110			189,875,936

See accompanying notes to consolidated financial statements.

-3-

SMARTIRE SYSTEMS INC.

Consolidated Statement of Stockholders' Equity

(Deficiency) and Comprehensive Income (Loss)

(Expressed in United States dollars)

(Prepared in accordance with U.S. generally accepted accounting principles)

Six months ended January 31, 2006 (unaudited) and year ended July 31, 2005

	Common Shares			Additional		Deficit		Accumulated		Stockholders'		Comprehensive
		Shares	Amount	paid-in				other		equity		loss
				capital				comprehensive		(deficiency	)
								income (loss)
			$	$		$		$		$		$
Balance as at July 31, 2004		103,130,761	58,368,020	4,417,323		(59,018,256	)	(300,871	)	3,466,216		(10,719,543	)
Exercise of stock options for cash		6,059,998	787,800	(606,000	)	-		-		181,800		-
Conversion of convertible debentures and accrued interest to common
shares allocated pro-rata between additional paid-in-capital and common
shares		51,340,389	2,147,293	(648,644	)	-		-		1,498,649		-
Intrinsic value of beneficial conversion feature of convertible debt		-	-	11,005,243		-		-		11,005,243		-
Settlement of convertible debt		-	-	(671,642	)	-		-		(671,642	)	-
Intrinsic value of beneficial conversion feature of preferred shares		-	-	3,999,999		-		-		3,999,999		-
Financing cost related to preferred shares		-	-	(145,000	)	-		-		(145,000	)	-
Financing cost related to convertible debentures		-	-	(1,038,037	)	-		-		(1,038,037	)	-
Exercise of warrants for cash, net of issuance costs of $46,872		18,940,560	1,588,643	(1,017,299	)	-		-		571,344		-
Cash-less exercise of warrants		13,364,073	1,026,617	(1,026,617	)	-		-		-		-
Shares issued upon draw downs on equity line, net of issuance costs of
$515,170		78,887,710	2,505,766	410,420		-		-		2,916,186		-
Shares issued as placement fees on equity line of credit		75,188	10,000	-		-		-		10,000		-
Shares issued as compensation for services		6,764,205	261,578	-		-		-		261,578		-
Compensation expense		-	-	4,018,075		-		-		4,018,075		-
Loss for the period		-	-	-		(16,120,218	)	-		(16,120,218	)	(16,120,218	)
Translation adjustment		-	-	-		-		429,764		429,764		429,764
Balance as at July 31, 2005		278,562,884	66,695,717	18,697,821		(75,138,474	)	128,893		10,383,957		(15,690,454	)
Exercise of stock options for cash		860,000	111,800	(86,000	)	-		-		25,800		-
Exercise of warrants for cash		1,100,000	110,000	-		-		-		110,000		-
Conversion of convertible debentures and accrued interest to
common shares allocated pro-rata between additional paid-in
capital and common shares		7,123,772	306,352	(92,286	)	-		-		214,066		-
Settlement of convertible debentures		2,000,000	79,549	(41,895	)	-		-		37,654		-
Modification of convertible debenture (note 4(c))		-	-	(3,850,230	)	-		-		(3,850,230	)	-
Stock-based compensation recovery (note 2(b)(ii))		-	-	(1,944,175	)	-		-		(1,944,175	)	-
Amortization of financing fees		-	-	182,168		-		-		182,168		-
Loss for the period		-	-	-		(22,063,528	)	-		(22,063,528	)	(22,063,528	)
Translation adjustment		-	-	-		-		697,961		697,961		697,961
Balance as at January 31, 2006 (as restated - note 1)		289,646,656	67,303,418	12,865,403		(97,202,002	)	826,854		(16,206,327	)	(21,365,567	)

See accompanying notes to consolidated financial statements.

-4-

SMARTIRE SYSTEMS INC.

Consolidated Statement of Cash Flows

(Expressed in United States dollars)

(Prepared in accordance with U.S. generally accepted accounting principles)

Six months ended January 31, 2006 and 2005

(Unaudited)

		2006			2005
		(as restaed - note 1)
Cash provided (used for):
Operating activities:
Loss for the period	$	(22,063,528	)	$	(6,487,840	)
Items not affecting cash:
Depreciation and amortization		715,080			740,420
Unrealized (gain)/loss on derivative instruments		211,733			-
Stock-based compensation expense (recovery)		(1,944,175	)		172,588
Inventory write-down		-			200,000
Loss on settlement of debt		214,274
Non-cash interest and finance charges		17,618,031			2,462,652
Change in non-cash working capital:
Receivables		(251,005	)		(2,055	)
Inventory		290,384			(136,839	)
Prepaid expenses		(290,283	)		(66,314	)
Accounts payable and accrued liabilities		618,901			(582,618	)
Net cash used in operating activities		(4,880,588	)		(3,700,006	)
Investing activities:
Purchase of capital assets		(115,602	)		(25,510	)
Purchase of short-term investments		(3,299,084	)		-
Net cash used in investing activities		(3,414,686	)		(25,510	)
Financing activities:
Cash received on exercise of stock options		25,800			-
Cash received on exercise of warrants		110,000			546,788
Proceeds from equity line of credit		-			2,725,000
Proceeds from promissory notes		-			525,000
Proceeds from convertible debentures		-			2,695,000
Settlement of convertible debentures		(228,000	)		-
Financing costs		-			515,478
Repayment of promissory notes		-			(2,025,000	)
Net cash provided by financing activities		(92,200	)		4,982,266
Effect of exchange rate difference on cash and cash equivalents		606,330			(91,085	)
Net increase (decrease) in cash and cash equivalents		(7,781,144	)		134,709
Cash and cash equivalents, beginning of year		10,059,763			112,951
Cash and cash equivalents, end of period	$	2,278,619		$	247,660
Supplementary information:
Interest and finance charges paid	$	1,041,071		$	96,330
Non-cash investing and financing activities:
Conversion of convertible debentures to common shares		400,554			857,388
Shares issued for services		-			172,588

See accompanying notes to consolidated financial statements.

-5-

SMARTIRE SYSTEMS INC.

Notes to Consolidated Financial Statements

(Expressed in United States dollars)

(Unaudited)

(Prepared in accordance with U.S. generally accepted accounting principles)

Six months ended January 31, 2006 and 2005

1. Interim financial statements:

The consolidated financial statements include the accounts of the parent company and its subsidiaries after elimination of all inter-company balances and transactions. All subsidiaries are 100% owned.

The unaudited consolidated financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States (generally accepted accounting principles) for interim financial information and with the instructions for Form 10-QSB and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management all adjustments, including normal recurring adjustments, necessary for a fair presentation of the interim periods presented have been included. The interim results are not necessarily indicative of the operating results expected for the full fiscal year ending on July 31, 2006.

The Company has amended its Form 10-QSB for the period ended January 31, 2006 as previously filed on March 17, 2006.

The Company has had extensive discussions with the Staff of the Securities and Exchange Commission, related to the Company's accounting of its $30,000,000, 10% convertible debentures with Cornell Capital Partners, LP. The comments relate to the Company's accounting for its convertible debentures agreements which have warrants, conversion features and related registration rights with respect to Statement of Financial Accounting Standards (“SFAS”) No. 133 and Emerging Issues Task Force (“EITF”) 00-19. As a result of these discussions, the warrants, and registration rights agreement have now been for as derivative instrument liabilities, rather than as equity, and the conversion options related to the debentures held by Cornell, together with other embedded derivative instruments, have been bifurcated from the debt hosts and accounted for separately as derivative instrument liabilities. The Company has also received further comments from the Staff of the SEC relating to its accounting for the gain recorded upon the extinguishment of its $2.5 million, 5% convertible debenture, originally recorded in the period ended April 30, 2005, with respect to guidance in EITF 00-27, Issue 12(b). As a result of these comments and the Company's subsequent discussions with the SEC, the Company has amended its form 10-QSB’s for the periods ending April 30, 2005, and October 31, 2005 and have amended its Form 10-KSB/A for the year ended July 31, 2005, the conversion prices used in the calculation of the accounting gain to reflect that of the closing bid price of its common stock on the date of extinguishment. The Company has modified the accounting and footnote disclosure related to its debentures accordingly.

The effect of the (non-cash) charges related to accounting separately for these derivative instrument liabilities on the Company's consolidated statement of operations for the three and six months ended January 31, 2006 was an increase in its net loss of $2,592,162 for each period. Basic and diluted net loss per share for the three and six months ended January 31, 2006 increased by $0.01 to $0.02 and $0.09 per share respectively. The effect of the (non-cash) charges related to accounting separately for these derivative instrument liabilities on the Company's consolidated balance sheet as of January 31, 2006, and the carry forward charges related to the change in accounting methodology for the gain on extinguishment of convertible debt was an increase in the Company's derivative financial instrument liability of $7,061,963, a decrease in the Company's additional paid-in capital of $6,843,906 and an increase in the Company's accumulated deficit of $218,057.

The Company's consolidated financial statements have been prepared on the assumption that the Company will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The Report of the Independent Registered Public Accounting Firm on the financial statements of the Company as of and for the fiscal year ended July 31, 2005 included in Form 10-KSB contained an explanatory paragraph that expresses substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

As of January 31, 2006, the Company had an accumulated deficit of $97,202,002 and incurred a net loss of $22,063,528 for the six-month period ended January 31, 2006. As of January 31, 2006 the Company had cash and cash equivalents and short-term investments of $5,577,703, working capital of $8,105,233, a current ratio of 8.0, total assets of $12,474,276, total liabilities of $28,680,603, and a stockholders' deficiency of $16,206,327.

Although the Company has a $100 million Standby Equity Distribution Agreement with Cornell Capital Partners, it is uncertain when the Company will be permitted to draw down on the Standby Equity Distribution Agreement during the period that the outstanding principal and accrued and unpaid interest under the 10% convertible dentures remain outstanding as drawdowns are subject to an effective Registration statement. As a result, the Company may require additional financing to fund its operations. These consolidated financial statements have been prepared on the going concern basis which assumes that adequate sources of financing will be obtained as required and that the Company's assets will be realized and liabilities settled in the ordinary course of business. Accordingly, these consolidated financial statements do not include any adjustments related to the recoverability of assets and classification of assets and liabilities that might be necessary should the Company be unable to continue as a going concern. Interim unaudited financial results should be read in conjunction with the audited financial statements included in the SEC Report on Form 10-KSB, for the period ended July 31, 2005.

2. Significant accounting policies:

(a) Short-term investments:

Short-term investments are comprised of term deposits with varying maturities from 91 days to 12 months. All short-term investments are classified as held-to-maturity and are recorded at cost including accrued interest, which approximates fair market value, with changes going to the statement of operations.

(b) Stock-based compensation:

i. The Company has elected under FAS 123, Accounting for Stock-based Compensation, to account for employee stock options using the intrinsic value method. This method is described in Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As the Company grants stock options with an exercise price not less than the market value of the underlying common shares on the date of grant, no compensation expense is required to be recognized under APB 25 for fixed plan awards. If the exercise price of employee stock option award is not fixed in the functional currency of the Company or in the currency the employee is paid, the award is accounted for as a variable award until the award is exercised, forfeited, or expires unexercised. The Company measures compensation as the amount by which the quoted market value of the common shares of the Company's stock covered by the grant exceeds the option price, with changes in the market price included in the measurement of loss.

In accordance with FAS 148, the following table illustrates the effect on net loss and net loss per share as if the Company had applied the fair value recognition provisions of FAS 123. Because options vest over several years and additional option grants are expected to be made in future years, the pro forma results are not representative of the pro forma results for future periods.

-6-

SMARTIRE SYSTEMS INC.

Notes to Consolidated Financial Statements

(Expressed in United States dollars)

(Unaudited)

(Prepared in accordance with U.S. generally accepted accounting principles)

Six months ended January 31, 2006 and 2005

	Three Months Ended ��							Six Months Ended
		January 31,			January 31,			January 31,			January 31,
		2006 (as restated - note 1)			2005			2006 (as restated - note 1)			2005
Net loss:
As reported	$	(3,852,005	)	$	(4,103,940	)	$	(22,063,528	)	$	(6,487,840	)
Stock-based compensation recovery
recognized using intrinsic value
method		(310,200	)		-			(1,944,175	)		-
Stock-based compensation expense
determined under fair value based
method for all awards		(199,704	)		(1,076,635	)		(217,855	)		(1,083,012	)
Pro forma	$	(4,301,909	)	$	(5,180,575	)	$	(24,225,558	)	$	(7,570,852	)
Basic and diluted loss per share:
As reported		(0.01	)		(0.02	)		(0.08	)		(0.03	)
Pro forma		(0.01	)		(0.02	)		(0.08	)		(0.04	)

The Company recognizes compensation expense on a straight-line basis over the vesting period beginning on the date the stock option is granted.

The fair value of each option and warrant granted is estimated on the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions.

	January 31,	January 31,
	2006	2005
Expected dividend yield	0%	0%
Expected stock price volatility	144%	143%
Risk-free interest rate	3.50%	3.60%
Expected life options and warrants	5 years	5 years

The Company recognizes compensation expense for stock options, common stock and other instruments issued to non-employees for services received based upon the fair value of the equity instruments issued as the services are performed and the instrument is earned.

ii. During the six months ended January 31, 2006, the Company recorded a $1,944,175 (2005 - nil) recovery of stock compensation expense for variable awards which reduced engineering, research and development expenses by $760,122 (2005 - nil), general and administrative expenses by $1,134,077 (2005 - nil) and marketing expenses by $49,976 (2004 - nil).

(c) Recent accounting pronouncements:

In December 2004, the FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services, with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. This Statement is a revision to Statement 123 and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. The Company has not yet determined the effect that the adoption of this new statement will have on the Company's historical financial position or results of operations. This statement will be effective for the Company as of August 1, 2006.

In September 2005, the Emerging Issues Task Force ("EITF") issued EITF No.05-7, "Accounting for modifications to conversion options embedded in debt instruments and related issues." EITF 05-7 requires the Company to consider the change in the fair value of the embedded conversion option for any modified convertible debt when determining whether a substantial modification has occurred under the provisions of EITF 96-19. The provisions of EITF 05-7 are effective for the first interim or annual reporting period beginning after December 15,2005. The Company has adopted the provisions of EITF 05-7 effective August 1,2006.

3. Deferred financing costs:

As at July 31, 2005, the Company had deferred $16,084,086 of financing costs relating to its $160.0 million equity line of credit. As described in note 5, on September 23, 2005 the Company withdrew the Registration Statement previously filed on July 22, 2005 with the SEC. As a result of the withdrawal of the Registration Statement the Company did not have the ability to draw down on the $160.0 million equity line of credit. As further disclosed in note 5, it is currently not determinable when the Company will be able to draw down on the amended $100.0 million equity line of credit. For the six months ended January 31, 2006, the Company has charged $16,084,086 (2005 - nil) to the statement of operations as interest and financing expense.

-7-

SMARTIRE SYSTEMS INC.

Notes to Consolidated Financial Statements

(Expressed in United States dollars)

(Unaudited)

(Prepared in accordance with U.S. generally accepted accounting principles)

Six months ended January 31, 2006 and 2005

4. Convertible debentures:

		Redemption						Balance to be
		value of debt			Debt component			accreted to debt
Balance as at July 31, 2005	$	32,096,333		$	21,985,251		$	10,111,082
Conversions:
8% convertible debenture (note 4(b))		(115,000	)		(115,000	)		-
Discounted convertible debentures (note 4(b))		(189,511	)		(189,511	)		-
Modification
10% convertible debentures (note 4(c))		-			(3,000,000	)		3,000,000
Interest accretion:
10% convertible debentures (note 4(c))		-			1,304,693			(1,304,693	)
5% convertible debenture		-			19,137			(19,137	)
Balance as at January 31, 2006	$	31,791,822		$	20,004,570		$	11,787,252
Less: Current portion of convertible debentures		1,791,822			310,960			1,480,862
	$	30,000,000		$	19,693,610		$	10,306,390

As at January 31, 2006 the following convertible debentures with respective redemption values were outstanding:

i. $96,822 of the convertible debentures issued at a 22% original discount from the face principal amount on December 24, 2003;

ii. $195,000 of the 5% convertible debenture issued on December 15, 2004;

iii. $1,500,000 of the 5% convertible debenture issued on May 20, 2005;

iv. $30,000,000 of the 10% convertible debentures issued on June 23, 2005.

(a) As at January 31, 2006, the Company was in arrears on payments of principal and interest under its 5% convertible debenture issued on May 20, 2005 in the amount of $500,000 and $54,343 in principal and interest respectively. The Company has obtained an extension from the principal holder to defer all principal and interest payments under this convertible debenture until April 1, 2006.

(b) During the six months ended January 31, 2006, holders of the 8% convertible debentures converted the remaining $115,000 of principal and $19,627 of accrued interest into 4,286,665 common shares of the Company and holders of the discounted convertible debentures converted $171,165 of principal and $18,346 of accrued interest into 4,837,107 common shares of the Company.

(c) On December 30, 2005, the Company amended certain of its terms and conditions relating to the $30,000,000, 10% convertible debentures entered into on June 23, 2005. Terms and conditions have been amended as follows:

i. Principal and interest payments due in cash are eliminated during the term of the debentures;

ii. Debentures are convertible into shares of Common Stock at the option of the Holder at the lesser of $0.1125 and a 4.5% discount to market. Market is based on the lowest Closing Bid Price of the Common Stock for the five (5) trading days immediately preceding the date the conversion notice is provided;

iii. If at the end of the three year term, the debentures are not fully converted, the debenture holders must convert the balance due into shares of the Company up to their beneficial ownership limitation of 4.9%, which may be waived provided the debenture holders provide the Company with 65 days notice. The remaining balance is due in cash by the Company;

iv. Interest is payable in shares of the Company's Common Stock and is calculated as ninety-five and one-half percent (95.5%) of the 5 day average of the Closing Bid Price of the Common Stock for the five (5) trading days immediately preceding the date the interest conversion is made;

v. The Company has the right to redeem all or any portion of the outstanding principal and accrued interest under the convertible debentures at a 20% premium prior to the Maturity Date provided that our Closing Bid Price as reported by Bloomberg, LP, is less than the Fixed Conversion Price at the time of the Redemption Notice. The Debenture holder shall receive a warrant to purchase one million (1,000,000) shares of the Company's Common Stock for every One Hundred Thousand Dollars ($100,000) redeemed, pro rata (the "Warrant"). The Warrant shall be exercisable on a "cash basis" and have an exercise price of one hundred ten percent (110%) of the Closing Bid Price of our Common Stock on the date the Company provides the Redemption Notice.

The Company filed a Registration Statement on Form SB-2 on January 11, 2006 and subsequently an amended Registration Statement on Form SB-2/A on February 27, 2006 to register the underlying securities. As of the date of these financial statements this Registration Statement has not yet been declared effective by the SEC. Previously, the Company had been in violation of certain terms of its original debentures due to the withdrawal of the Registration Statement on Form SB-2 on September 23, 2005 which was filed on July 22, 2005 to register the underlying securities under the terms of the original debentures.

-8-

SMARTIRE SYSTEMS INC.

Notes to Consolidated Financial Statements

(Expressed in United States dollars)

(Unaudited)

(Prepared in accordance with U.S. generally accepted accounting principles)

Six months ended January 31, 2006 and 2005

The Company has reviewed the amended terms of the $30 million convertible debentures under the provisions in EITF 00-19 and FAS 133 and determined that the convertible debentures do not meet the definition of conventional convertible debt under EITF 00-19. As a result, the warrants combined with its registration rights agreement and conversion feature combined with its registration rights agreement should be accounted for as derivatives under FAS 133 and have been relcassified from equity to liabilities. Under FAS 133 derivative instruments will be accounted for at fair value with the change in fair value recorded as a charge or credit to the statement of operations (note 5).

5. Derivative financial instrument liability:

The Company uses the Black-Scholes option pricing model to estimate the fair value of the warrants and their related registration rights. As at January 31, 2006, the Company used the market price of its common stock on the date of valuation, an expected dividend yield of 0% and the remaining period to the expiration date of its warrants to fair value the warrants.

For the conversion feature relating to the convertible debenture and its related registration rights agreement, the Company used valuation models based on the share price of the Company and other relevant assumptions in order to estimate the fair value.

As of January 31, 2006, the Company has recorded an aggregate of $7,061,963 relating to the fair value of the warrants, embedded conversion feature and registration rights agreement with respect to its $30,000,000, 10% convertible debentures.

6. Standby equity distribution agreements:

On June 23, 2005, the Company entered into a $160.0 million equity line of credit with Cornell Capital. On September 23, 2005, the Company formally requested that the Registration Statement on Form SB-2 previously filed with the SEC on July 22, 2005 be withdrawn. The Registration Statement was not previously declared effective by the SEC and no securities were sold pursuant to the Registration Statement.

On December 30, 2005, the Company entered into an agreement to terminate its $160.0 million Standby Equity Distribution Agreement ("SEDA") and enter into a new $100.0 million SEDA with Cornell Capital. Terms of the agreement are the same as the previous agreement except for the following:

i. Term of the agreement is five years from the date of effectiveness;

ii. Fees on draw downs reduced to 2.5% from 5%;

iii. The registration statement to be filed on a date mutually agreed to by the Company and the Investor.

The Company has not registered the equity line of credit. The Company may not request advances under the $100.0 million equity line of credit until the underlying shares of its common stock are registered with the SEC and it is uncertain whether it will register such underlying shares until all of the outstanding principal and accrued and unpaid interest on the 10% convertible debentures have been either converted by the holders or paid in full by the Company, which must occur on or before July 23, 2008. The term of the $100.0 million SEDA is to commence on the date a registration statement covering the underlying shares becomes effective and will expire five years after such date. Due to the uncertainty as to when the Company will be able to access its equity line, it has expensed fees related to the $160.0 million equity line of credit.

7. Share capital:

Authorized:

Unlimited number of common shares with no par value 100,000 preferred shares, issuable in series

Common shares issued and fully paid:
	Number of
	shares	Amount
Balance at July 31, 2005	278,562,884	66,695,717
Common shares issued upon conversion of convertible debentures	7,123,772	306,352
Common shares issued upon settlement of convertible debentures	2,000,000	79,549
Common shares issued upon exercise of warrants	1,100,000	110,000
Common shares issued on exercise of employee stock options	860,000	111,800
Balance at January 31,2006	289,646,656	67,303,418

8. Segmented information:

The Company operates in the wireless vehicle industry. Management of the Company makes decisions about allocating resources based on this one operating segment. Geographic information is as follows:

-9-

SMARTIRE SYSTEMS INC.

Notes to Consolidated Financial Statements

(Expressed in United States dollars)

(Unaudited)

(Prepared in accordance with U.S. generally accepted accounting principles)

Six months ended January 31, 2006 and 2005

Revenue from external customers:

		Three months ended				Six months ended
		January 31,2006		January 31,2005		January 31,2006		January 31,2005
United States	$	489,256	$	139,187	$	762,275	$	252,542
United Kingdom		266,344		191,254		490,633		349,693
Other		84,015		60,468		179,573		89,843
	$	839,615	$	390,909	$	1,432,481	$	692,078

As at January 31, 2006, 83% (July 31, 2005-52%) of the Company's fixed assets were in Canada, 17% (July 31, 2005 - 18%) were in Europe and nil were in Korea (July 31, 2005 - 30%).

Major customers, representing 10% or more of total sales, include:

	Three months ended				Six months ended
		January 31,2006		January 31,2005		January 31,2006		January 31,2005
Customer A	$	366,292	$	-	$	524,466	$	-
Customer B		258,168		154,925		452,294		289,352
Customer C		101,796		55,735		165,101		108,563

9. Loss on settlement of debentures:

On December 24, 2005, the Company signed a Settlement Agreement and Mutual Release with a convertible debenture holder that had previously provided the Company with notice of a summons with the Supreme Court of the State of New York. The holder had alleged the Company had refused to honor its request to convert the value of the debt of $91,726 into 9,268,875 common shares of the Company.

Consideration consisted of 2,000,000 common shares of the Company, representing a partial exercise of the debenture at the set conversion price of $0.028 per share plus $250,000 (less withholding taxes of $22,000) payable to the holder of the debenture, representing payment of the balance of the debenture and other good and valuable consideration. For accounting purposes, the Company has recorded a loss on settlement of debt of $214,274, which represents the aggregate consideration provided less the face value of the debt.

The holder was previously seeking $4,393,360 plus interest from April 25, 2005 and attorneys fees.

10. Related party transactions:

(a) During the six months ended January 31, 2006, the Company paid $900,000 (net of $100,000 of withholding taxes) in interest payments to Cornell Capital for interest due on the $30,000,000 convertible debentures. Cornell Capital is considered a related party from a financial perspective due to the number and size of the financial transactions that have been entered into with the Company. Cornell Capital does not have influence over the Company's operating or investing activities.

(b) During the six months ended January 31, 2006, the Company paid $120,000 (2005 - nil) in consulting fees to the Company's Chairman pursuant to a consulting agreement entered into on June 30, 2005.

11. Contingency:

On January 30, 2006 the Company was served with a demand for arbitration by Travel Technology Innovations LLC ("TTI"). The demand for arbitration resulted from the Company's January 1, 2006 termination of the Sales and Distribution agreement signed with TTI on March 12, 2005 and seeks damages for potential lost profits of $1,000,000. As of January 31, 2006 it is not possible to determine the outcome of the arbitration and no amount has been recorded in the financial statements as a potential liability.

12. Subsequent event:

Subsequent to quarter-end, the Company received a Notice of Conversion from the sole remaining holder of the discounted convertible debenture to convert the remaining outstanding principal of $96,822 into 3,474,857 common shares of the Company.

13. Differences between Canadian and United States Generally Accepted Accounting Principles and Practices:

These consolidated financial statements have been prepared in accordance with accounting principles and practices generally accepted in the United States ("US GAAP") which differ in certain respects from those principles and practices that the Company would have followed had its consolidated financial statements been prepared in accordance with accounting principles and practices generally accepted in Canada ("Canadian GAAP").

(a) Under U.S. GAAP, the adoption of U.S. dollar in 2001 as reporting currency was implemented retroactively, such that prior period financial statements were translated under the current rate method using foreign exchange rates in effect on those dates. Under Canadian GAAP, a change in reporting currency is implemented by translating all prior year financial statement amounts at the foreign exchange rate on the date of change in reporting currency, which was July 31, 2001. As a result, there is a difference in share capital, deficit and cumulative translation adjustment amount under Canadian GAAP as compared to US GAAP.

-10-

SMARTIRE SYSTEMS INC.

Notes to Consolidated Financial Statements

(Expressed in United States dollars)

(Unaudited)

(Prepared in accordance with U.S. generally accepted accounting principles)

Six months ended January 31, 2006 and 2005

(b) Under U.S. GAAP, the Company has elected to continue to apply the guidance set out in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretation in accounting for its employee stock option. As the Company grants options with an exercise price not less than the market value of the underlying common shares on the date of grant, no compensation expense is required to be recognized under APB 25. If the exercise price of employee stock option award is not fixed in the functional currency of the Company or in the currency the employee is paid, the award is accounted for as variable award until the award is exercised, forfeited, or expires unexercised. The Company measures compensation expense as the amount by which the quoted market value of the common shares of the Company's common stock covered by the grant exceeds the option price, with changes in the market price included in the measurement of loss.

Prior to 2003, under Canadian GAAP, no compensation was recorded for employee options. Subsequent to August 1, 2003, the Company elected to use the fair-value based method under Canadian GAAP, on a prospective basis, to record compensation expense for options. Had the Company determined compensation expense for option grants made to employees after July 31, 2002 based on the fair values at grant dates of the stock options consistent with the fair value method, the Company's loss and loss per share would have been as follows:

	Three Months Ended						Six Months Ended
		January 31,			January 31,			January 31,			January 31,
		2006 (as restated - note 1)			2005			2006 (as restated - note 1)			2005
Net loss:
In accordance with Canadian GAAP (note 13(d))	$	(4,127,091	)	$	(4,898,266	)	$	(23,749,000	)	$	(6,870,276	)
Stock-based com pensation expense
included in reported net loss		199,704			1,074,986			217,855			1,084,774
Stock-based com pensation expense
determined under fair value based
method for all awards		(199,704	)		(1,076,635	)		(217,855	)		(1,083,012	)
Pro forma	$	(4,127,091	)	$	(4,899,915	)	$	(23,749,000	)	$	(6,868,514	)
Basic and diluted loss per share:
As reported		(0.01	)		(0.02	)		(0.08	)		(0.03	)
Pro forma		(0.01	)		(0.02	)		(0.08	)		(0.04	)

(c) Under U.S. GAAP, the proceeds from the issuance of convertible debentures, which are considered to be conventional convertible debt as defined in EITF 00-19, with detachable warrants are allocated to the fair value of warrants issued and intrinsic value of beneficial conversion feature.  The remaining proceeds are allocated to debt which is being accreted to the redemption value of the convertible debentures over the maturity period.  On the date of conversion of debt to equity, the difference between the carrying amount and redemption amount is charged to statement of operations as interest expense. Convertible debentures, which do not meet the definition of conventional convertible debt as defined in EITF 00-19 and any warrants and registration rights agreement issued in connection with the debt agreements are accounted for as derivative instrument liabilities rather than as equity, and the conversion options related to the debt, together with other embedded derivative instruments, have been bifurcated from the debt hosts and accounted for separately as a derivative instrument in liabilities.

Under Canadian GAAP, the proceeds from the issuance of convertible debentures with detachable warrants are allocated to the warrants issued and the beneficial conversion feature based on their fair values. The remaining proceeds are allocated to debt which is then being accreted to the redemption value of the convertible debentures over the maturity period. On the date of conversion of debt to equity, the carrying value of debt is reclassified to equity with no additional interest accretion. When the Company has the option of repaying the convertible debentures in cash or its common shares, the entire principal amount of is recorded as equity. The principal equity is accreted to the redemption value of the convertible debentures over the maturity period and is charged to deficit.

(d) Under US GAAP, the discount on convertible debt is netted against the value of debenture, and debt issuance cost is recorded as deferred financing cost and is amortized over the maturity period. Under Canadian GAAP, the discount is recorded as deferred financing cost and is being amortized over the maturity period. Debt issuance cost is charged to equity.

(e) Under U.S. GAAP the modification of the terms of the $30 million convertible debentures reduces the carrying value of the original debentures by an amount equal to the change in the fair value of the embedded conversion option. Under Canadian GAAP, as the modification of the terms of the debentures does not represent a settlement but a renegotiation of the debt instrument, no adjustment has been made to the carrying value of the $30 million convertible debentures.

-11-

SMARTIRE SYSTEMS INC.

Notes to Consolidated Financial Statements

(Expressed in United States dollars)

(Unaudited)

(Prepared in accordance with U.S. generally accepted accounting principles)

Six months ended January 31, 2006 and 2005

	January 31,2006					July 31,2005
		Canadian		U.S.			Canadian		U.S.
Consolidated balance sheets		GAAP		GAAP			GAAP		GAAP
			(as restated - note 1)
Current assets	$	9,271,319	$	9,271,319		$	13,292,487	$	13,292,487
Capital assets		775,017		775,017			716,763		716,763
Deferred financing costs		109,700		1,906,864			16,206,086		18,209,280
Other assets		521,076		521,076			1,066,013		1,066,013
Current liabilities		1,166,086 18		1,166,086			1,649,690		5,781,918
Long term convertible debentures		2,994,144		20,449,774			1,272,123		17,118,667
Preferred shares subject to
mandatory redemption		2,780		2,780			1		1
Derivative liability		-		7,061,963			-		-
Stockholders' equity (deficiency)		6,514,102		(16,206,327	)		28,359,535		10,383,957

	Three Months Ended						Six Months Ended
		January 31,			January 31,			January 31,			January 31,
Consolidated statement of operations and deficit:		2006			2005			2006			2005
	(as restated - note 1)						(as restated - note 1)
Net loss in accordance with U.S. GAAP	$	(3,852,005	)	$	(4,103,940	)	$	(22,063,528	)	$	(6,487,840	)
Effects of difference in accounting for:
Stock based compensation recovery under US. GAAP (b)		(310,200	)		-			(1,944,175	)		-
Stock based compensation expense under Canadian GAAP (b)		(199,704	)		(1,074,986	)		(217,854	)		(1,084,774	)
lnterest accretion and amortization of debenture finance
costs recorded under U.S. GAAP (b)(d)		1,669,366			1,529,505			19,300,502			2,081,921
Interest accretion and amortization of debenture finance
costs under Canadian GAAP (d)		(1,434,548	)		(1,248,845	)		(18,823,945	)		(1,379,583	)
Net loss in accordance with Canadian GAAP		(4,127,091	)		(4,898,266	)		(23,749,000	)		(6,870,276	)
Beginning deficit in accordance with Canadian GAAP		(84,686,310	)		(54,337,248	)		(65,064,401	)		(51,971,332	)
Interest on convertible debentures and amortization of
finance charges		-			(299,314	)		-			(693,220	)
Ending deficit in accordance with Canadian GAAP		(88,813,401	)		(59,534,828	)		(88,213,401	)		(59,534,828	)
Basic and diluted loss per share
(in accordance with Canadian GAAP)	$	(0.01	)	$	(0.02	)	$	(0.08	)	$	(0.04	)

-12-

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS

OVERVIEW

The following discussion of our financial condition, changes in financial condition and results of operations for the three and six months ended January 31, 2006 and 2005 should be read in conjunction with our most recent audited annual financial statements for the financial year ended July 31, 2005, the unaudited interim financial statements included herein, and, in each case, the related notes.

We have three wholly owned subsidiaries: SmarTire Technologies Inc., SmarTire USA Inc. and SmarTire Europe Limited. SmarTire Technologies Inc. was incorporated on June 3, 1988 under the laws of the Province of British Columbia, and was the original developer of our patented technology. SmarTire USA Inc., a Delaware corporation incorporated on May 16, 1997, is our exclusive marketing agency for SmarTire in North America. SmarTire Europe Limited, a United Kingdom corporation incorporated on February 25, 1998, is our exclusive sales and distribution operation for Europe.

We are a "foreign private issuer," as such term is defined in Rule 3b-4 under the Securities Exchange Act of 1934. However, we have elected to file with the SEC Annual Reports on Form 10-KSB, Quarterly Reports on Form 10-QSB and Current Reports in Form 8-K.

We develop and market technically advanced tire pressure monitoring systems ("TPMSs") for the transportation and automotive industries that monitor tire pressure and tire temperature. Our TPMSs are designed for improved vehicle safety, performance, reliability and fuel efficiency.

Although we currently sell only TPMSs for passenger cars, buses, recreational vehicles, trucks and motorcycles, our vision is to become a preeminent provider of wireless sensing and control systems for the vehicle industry. Our vision may be extended to three basic types of systems: sensing, control and system applications.

Sensing Applications

Our vision is to commercialize a wide array of sensors, compatible with our TPMSs for the vehicle industry. We developed a receiver module with Vansco Electronics LP that functions as a "wireless gateway" that we began shipping to customers in August 2005. This receiver module can wirelessly receive signals from up to 256 new sensors in addition to signals from tire pressure sensors. The data from these sensors can then be placed on the vehicle, bus or on a display module. This ensures that the driver, maintenance group or monitoring agencies have access to the sensor data as required. In addition to tire pressure monitoring, customers would have the ability to access far more data on their vehicle. This translates to a higher value proposition to the customer, while giving us the ability to sell more products. We plan to develop one additional application in the next year that can be integrated into our receiver module.

Control Applications

A natural evolution of our product family is to use the "wireless gateway" module to not only receive signals from sensors but to act on the data received.

The basic premise is based on using sensors to interpret a condition and then have the "wireless gateway" module send a control signal to a device to perform a specified action based on the sensor output. For example, when the "wireless gateway" module receives data from a tire sensor it can control a "horn" to provide an audible warning, activate a lamp or provide information to a vehicle display control.

We have trademarked our wireless gateway product line as the SmartWave(TM) brand. The SmartWave brand will apply to all products developed under our wireless gateway architecture and we are currently evaluating a number of other control applications.

Government Regulations

Our products are subject to regulation by the government agencies responsible for radio frequencies in each country that our TPMSs will be sold. For example, in the United States approval must be received from the Federal Communications Commission for each product. Some countries require additional governmental approvals in certain circumstances. For example, in the United Kingdom, all electronic equipment to be installed in emergency and police vehicles must be approved by the Vehicle Installation Development Group, a governmental body. Also, as a practical matter, certain non-governmental approvals may be necessary for market acceptance of our products in certain countries. For example, the approval of TUV (an independent testing company) is considered necessary to market our TPMSs in Germany.

We believe that we have all of the necessary governmental approvals for our current TPMSs in our intended market countries. As each new TPMSs is introduced to the market, we intend to apply for the necessary approvals.

Our direct measurement TPMSs generally exceeds the standard for tire pressure monitoring established by the National Highway Transportation Safety Administration ("NHTSA"). Accordingly, we believe the auto manufacturers must accelerate their implementation plans in order to meet these new NHTSA regulations, which will create additional opportunities to market our products to OEMs in the automobile industry. In addition, although the Transportation Recall Enhancement, Accountability, and Documentation Act of 2000 ("TREAD Act") only applies to passenger automobiles, we believe that other motor vehicles, including medium and heavy trucks, buses and motorcycles will be impacted by this legislation in subsequent years. We also believe that compliance with the TREAD Act by European, Japanese, Chinese and other automakers will accelerate the adoption of TPMSs globally.

It is difficult to predict the magnitude of the expected sales increase or the exact timing of the increase since our products will continue to face competition from other TPMSs manufactured by our competitors, and the timing of additional legislative initiatives on tire safety, if any, in the United States and abroad remains uncertain. We expect that as TPMSs become standard equipment for new passenger vehicles, demand for TPMSs as dealer installed options and aftermarket products will gradually decline.

On November 21, 2005 we entered into a manufacturing agreement with Vansco Electronics LP. Under the agreement, Vansco will manufacture key subsystems for our wireless gateway family of products. Vansco specializes in the design and manufacturing of electronic, electro-mechanical and electro-hydraulic controls and instrumentation and offers engineering design expertise in system integration, hardware, software, wire harness and electronics packaging.

On November 21, 2005, we and Hyundai Autonet Company, Ltd ("HACO") mutually terminated our contract manufacturing agreement entered into in October 2003. This termination was a result of HACO's acquisition by Hyundai Motor Company. The termination has not impacted our business, nor were there any costs of termination.

-13-

RESULTS OF OPERATIONS

Three months ended January 31, 2006 and January 31, 2005

Revenue

Gross revenue for the three months ended January 31, 2006 increased to $839,615 from $390,909 for the three months ended January 31, 2005. The breakdown of the sources of our gross revenue is as follows:

·   Sales of OEM TPMSs for use on buses were $388,525 for the three months ended January 31, 2006 compared to $0 for the three months ended January 31, 2005. Sales of this product include sales to OEMs for installation on new and existing buses. Although we anticipate an increase in sales of this product, it is difficult for us to predict what the volume of sales will be in this market.

·   Sales of aftermarket TPMSs for use on buses were $6,845 for the three months ended January 31, 2006 compared to $5,389 for the three months ended January 31, 2005. Although we anticipate as increase in sales of this product, it is difficult for us to predict what the volume of sales will be in this market.

·   Sales of OEM passenger car TPMSs increased to $258,368 for the three months ended January 31, 2006 from $171,531 for the three months ended January 31, 2005. The increase was primarily due to an increase in sales to Aston Martin, Ford's flagship division. We anticipate sales of this product to continue to increase as we are now on a third platform of Aston Martin.

·   Sales of aftermarket passenger car TPMSs increased to $35,657 for the three months ended January 31, 2006 from $35,161 for the three months ended January 31, 2005. It is difficult for us to predict what the volume of sales of this product will be.

·   Sales of OEM recreational vehicle TPMSs increased to $72,820 for the three months ended January 31, 2006 from $36,830 for the three months ended January 31, 2005. We anticipate sales of this product to the OEM market to continue to increase.

·   Sales of aftermarket recreational vehicle TPMSs decreased to $59,170 for the three months ended January 31, 2006 from $69,764 for the three months ended January 31, 2005. We anticipate sales of this product to increase substantially during the remainder of the fiscal year; however it is difficult for us to predict what the volume of sales will be.

·   Sales of OEM TPMSs for use on truck vehicles were $0 for the three months ended January 31, 2006 compared to $3,653 for the three months ended January 31, 2005. The majority of these systems are currently being used for test purposes. Although interest in this product is high, it is difficult for us to predict what the volume of sales will be, as this will depend primarily on market acceptance.

·   Sales of TPMSs for use on trucks were $2,700 for the three months ended January 31, 2006 compared to $17,660 for the three months ended January 31, 2005. The majority of these systems are currently being used for test purposes. Although interest in this product is high, it is difficult for us to predict what the volume of sales will be, as this will depend primarily on market acceptance.

·   Sales of aftermarket motorcycle TPMSs decreased to $3,912 for the three months ended January 31, 2006 from $29,285 for the three months ended January 31, 2005. As sales to this market are seasonal, we anticipate sales to increase during our quarter ended April 30, 2006; however it is difficult for us to predict what the volume of sales will be in this market. o Sales of miscellaneous products were $11,618 for the three months ended January 31, 2006 compared to $21,636 for the three months ended January 31, 2005.

Gross Margin

Gross margin on product sales increased to 24% for the three months ended January 31, 2006 from -25% for the three months ended January 31, 2005. The negative margin for the three months ended January 31, 2005 was due to an inventory write-down of $200,000 for slow moving aftermarket passenger car TPMSs. Without the inventory write-down, our gross margin would have been 26% for the three months ended January 31, 2005. Excluding the inventory write-down for the three months ended January 31, 2005, our gross margin decreased by 2%. The decrease occurred as the product mix of TPMSs sold in the three months ended January 31, 2006 had lower gross margins than the product mix of TPMSs sold in the three months ended January 31, 2005. We anticipate our gross margin to increase as our sales volumes increase as we expect we will be able to achieve lower costs with higher sales volumes.

Expenses

Expenses decreased to $1,945,680 for the three months ended January 31, 2006 from $2,087,585 for the three months ended January 31, 2005. Excluding a stock-based compensation recovery of $310,200, operating expenses increased by $168,295 to $2,255,880 for the three months ended January 31, 2006. The stock-based compensation recovery resulted as the market value of our vested options decreased during the three months ended January 31, 2006 as discussed in note 2 (b) (ii) to the financial statements.

Engineering, research and development expenses increased to $550,863 for the three months ended January 31, 2006 from $495,665 for the three months ended January 31, 2005. Excluding a stock-based compensation recovery of $118,926 recorded in the three months ended January 31, 2006, engineering, research and development expenses increased by $174,124 to $669,789. The increase, excluding the stock-based compensation recovery, was mainly due to an increase in wage expense which resulted from an increase in the number of engineering related employees. In addition we incurred higher rent and utility expenses as we leased additional space to accommodate the additional engineering related employees. The increase was partially offset by a decrease in product testing expenses.

Marketing expenses decreased to $365,195 for the three months ended January 31, 2006 from $410,726 for the three months ended January 31, 2005. Excluding a stock-based compensation recovery of $11,494 recorded in the three months ended January 31, 2006, marketing expenses decreased by $34,037 to $376,689. The decrease, excluding the stock-based compensation recovery, was a result of lower wage expense as a result of less sales and marketing employees for the three months ended January 31, 2006 than the three month period ended January 31, 2005. The decrease was partially offset by higher advertising and promotion costs and increased attendance at trade shows.

General and administrative expenses decreased to $686,370 for the three months ended January 31, 2006 from $800,911 for the three months ended January 31, 2005. Excluding a stock-based compensation recovery of $179,780 recorded in the three months ended January 31, 2006, general and administrative expenses increased by $65,239 to $866,150. The increase, excluding the stock-based compensation recovery, was mainly a result of higher professional fees and higher investor relations costs. The increase in professional fees was primarily due to the cost of legal services incurred to defend against a lawsuit from a debenture holder, the cost of restructuring both our $30 million 10% convertible debentures issued on June 23, 2005 by us to Cornell Capital Partners, LP and our $160 million equity line of credit entered into in June 2005, issued to us by Cornell Capital Partners, LP., which was replaced with a new $100 million Standby Equity Distribution Agreement on December 30, 2005 and the cost of filing a registration statement on January 11, 2005 and an amended registration statement on February 27, 2005 with the Securities and Exchange Commission to register our debentures.

Depreciation and amortization expense decreased to $343,252 for the three months ended January 31, 2006 from $380,283 for the three months ended January 31, 2005.

Interest and finance charges increased to $4,261,528 for the three months ended January 31, 2006 from $1,990,097 for the three months ended January 31, 2005. Non-cash interest and finance charges for the three months ended January 31, 2006 were $921,864 compared to $2,828,728 for the three months ended January 31, 2005.

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Interest Income

Interest income of $61,656 was earned for the three months ended January 31, 2006 as compared to $1,307 for the three months ended January 31, 2005 and was the result of higher average cash balances during the three months ended January 31, 2006.

Loss on settlement of debt

A loss on the settlement of debt of $214,274 was incurred for the three months ended January 31, 2006 as compared to nil for the three months ended January 31, 2005. The loss on settlement of debt represents the aggregate consideration provided less the face value of the debt. The settlement of debt is described in greater detail under Item 1-Legal Proceedings.

Derivative instrument loss

A derivative instrument loss of $211,733 was incurred for the three months ended January 31, 2006. The derivative instrument income loss represents the mark to market adjustment on derivative instruments.

Foreign exchange loss

A foreign exchange loss of $73,376 was incurred for the three months ended January 31, 2006 as compared to a foreign exchange gain of $71,345 for the six months ended January 31, 2005. We are adversely impacted by a lower $US against the $CDN as a significant portion of our operations are paid in Canadian dollars. Foreign exchange gains or losses are due to fluctuations in currency exchange rates and are impossible to predict.

Six months ended January 31, 2006 and January 31, 2005

Revenue

Gross revenue for the six months ended January 31, 2006 increased to $1,432,481 from $692,078 for the six months ended January 31, 2005. The breakdown of the sources of our gross revenue is as follows:

·   Sales of OEM TPMSs for use on buses were $551,393 for the six months ended January 31, 2006 compared to $0 for the six months ended January 31, 2005. Sales of this product include sales to OEMs for installation on new and existing buses. Although it is difficult for us to predict what the volume of sales of this product will be, we anticipate sales of this product to continue to increase.

·   Sales of aftermarket TPMSs for use on buses were $8,842 for the six months ended January 31, 2006 compared to $5,389 for the six months ended January 31, 2005. Although we anticipate an increase in sales of this product, it is difficult for us to predict what the volume of sales will be in this market.

·   Sales of OEM passenger car TPMSs increased to $481,689 for the six months ended January 31, 2006 from $318,793 for the six months ended January 31, 2005. The increase was primarily due to an increase in sales to Aston Martin, Ford's flagship division. We anticipate sales of this product to continue to increase as we are now on a third platform of Aston Martin. o Sales of aftermarket passenger car TPMSs increased to $100,830 for the six months ended January 31, 2006 from $82,162 for the six months ended January 31, 2005. It is difficult for us to predict what the volume of sales of this product will be.

·   Sales of OEM recreational vehicle TPMSs increased to $125,763 for the six months ended January 31, 2006 from $62,052 for the six months ended January 31, 2005. We anticipate sales of this product to the OEM market to continue to increase.

·   Sales of aftermarket recreational vehicle TPMSs decreased to $97,082 for the three months ended January 31, 2006 from $121,433 for the six months ended January 31, 2005. We anticipate sales of this product to increase substantially during the remainder of the fiscal year, however it is difficult for us to predict what the volume of sales will be.

·   Sales of OEM TPMSs for use on trucks vehicles were $3,750 for the six months ended January 31, 2006 compared to $3,653 for the six months ended January 31, 2005. The majority of these systems are currently being used for test purposes. Although interest in this product is high, it is difficult for us to predict what the volume of sales will be, as this will depend primarily on market acceptance.

·   Sales of aftermarket TPMSs for use on trucks were $8,858 for the six months ended January 31, 2006 compared to $28,449 for the six months ended January 31, 2005. The majority of these systems are currently being used for test purposes. Although interest in this product is high, it is difficult for us to predict what the volume of sales will be, as this will depend primarily on market acceptance.

·   Sales of aftermarket motorcycle TPMSs decreased to $11,269 for the six months ended January 31, 2006 from $46,019 for the six months ended January 31, 2005. As sales to this market are seasonal, we anticipate sales to increase starting in April 2006; however it is difficult for us to predict what the volume of sales will be in this market.

·   Sales of miscellaneous products were $43,005 for the six months ended January 31, 2006 compared to $24,128 for the six months ended January 31, 2005.

Gross Margin

Gross margin on product sales increased to 26% for the six months ended January 31, 2006 from -3% for the six months ended January 31, 2005. The negative margin for the six months ended January 31, 2005 was due to an inventory write-down of $200,000 for slow moving aftermarket passenger car TPMSs Without the inventory write-down our gross margin would have been 26% for the six months ended January 31, 2005. We anticipate our gross margin to increase as our sales volumes increase as we expect we will be able to achieve lower costs with higher sales volumes.

Expenses

Expenses were $2,540,704 for the six months ended January 31, 2006, compared to expenses of $4,025,325 for the six months ended January 31, 2005. Excluding stock-based compensation recovery of $1,944,175 recorded in the six months ended January 31, 2006, operating expenses would have increased by $459,554 to $4,484,879 for the six months ended January 31, 2006. The stock-based compensation recovery resulted as the market value of our vested options decreased during the three months ended January 31, 2006 as discussed in note 2 (b) (ii) to the financial statements.

Engineering, research and development expenses for the six months ended January 31, 2006 decreased to $517,418 from $997,350 for the six months ended January 31, 2005. Excluding a stock-based compensation recovery of $760,122 recorded in the six months ended January 31, 2006, engineering, research and development expenses increased by $280,190 to $1,277,540 for the six months ended January 31, 2006. The increase, excluding the stock-based compensation recovery, was mainly due to an increase in wage expense which resulted from an increase in the number of engineering related employees. We also incurred higher travel costs which were a result of an increase in application engineering required to install our TPMS at our new customers and to set up our manufacturing in the US with Vansco. In addition higher rent and utility expenses were incurred as we leased additional space to accommodate additional engineering related employees. The increase was partially offset by a decrease in prototype development expenses.

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Marketing expenses for the six months ended January 31, 2006 decreased to $781,403 from $907,513 for the six months ended January 31, 2005. Excluding a stock-based compensation recovery of $49,976 recorded in the six months ended January 31, 2006, marketing expenses decreased by $76,134 to $831,379 for the six months ended January 31, 2006. The decrease, excluding the stock-based compensation recovery, was a result of lower wage expense as a result of less sales and marketing employees for the three months ended January 31, 2006 than the three month period ended January 31, 2005. The decrease was partially offset by higher advertising and promotion costs.

General and administrative expenses for the six months ended January 31, 2006 decreased to $526,803 from $1,380,042 for the six months ended January 31, 2005. Excluding a stock-based compensation recovery of $1,134,077 recorded in the six months ended January 31, 2006, general and administrative expenses increased to $1,660,880 for the six months ended January 31, 2006. The increase, excluding the stock-based compensation recovery, was mainly a result of increased professional fees and higher investor relation costs. The increase in professional fees was primarily due to the cost of legal services incurred to defend against a lawsuit from a debenture holder, the cost of restructuring both our $30 million 10% convertible debentures issued on June 23, 2005 by us to Cornell Capital Partners, LP and our $160 million equity line of credit entered into in June 2005, issued to us by Cornell Capital Partners, LP., which was replaced with a new $100 million Standby Equity Distribution Agreement on December 30, 2005 and the cost of filing a registration statement on January 11, 2005 and an amended registration statement on February 27, 2005 with the Securities and Exchange Commission to register our debentures.

Depreciation and amortization expense decreased to $715,080 for the six months ended January 31, 2006 from $740,420 for the six months ended January 31, 2005.

Interest and finance charges increased to $21,892,964 for the six months ended January 31, 2006 from $2,575,118 for the six months ended January 31, 2005. Interest and finance charges for the six months ended January 31, 2006 included a $16 million fee paid on June 23, 2005 for the $160 million standby equity distribution agreement with Cornell Capital Partners, which was replaced by a $100 million standby equity distribution agreement on December 30, 2005, plus related professional fees and interest accretion on our convertible debentures and preferred shares.

Excluding charges related to our standby equity distribution agreement, non-cash interest expense for the six months ended January 31, 2006 were $4,129,107 compared to $2,462,652 during the six months ended January 31, 2005.

Interest Income

Interest income of $135,102 was earned for the six months ended January 31, 2006 as compared to $1,791 for the six months ended January 31, 2005 and was the result of higher average cash balances during the six months ended January 31, 2006.

Loss on settlement of debt

A loss on the settlement of debt of $214,274 was incurred for the six months ended January 31, 2006 as compared to nil for the six months ended January 31, 2005. The loss on settlement of debt represents the aggregate consideration provided less the face value of the debt. The settlement of debt is described in greater detail under Item 1-Legal Proceedings.

Derivative instrument loss

A derivative instrument loss of $685,298 was incurred for the six months ended January 31, 2006. The derivative instrument loss represents the mark to market adjustment on derivative instruments.

Foreign exchange loss

A foreign exchange loss of $301,063 was incurred for the six months ended January 31, 2006 as compared to a foreign exchange gain of $128,989 for the six months ended January 31, 2005. We are adversely impacted by a lower $US against the $CDN as a significant portion of our operations are paid in Canadian dollars. Foreign exchange gains or losses are due to fluctuations in currency exchange rates and are impossible to predict.

LIQUIDITY AND CAPITAL RESOURCES

CURRENT POSITION

We have continued to finance our activities primarily through the issuance and sale of securities. We have incurred losses from operations in each year since our inception. As at January 31, 2006, we had an accumulated deficit of $99,582,431. Our net loss for the three months ended January 31, 2006 was $6,232,434 and for the six months ended January 31, 2006 was $24,443,957 compared to $4,103,940 for the three months ended January 31, 2005 and $6,487,840 for the six months ended January 31, 2005. As of January 31, 2006 our stockholders' deficiency was $21,113,191and we had working capital of $8,105,233.

Our cash position, including short-term investments at January 31, 2006 was $5,577,703 as compared to $10,059,763 at July 31, 2005. This decrease was due to the net decrease in the use of cash in our operating, financing and investing activities as described below.

Our net loss of $24,443,957 for the six months ended January 31, 2006 includes non-cash charges of $715,080 for depreciation and amortization, a stock based compensation recovery of $1,944,175, a loss on settlement of debt of $214,274 and $17,618,031 for interest and finance charges as disclosed above under interest and finance charges. Increases in non-cash working capital during this period amounted to $367,997. Non-cash working capital changes included increases in accounts receivable, prepaid expenses and accounts payable and accrued liabilities and a decrease in inventory. The net cash used in operating activities for the six months ended January 31, 2006 was $4,880,588. Of this amount, $1,000,000 (including $100,000 of withholding taxes) was paid in interest expense on our convertible debentures and $228,000 was paid as partial compensation to settle our dispute with a debenture holder. As it is uncertain whether we will be able to access our $100 million Standby Equity Distribution Agreement when required, we may require subsequent financings to meet our operating cash flow requirements.

During the six months ended January 31, 2006, we also purchased certain capital assets at an aggregate cost of $115,602.

During the six months ended January 31, 2006, we realized aggregate gross cash proceeds of $135,800 as follows:

On October 20, 2005, a warrant holder exercised 1,100,000 warrants at an exercise price of $0.10 for gross proceeds of $110,000.

During the six months ended January 31, 2006, 860,000 stock options were exercised for gross proceeds of $25,800.

On June 30, 2005, we closed a $30 million securities purchase agreement with Cornell Capital Partners, Highgate House Funds, Ltd. and LCC Global Limited. In accordance with the securities purchase agreement, we issued, for a purchase price of $30 million, (i) a 10% convertible debenture due June 23, 2008, with a principal balance of $20 million, to Cornell Capital Partners, in trust for LCC Global, (ii) a 10% convertible debenture due June 23, 2008, with a principal balance of $8 million, to Cornell Capital Partners, in trust for LCC Global, and (iii) a 10% convertible debenture due June 23, 2008, with a principal balance of $2 million, to Highgate House Funds, in trust for LCC Global. We paid to Yorkville Advisors LLC, the general partner of Cornell Capital Partners, a cash structuring fee of $3 million in connection with this transaction.

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On December 30, 2005, we, Starome Investments Limited, Xentennial Holdings Limited, Staraim Enterprises Limited, Cornell Capital Partners, Highgate House Funds and LCC Global entered into Amendment No.1 to the Securities and Purchase Agreement pursuant to which we amended and restated the 10% convertible debentures in an aggregate principal amount of $30 million. We amended and restated the 10% convertible debentures to (i) modify the terms of such 10% convertible debentures, (ii) effect the transfer by (A) Cornell Capital Partners and LCC Global to Starome Investments, a corporation organized under the laws of Cyprus, of the 10% convertible debenture with the principal balance of $20 million, (B) Cornell Capital Partners and LCC Global to Xentennial Holdings, a corporation organized under the laws of Cyprus, of the 10% convertible debenture with the principal balance of $8 million and (iii) effect the transfer by Highgate House Funds and LCC Global to Staraim Enterprises, a corporation organized under the laws of Cyprus, of the 10% convertible debenture with the principal balance of $2 million ((i), (ii) and (iii) above being referred to as the "restructuring"). The following material amendments were made to each of the 10% convertible debentures in connection with the "restructuring":

·   The olders of the 10% convertible debentures agreed to eliminate our obligation to make recurring payments in cash of principal and interest during the term of the 10% convertible debentures. Such holders may convert outstanding principal and accrued and unpaid interest under the 10% convertible debentures at any time into shares of our common stock, subject to a 4.9% beneficial ownership limitation, which may be waived provided the holders of 10% convertible debentures provide us with 65 days notice. On June 23, 2008, any outstanding principal and accrued and unpaid interest under the 10% convertible debentures must be converted by the holders of the 10% convertible debentures into shares of our common stock; provided, however, that to the extent such conversion would cause any holder to exceed the 4.9% beneficial ownership limitation, we must pay such excess amount in cash. Holders of the 10% convertible debentures are not entitled to receive cash payments of interest during their term.

·   We agreed to change the conversion price of the outstanding principal under the 10% convertible debentures from a fixed price of $0.1125 to a price equal to the lesser of (i) $0.1125 (subject to adjustment) and  

·   (ii) 95.5% of the lowest closing bid price of our common stock during the five trading days immediately preceding the conversion.

·   The conversion price of accrued and unpaid interest under the 10% convertible debentures is 95.5% of the average of the closing bid prices of our common stock for the five trading days immediately preceding the conversion of any such interest by a holder into shares of our common stock.

·   The holders of the 10% convertible debentures agreed to permit us to redeem at any time all or any portion of the outstanding principal and accrued interest under the 10% convertible debentures provided that the closing bid price of our stock is less than $0.1125. We must pay a 20% redemption premium on any amounts being redeemed and must issue to the holder of the 10% convertible debenture being redeemed a five-year warrant to purchase $1 million shares of our common stock for every $100,000 redeemed. The "redemption warrant" will be exercisable on a cash basis at an exercise price of 110% of the closing bid price of our common stock on the date we provide notice of our intent to redeem.

On December 30, 2005, we and Cornell Capital Partners terminated the $160 million Standby Equity Distribution Agreement, originally entered into on June 23, 2005, and replaced it with a new $100 million Standby Equity Distribution Agreement (the "$100 million Standby Equity Distribution Agreement"). We may not request advances under the $100 million Standby Equity Distribution Agreement until the underlying shares of our common stock are registered with the SEC, it is unlikely that we will register such underlying shares until all of the outstanding principal and accrued and unpaid interest on the amended and restated 10% convertible debentures have been either converted by the holders or redeemed or paid in full by us, which must occur on or before July 23, 2008. The term of the $100 million Standby Equity Distribution Agreement will commence on the date a registration statement covering the underlying shares becomes effective and will expire five years after such date. Under the old $160 million Standby Equity Distribution Agreement, Cornell Capital Partners was entitled to retain 5% of each advance requested by us. In consideration for the reduction of the amount available to us under the new $100 Standby Equity Distribution Agreement, Cornell Capital Partners agreed to reduce this 5% advance fee to 2.5% of each advance.

We may request advances under the $100 million Standby Equity Distribution Agreement once the underlying shares are registered with the SEC. Once the registration statement covering the underlying shares of common stock becomes effective, we may request an advance every five trading days. The amount of each advance is subject to a maximum amount of $3 million every seven trading days. A closing will be held six trading days after such written notice at which time we will deliver shares of common stock and Cornell Capital Partners will pay the advance amount. For each share of common stock purchased under the equity line of credit, Cornell Capital Partners will pay 98% of the lowest closing bid price on the OTC Bulletin Board or other principal market on which our common stock is traded for the five days immediately following the notice date. We may continue to request advances until Cornell Capital Partners has advanced $100 million or 5 years have elapsed from the date a registration statement covering the underlying shares of common stock becomes effective.

Under the $100 million Standby Equity Distribution Agreement, Cornell Capital Partners and its affiliates may not own more than 9.9% of our outstanding common stock at any time. Because Cornell Capital Partners can repeatedly acquire and sell shares, this limitation does not limit the potential dilutive effect or the total number of shares that Cornell Capital Partners may receive under the $100 million Standby Equity Distribution Agreement.

The following conditions must be satisfied before Cornell Capital Partners is obligated to purchase any common shares under any draw down notice that we may deliver from time to time under the $100 million Standby Equity Distribution Agreement:

·   a registration statement for the shares must be declared effective by the SEC and must remain effective and available as of the draw down settlement date for making re-sales of the common shares purchased by Cornell Capital Partners;

·   there must be no statute, rule, regulation, executive order, decree, ruling or injunction which would prohibit the consummation of any of the transactions contemplated by the $100 million Standby Equity Distribution Agreement;

·   there must be no material action, suit or proceeding before any arbitrator or any governmental authority against us or any of our subsidiaries, or against any of the officers, directors or affiliates of our company or any of our subsidiaries, in respect of the $100 million Standby Equity Distribution Agreement or in respect of the transactions contemplated by the $100 million Standby Equity Distribution Agreement;

·   trading in our common stock must not have been suspended by the SEC or by the regulators of the principal market for our common stock (currently the OTC Bulletin Board); and

·   the principal market for our common stock must not have instituted, or otherwise been made subject to, a general suspension or limitation on the trading of securities through its facilities at any time prior to delivery of our draw down notice.

During the term of the $100 million Standby Equity Distribution Agreement, we may request advances of up to $3 million upon giving notice of not less than five trading days. We may request such advances every five trading days until the advances aggregate to $100 million.

During the term of the $100 million Standby Equity Distribution Agreement, subject to certain exceptions for issuances resulting from prior commitments, we cannot, without the prior consent of Cornell Capital Partners:

·   issue or sell any common stock or preferred stock with or without consideration;

·   issue or sell any preferred stock, warrant, option, right, contract, call, or other security or instrument granting the holder thereof the right to acquire common stock with or without consideration,

·   enter into any security instrument granting the holder a security interest in any of our assets; or

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·   file any registration statements on Form S-8.

Provided we give Cornell Capital Partners two days prior written notice, the foregoing restrictions will exclude options, warrants or other securities convertible or exchangeable into shares of our common stock that were outstanding prior to December 30, 2005.

Cornell Capital Partners, and each of its directors, officers, partners, employees and agents, is entitled to customary indemnification from us for any losses or liabilities suffered by any such person based upon material misstatements or omissions from the $100 million Standby Equity Distribution Agreement, registration statement and the prospectus, except as they relate to information supplied by Cornell Capital Partners to us for inclusion in the registration statement and prospectus.

With respect to the $1.5 million 5% convertible debenture due May 20, 2006 issued to Cornell Capital Partners, principal will be due and payable in 12 equal installments. The installments of principal were due and payable commencing on October 1, 2005 and subsequent installments were due and payable on the first day of each calendar month thereafter until the outstanding principal balance is paid in full. However, Cornell Capital Partners granted us an extension to April 1, 2006 to commence making these principal and interest payments. Interest on the outstanding principal balance is due and payable monthly, in arrears, commencing on August 1, 2005 and will continue to be payable on the first day of each calendar month thereafter that any amounts under the convertible debenture remain payable.

FUTURE OPERATIONS

Presently, our revenues are not sufficient to meet operating and capital expenses. We have incurred operating losses since inception, and this is likely to continue for the foreseeable future.

At January 31, 2006, we had cash and short-term investments of approximately $5.5 million. We may require up to $3.3 million in financing through the next twelve months in order to continue in business as a going concern because our management projects that we will require $4.3 million to $9.8 million to fund our debt repayment, ongoing operating expenses, working capital requirements through January 31, 2007, as detailed below.

	Estimated Range
Marketing	$	1,700,000		$	2,000,000
Engineering, research and development		2,000,000			2,500,000
General and administrative		2,200,000			3,000,000
Capital Purchases		100,000			300,000
Debt repayments (1)		300,000			1,600,000
General Working Capital (2)		(2,200,000	)		(600,000	)
TOTAL	$	4,300,000		$	8,800,000

(1) Principal payments on all of our outstanding debt and interest payable under our 10% convertible debentures is convertible into shares of our common stock.

(2) Our working capital requirements are impacted by our inventory requirements. Therefore, any increase in sales of our products will be accompanied not only by an increase in revenues, but also by an increase in our working capital requirements.

The continuation of our business is dependent upon obtaining further financing, market acceptance of our current products and any new products that we may introduce, the continuing successful development of our products and related technologies, and, finally, achieving a profitable level of operations.

The issuance of additional equity securities by us could result in a significant dilution in the equity interests of our current stockholders. Obtaining commercial loans, assuming those loans would be available, will increase our liabilities and future cash commitments.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management's application of accounting policies. We believe that understanding the basis and nature of the estimates and assumptions involved with the following aspects of our consolidated financial statements is critical to an understanding of our financials.

Going Concern

As at January 31, 2006, we had an accumulated deficit of $99,582,431. We have incurred recurring operating losses, and our net loss for the six months ended January 31, 2006 was $24,443,957. During the six months ended January 31, 2006, we used cash of $4,880,588 in operating activities. As of January 31, 2006, we had a stockholders' deficiency of $21,113,191 and we had working capital of $8,105,233.

During the six months ended January 31, 2006, we realized gross cash proceeds of $135,800 from financing activities. There can be no assurance that we can draw down amounts under the restructured $100 million equity line of credit, as draw downs are subject to an effective Registration Statement filed with the SEC and it is uncertain when the we will be permitted to submit a registration statement to register our $100 million Standby Equity Line of Credit during the period that the outstanding principal and accrued and unpaid interest under the 10% convertible dentures remain outstanding as drawdowns are subject to an effective Registration statement. These consolidated financial statements have been prepared on the going concern basis which assumes that adequate sources of financing will be obtained as required and that our assets will be realized and liabilities settled in the ordinary course of business. Accordingly, these consolidated financial statements do not include any adjustments related to the recoverability of assets and classification of assets and liabilities that might be necessary should we be unable to continue as a going concern.

Inventory

Inventory is carried at the lower of cost, determined on a weighted average cost method, and net realizable value. The determination of net realizable value is based on several assumptions and estimates. We provide an allowance that we consider to be reasonable for non-moving or slow moving inventory items and for items with expected future realizable value lower than cost. These assumptions and estimates may be inaccurate and may be revised.

The markets in which we compete are rapidly changing due to technological developments and increasing focus on automotive safety. Other companies offer products similar to those offered by us, and target the same customers as we do. Many of these companies have substantially greater financial, marketing and technical resources. We also anticipate that the competition within these markets will increase as demand for the products escalates. It is possible that new competitors or alliances among existing competitors may emerge and such competitors may rapidly acquire significant market share and make it difficult for us to sell our current inventory. All of these elements could reduce the net realizable value of our inventory.

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Warranty Obligations

On an ongoing basis, we record our best estimate of our warranty obligations and product returns related to products sold. These estimates are made after the consideration of contractual warranty obligations and historical experience. Unforeseen events, including increased technological difficulties with products, could occur that have not been anticipated in estimating the warranty provision. Additional costs or estimates will be recognized as determinable.

Revenue Recognition

We recognize revenue when there is persuasive evidence of an arrangement, goods are shipped and title passes, collection is probable, and the fee is fixed or determinable. Customer acceptance is used as the criterion for revenue recognition when the product sold does not have an established sales history to allow management to reasonably estimate returns and future provisions. Provisions are established for estimated product returns and warranty costs at the time the revenue is recognized. We record deferred revenue when cash is received in advance of the revenue recognition criteria being met. Revenue from engineering services is recognized on services as they are rendered and pre-defined milestones are achieved.

Other Assets

Other assets are recorded at cost and are being amortized over five years on a straight line basis. Other assets are comprised of licenses to manufacture and sell TPMSs to the OEMs. On an ongoing basis, management assesses whether the expected net recoverable amount of the licenses exceeds the book value of the licenses. The net recoverable amount is determined on a projected cash flow basis, undiscounted at an appropriate rate. Our belief is based on an undiscounted cash flow analysis of management's current best estimate of projected annual sales to the passenger vehicle and light truck OEM market plus management's projected sales to the heavy truck OEM market. Although we expect to generate cash flow from sales to the OEM marketplace, it is possible that we will not generate cash flow from sales to the OEM marketplace in excess of net book value, or that we will generate cash flow from sales to the OEM market in future years after the other assets have been fully amortized.

Off-Balance Sheet Arrangements

We have not entered into any transaction, agreement or other contractual arrangement with an entity unconsolidated with us under which we have:

o an obligation under a guarantee contract;

o a retained or contingent interest in assets transferred to the unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to such entity for such assets;

o an obligation, including a contingent obligation, under a contract that would be accounted for as a derivative instrument; or

o an obligation, including a contingent obligation, arising out of a variable interest in an unconsolidated entity that is held by, and material to, us where such entity provides financing, liquidity, market risk or credit risk support to, or engages in leasing, hedging, or research and development services with us.

ITEM 3. CONTROLS AND PROCEDURES

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time period specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure.

As required by Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this quarterly report, being January 31, 2006, we have carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Chief Financial Officer. Based upon that evaluation, our President and Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective. There have been no changes in our internal controls during our quarter ended January 31, 2006 that have materially affected or are reasonably likely to affect our internal controls over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On April 21, 2005, Bristol Investment Fund, Ltd., a holder of our discounted debentures in the amount of $91,726, commenced a lawsuit in the Supreme Court of New York against us, essentially alleging that we wrongfully refused to honor its request to convert the debt into 9,268,875 shares of our common stock. The lawsuit sought an order compelling us to pay $4,393,360 plus interest from April 25, 2005 for damages and attorneys fees.

On January 5, 2006, we entered into a Settlement Agreement and Mutual Release with Bristol Investment Fund, Ltd. In connection with the Agreement and Mutual Release, we issued (i) a bank check in the amount of $228,000 payable to "Bristol Investment Fund, Ltd. representing $250,000, less $22,000 in Canadian withholding taxes"; (ii) 2,000,000 shares of our common stock (the "Bristol Shares") in certificates of 1,000,000 shares each; and (iii) an executed Stipulation of Discontinuance with prejudice. Bristol Investment Fund, Ltd. further agreed that no sale of the Bristol Shares will be made before January 16, 2006 and that no more than 1,000,000 of the Bristol Shares may be sold before February 16, 2006. Bristol Investment Fund, Ltd. further acknowledged that the discounted debenture has been paid in full and no further sums are due thereunder.

For accounting purposes, we recorded a loss on settlement of debt of $214,274, which represents the aggregate consideration provided less the face value of the debt.

On January 30, 2006, Travel Technology Innovations LLC ("TTI") provided us with a demand for arbitration. TTI alleges we have breached our sales and distribution agreement by seeking to prematurely terminate the agreement in violation of its terms, thereby damaging TTI through lost profits and has put forth a claim of $1 million. In light of the status of the case, which is in its initial phases, we cannot determine the likely outcome of this action or whether the arbitrators will grant TTI's claim.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following change in our securities occurred during the three months ended January 31, 2006:

o On January 5, 2006, we issued 2,000,000 shares of our common stock to Bristol Investment Fund Ltd. pursuant to a settlement agreement and mutual release pursuant to Rule 506 of Regulation D under the Securities Act.

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES

See Item 1 above.

We have received an extension until April 1, 2006 to pay the principal monthly repayments of $125,000 on our 5% $1,500,000 convertible debentures.

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

The annual and special meeting of our shareholders was held in Vancouver, Canada on December 9, 2005. A total of 162 shareholders attended the annual and special meeting in person or by proxy, representing a total of 223,687,521 (or 81.03%) of the 283,709,549 shares of our common stock issued and outstanding as at the close of business October 21, 2005, the record date for the meeting.

The following proposals were adopted by our shareholders by ordinary resolution: (1) to appoint KPMG LLP, Chartered Accountants, of Vancouver, British Columbia, as the auditor of our company to hold office for the ensuing year; (2) to authorize our Board of Directors to fix the remuneration to be paid to the auditor; (3) to set the number of our directors, between the minimum and maximum number of directors prescribed by our company's articles of continuance, at four; (4) to elect WILLIAM CRONIN, MARTIN GANNON, JOHNNY CHRISTIANSEN and ROBERT RUDMAN as directors of our company, to hold office until the next annual meeting of shareholders, or until their successors are appointed; and (5) to approve an additional formal stock incentive plan providing for the granting of stock-based incentives to those eligible employees, directors, officers and consultants of our company, or of any of our subsidiaries, who are resident in the United States and/or subject to taxation in the United States, provided that a maximum of 10,000,000 shares of common stock of our company shall be issuable pursuant to all awards granted under the plan.

Of the 223,687,521 shares represented at the meeting, 12,500 shares were held by shareholders attending in person, and 223,675,021 shares were held by shareholders attending by proxy. The number of shares cast by way of proxy for, against and withheld, as well as the number of abstentions and broker non-votes as to each of these matters are as follows:

						BROKER
	PROPOSAL	SHARES FOR	SHARES AGAINST	WITHHELD	NOT VOTED	NON-VOTES
1	To appoint KPMG LLP as auditor	223,038,690	0	648,831	0	0
2	To authorize the directors to fix auditor remuneration	222,874,123	621,348	192,050	0	0
3	To set the number of directors at four	221,553,527	989,989	1,144,005	0	0
4	To elect the following directors:
	a. Robert Rudman	221,039,605	0	2,647,916	0	0
	b. Martin Gannon	223,234,765	0	452,756	0	0
	c. Johnny Christiansen	223,232,005	0	455,516	0	0
	d. William Cronin	223,253,220	0	434,301	0	0
5	To approve the 2005 stock incentive plan for United	16,808,732	4,243,305	363,353	202,272,131	0
	States residents

ITEM 5. OTHER INFORMATION

None.

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ITEM 6. EXHIBITS

Exhibit

Number Description

10.1 Agreement for Electronic Manufacturing Services, dated November 16,

2005, between Vansco Electronics LP and SmarTire Systems Inc. (1)

10.2 Settlement Agreement and Mutual Release, dated January 6, 2006, between

Bristol Investment Fund and SmarTire Systems Inc. (2)

31.1 Certification pursuant to section 302 of the Sarbanes-Oxley Act of

2002**

31.2 Certification pursuant to section 302 of the Sarbanes-Oxley Act of

2002**

32.1 Certification pursuant to18 U.S.C. section 1350, as adopted pursuant to

section 906 of the Sarbanes-Oxley Act of 2002**

32.2 Certification pursuant to18 U.S.C. section 1350, as adopted pursuant to

section 906 of the Sarbanes-Oxley Act of 2002**

** Filed herewith.

(1) Incorporated by reference to SmarTire Systems Inc.'s Form SB-2/A filed

with the Securities and Exchange Commission on February 27, 2006.

(2) Incorporated by reference to SmarTire Systems Inc.'s Form SB-2 filed

with the Securities and Exchange Commission on January 11, 2006.

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SIGNATURES

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

SMARTIRE SYSTEMS INC.

/s/ Leif Pedersen

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

Leif Pedersen

President and Chief Executive Officer

(On behalf of the Registrant and as Principal Executive Officer)

Date: July 3, 2006

/s/ Jeff Finkelstein

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

Jeff Finkelstein

Chief Financial Officer

(On behalf of the Registrant and as Principal Financial Officer

and Principal Accounting Officer)

Date: July 3, 2006

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