<PAGE>

                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q
(Mark One)

[X]      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2003

[ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

         For the transition period from ___________ to _____________

                        Commission file number: 001-16253

                       COMPUTERIZED THERMAL IMAGING, INC.
              -----------------------------------------------------
             (Exact name of Registrant as specified in its charter)

                 NEVADA                                          87-0458721
------------------------------------------------             -------------------
(State or other jurisdiction of incorporation or               (IRS Employer
              organization)                                  Identification No.)

       1719 West 2800 South
            Ogden, Utah                                            84401
----------------------------------------                       ----------------
(Address of principal executive offices)                        (Zip Code)

                                 (801) 776-4700
                            ------------------------
              (Registrant's telephone number, including area code)

         Check whether the registrant (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 [X]
No [ ]

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

         Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: Common stock, par
value $0.001, of which 112,895,031 shares were issued and outstanding as of
January 29, 2004.



<PAGE>


                       COMPUTERIZED THERMAL IMAGING, INC.

                                    FORM 10-Q

                                QUARTERLY REPORT

                                TABLE OF CONTENTS

                         PART I - FINANCIAL INFORMATION

ITEM 1.  Financial Statements..................................................2

         Condensed Consolidated Balance Sheets as of
         December 31, 2003 and June 30, 2003 ..................................2

         Condensed Consolidated Statements of Operations and Other
         Comprehensive Income (Loss) for the three and six months ended
         December 31, 2003 and 2002 and for the period from inception on
         June 10, 1987 to December 31, 2003 ...................................3

         Condensed Consolidated Statements of Cash Flows for the six months
         ended December 31, 2003 and 2002 and for the period from
         inception on June 10, 1987 to December 31, 2003 ......................4

Notes to Condensed Consolidated Financial Statements...........................6

ITEM 2. Management's Discussion and Analysis of Financial Condition and
  Results of Operations.......................................................13

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk............22

ITEM 4. Controls and Procedures...............................................22


                           PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings.....................................................23

ITEM 2. Changes in Securities.................................................24

ITEM 6. Exhibits and Reports on Form 8-K......................................24

SIGNATURES....................................................................25



<PAGE>

PART I - FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
<TABLE>

                                  COMPUTERIZED THERMAL IMAGING, INC.
                                     (A Development Stage Company)
                                 CONDENSED CONSOLIDATED BALANCE SHEETS
<CAPTION>

                                                                          December 31,    June 30,
                                                                              2003          2003
                                                                          (UNAUDITED)
                                                                         -------------   -------------
<S>                                                                      <C>             <C>
ASSETS
CURRENT ASSETS:
  Cash and cash equivalents                                              $    446,578    $    454,387
  Accounts receivable-trade, net (less allowance for doubtful accounts
   of $63,531 and $3,199 for December and June 2003, respectively              16,850         420,395
  Inventories                                                                 364,416         305,864
  Prepaid expenses                                                            171,453         310,248
  Deferred Finance Costs                                                           --              --
                                                                         -------------   -------------
        Total current assets                                                  999,297       1,490,894
                                                                         -------------   -------------
PROPERTY AND EQUIPMENT, Net                                                   215,494         312,719
                                                                         -------------   -------------
INTANGIBLE ASSETS:
  Intellectual property rights, net (less accumulated amortization:
   December - $13,513; June - $14,782)                                         16,730          18,065
                                                                         -------------   -------------
TOTAL ASSETS                                                             $  1,231,521    $  1,821,678
                                                                         =============   =============
LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
  Accounts payable                                                       $    650,760    $    655,075
  Accrued liabilities                                                         412,925         406,032
  Accrued settlement reserve                                                  100,000         100,000
  Convertible Debenture                                                            --         157,276
  Deferred revenues                                                         1,137,087         786,650
                                                                         -------------   -------------
        Total current liabilities                                           2,300,772       2,105,033
                                                                         -------------   -------------
STOCKHOLDERS' EQUITY (DEFICIT):
  Convertible preferred stock, $5.00 par value, 3,000,000
    shares authorized ; issued-none                                                --              --
  Common stock, $.001 par value, 200,000,000 shares authorized,
    112,870,031 and 109,329,098 issued and outstanding on
    December 31, 2003 and June 30, 2003, respectively                         112,869         109,329
  Additional paid-in capital                                               95,194,842      94,041,104
  Deficit accumulated during the development stage                        (96,376,962)    (94,433,788)
                                                                         -------------   -------------
        Total stockholders' equity (deficit)                               (1,069,251)       (283,355)
                                                                         -------------   -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)                     $  1,231,521    $  1,821,678
                                                                         =============   =============

        The accompanying notes are an integral part of these consolidated financial statements.

                                                    2
</TABLE>


<PAGE>
<TABLE>

                                              COMPUTERIZED THERMAL IMAGING, INC.
                                                 (A Development Stage Company)
                     CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME (LOSS)
                                                          (UNAUDITED)
<CAPTION>

                                                                                                               June 10, 1987
                                               Three month period ended           Six month period ended         (Inception)
                                                     December 31,                       December 31,               through
                                                 2003            2002             2003              2002      December 31, 2003
                                            --------------   --------------   --------------   --------------   --------------
<S>                                         <C>              <C>              <C>              <C>              <C>
INCOME:
  Revenues                                  $      93,645    $     594,971    $     156,342    $     858,901    $   3,576,812
  Cost of goods sold                              (20,530)        (748,004)         (62,932)        (952,381)      (2,592,451)
                                            --------------   --------------   --------------   --------------   --------------
GROSS MARGIN                                       73,115         (153,033)          93,410          (93,480)         984,361
                                            --------------   --------------   --------------   --------------   --------------
OPERATING EXPENSES:
  General and administrative                      379,839          646,244          924,816        1,479,035       35,411,629
  Litigation Settlements                          100,000          100,000               --        2,797,434
  Research and development                        296,794        1,153,657          663,700        2,401,969       31,419,551
  Marketing                                        97,073          387,077          251,128          995,592        8,659,258
  Depreciation and amortization                    40,903          175,994           95,700          339,578        5,151,115
  Impairment loss                                      --          711,194               --          711,194       12,322,192
                                            --------------   --------------   --------------   --------------   --------------
Total operating expenses                          914,609        3,074,166        2,035,344        5,927,368       95,761,179
                                            --------------   --------------   --------------   --------------   --------------
OPERATING LOSS                                   (841,494)      (3,227,199)      (1,941,934)      (6,020,848)     (94,776,818)
                                            --------------   --------------   --------------   --------------   --------------
OTHER INCOME (EXPENSE):
  Interest income                                   2,257           52,078            4,185          141,427        3,607,624
  Interest expense                                     --         (210,688)          (5,425)        (928,338)      (5,189,436)
  Other                                                --               --               --               --          193,711
                                            --------------   --------------   --------------   --------------   --------------
Total other income (expense)                        2,257         (158,610)          (1,240)        (786,911)      (1,388,101)
                                            --------------   --------------   --------------   --------------   --------------
LOSS BEFORE EXTRAORDINARY ITEM                   (839,237)      (3,385,809)      (1,943,174)      (6,807,759)     (96,164,919)

EXTRAORDINARY GAIN ON
  EXTINGUISHMENT OF DEBT                               --               --               --               --           65,637

NET LOSS                                         (839,237)      (3,385,809)      (1,943,174)      (6,807,759)     (96,099,282)

OTHER COMPREHENSIVE INCOME (LOSS)
  Unrealized gain (loss) on investments
    available for sale                                             (20,121)                           (5,688)              --
                                                             --------------                    --------------   --------------
TOTAL COMPREHENSIVE  (LOSS)                 $    (839,237)   $  (3,405,930)   $  (1,943,174)   $  (6,813,447)   $ (96,099,282)
                                            ==============   ==============   ==============   ==============   ==============
WEIGHTED AVERAGE SHARES
  OUTSTANDING                                 112,706,442       83,489,455      112,706,442       83,312,419
                                            ==============   ==============   ==============   ==============
BASIC AND DILUTED LOSS PER COMMON SHARE     $       (0.01)   $       (0.04)   $       (0.02)   $       (0.08)
                                            ==============   ==============   ==============   ==============


                    The accompanying notes are an integral part of these consolidated financial statements.

                                                              3
</TABLE>


<PAGE>
<TABLE>

                                               COMPUTERIZED THERMAL IMAGING, INC.
                                                 (A Development Stage Company)
                                        CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                          (UNAUDITED)
<CAPTION>
                                                                                                      From
                                                                                                    Inception
                                                                        Six Months Ended             through
                                                                          December 31,             December 31,
                                                                      2003             2002            2003
                                                                  -------------   -------------   -------------
<S>                                                               <C>             <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss                                                        $ (1,943,174)   $ (6,807,759)   $(96,099,282)
  Adjustments to reconcile net income (loss) to net cash
    used in operating activities:
  Depreciation and amortization                                         95,700         339,578       5,151,115
  Impairment loss and loss on disposition of assets                     (1,185)        762,015      12,295,611
  Bond Amortization                                                         --          32,294          51,447
  Amortization Bonds and deferred finance costs and discounts
    on notes payable                                                        --         560,514       1,648,594
  Conversion expense of convertible debenture                               --       1,776,839       1,776,839
  Common stock, warrants, and options issued
    as compensation for services                                            --              --       9,639,920
  Options extended beyond their expiration date                             --              --       1,687,250
  Common stock issued for interest expense                                  --              --         423,595
  Stock-based compensation on options marked to market                      --           7,280         347,075
  Common stock issued to settle litigation                                  --              --         514,380
  Options issued at discount to market to settle litigation                 --              --         475,000
  Options issued at discount to market as
    compensation expense                                                    --              --         226,586
  Common stock issued to pay Debenture                                 (98,067)        286,110         (98,067)
  Common stock issued for failure to complete
    timely registration                                                     --              --          82,216
  Common stock issued to 401(k) plan                                        --          21,883         117,860
  Extraordinary gain on extinguishment of debt                              --              --         (65,637)
  Bad debt expense                                                      60,393         (65,032)        507,116
  Interest expense on convertible debenture                                 --         492,406         492,406
  Changes in operating assets and liabilities:
    Accounts receivable - trade                                        343,152        (411,394)        (83,800)
    Accounts receivable - other                                             --          70,651         265,912
    Inventories                                                        (58,552)        520,765        (187,658)
    Prepaid expenses                                                   138,795         174,733          70,321
    Accounts payable                                                    (4,315)       (304,372)        497,870
    Accrued liabilities                                                104,960        (477,515)        396,493
    Accrued litigation settlement                                           --      (1,300,000)        100,000
    Deferred revenues                                                  350,437         410,179       1,137,087
                                                                  -------------   -------------   -------------
           Net cash used in operating activities                    (1,011,856)     (6,180,070)    (58,629,751)
                                                                  -------------   -------------   -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Proceeds from sale of assets                                              --              --         131,796
  Capital expenditures                                                   4,044         (87,318)     (2,808,863)
  Acquisition of Thermal Imaging, Inc. common stock                         --              --        (100,000)
  Purchase of software license                                              --              --      (3,850,000)
  Purchase of investments available for sale                                --              --     (43,851,010)
  Proceeds from redemption of investments available for sale                --       5,514,861      43,468,857
  Acquisition of Bales Scientific common stock,
    net of cash acquired                                                    --              --      (5,604,058)
                                                                  -------------   -------------   -------------
           Net cash provided by (used in) investing activities           4,044       5,427,543     (12,613,278)
                                                                  -------------   -------------   -------------


              The accompanying notes are an integral part of these consolidated financial statements. (Continued)

                                                               4
</TABLE>

<PAGE>
<TABLE>

                                            COMPUTERIZED THERMAL IMAGING, INC.
                                               (A Development Stage Company)
                                      CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                        (UNAUDITED)
<CAPTION>
                                                                                                 From
                                                                                               Inception
                                                                   Six Months Ended             through
                                                                     December 31,             December 31,
                                                                 2003             2002            2003
                                                             -------------   -------------    -------------
<S>                                                          <C>             <C>              <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from issuance of common stock and warrants,
    net of offering costs                                    $  1,000,000    $    314,385       64,976,581
  Advances to affiliate                                                --              --         (107,864)
  Advances from stockholders                                           --              --        2,320,738
  Preferential Dividend                                                --              --          (79,000)
  Proceeds from borrowing
  net of finance costs                                                 --              --        5,756,339
  Payments on debt                                                     --              --       (1,177,190)
                                                             -------------   -------------    -------------
           Net cash provided by financing activities            1,000,000         314,385       71,689,604
                                                             -------------   -------------    -------------
NET INCREASE (DECREASE) IN CASH
  AND CASH EQUIVALENTS                                             (7,812)       (438,142)         446,575

CASH AND CASH EQUIVALENTS AT
  BEGINNING OF YEAR                                               454,387         936,796               --
                                                             -------------   -------------    -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR                     $    446,575    $    498,654     $    446,575
                                                             =============   =============    =============
SUPPLEMENTAL CASH FLOW INFORMATION
  Cash paid for:
     Interest expense                                        $         --    $         --            8,770
     Income taxes                                                      --              --               --

SUPPLEMENTAL SCHEDULE OF NON-CASH
  FINANCING AND INVESTING ACTIVITIES
  Common stock issued to reduce debenture, interest
   and penalty                                               $    157,277    $    456,064        2,992,489
  Warrants issued for financing costs                             118,905         118,905
  Common stock issued to individuals to acquire
    minority interest of subsidiary                                    --              --          165,500
  Common stock issued in consideration of Bales Scientific             --              --        5,500,000
  Options issued at discount to market in connection
    with offering                                                      --              --          744,282
Stock offering costs capitalized                                       --              --         (744,282)
Common stock issued for advances from shareholders                     --              --        2,320,738
Common stock issued for notes payable, accrued
  discount and interest                                                --              --        2,224,953
Common stock issued for convertible subordinated
  debentures                                                           --              --          640,660
Common stock issued for liabilities                                    --              --           50,000




                 The accompanying notes are an integral part of these consolidated financial statements.

                                                            5
</TABLE>

<PAGE>

                       COMPUTERIZED THERMAL IMAGING, INC.
                          (A Development Stage Company)
              Notes to Condensed Consolidated Financial Statements
                                   (UNAUDITED)


NOTE A. UNAUDITED FINANCIAL STATEMENTS AND BASIS OF PRESENTATION

         The condensed consolidated financial statements of Computerized Thermal
Imaging (the "Company") for the three-month and six-month periods ended December
31, 2003 and 2002 are unaudited. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation of the Company's results of operation for the periods presented
have been included. These interim statements should be read in conjunction with
the audited consolidated financial statements and footnotes thereto contained in
the Company's most recent Annual Report on Form 10-K for the Year Ended June 30,
2003. The consolidated results of operations for the three-month and six-month
periods ended December 31, 2003 are not necessarily indicative of the results to
be expected for the full year.

         Certain amounts from the prior period financial statements have been
reclassified to conform to current period presentation.

         The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions, including for example, accounts receivable
allowances, inventory obsolescence reserves, deferred tax valuation allowances,
and reserves for pending or threatened litigation. These assumptions affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from these estimates.

         The accompanying condensed consolidated financial statements have been
prepared assuming the Company will continue as a going concern. In its Annual
Report on Form 10-K for the Year Ended June 30, 2003, the Company reported that
its recurring losses from operations, negative cash flows from operations,
pending shareholder class-action lawsuits and denial of coverage for any
resulting claims by the Company's provider of directors and officers insurance,
forced redemption of the Company's convertible debentures, the Company's need
for additional working capital, and the possibility that the Company may not
receive FDA approval for its primary product raised substantial doubt about the
Company's ability to continue as a going concern.

         In order to pursue its existing plan of operations, the Company will
have to secure additional financing through the sale of equity, the incurrence
of debt or the sale of assets, possibly including the Company's intellectual
property. There can be no assurance that capital will be available from any
source or, if available, that the terms and conditions associated with such
capital will be acceptable to the Company. If the Company raises equity or debt
capital, the sale of these securities could dilute existing shareholders, and
borrowings from third parties could result in assets being pledged as collateral
and could provide loan terms that could adversely affect the Company's
operations and the price of its common stock.

         The accompanying condensed consolidated financial statements do not
include any adjustments relating to the recoverability and classification of
recorded asset amounts or the amounts and classification of liabilities that
might be necessary if the Company is unable to continue as a going concern.

NOTE B. RECENTLY ISSUED ACCOUNTING STANDARDS

         In October 2002, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards No. 147 ("SFAS 147"),
ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS. SFAS 147 provides that the
guidance provided by SFAS 141 BUSINESS COMBINATIONS, SFAS 142, GOODWILL AND
OTHER INTANGIBLE ASSETS, and SFAS 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL
OF LONG-LIVED ASSETS will apply to acquisitions of financial institutions
(previously covered under special industry guidance). The transition provisions
of SFAS 147 became effective on October 1, 2002. At this time the Company does
not believe the adoption of SFAS 147 will have any impact on its condensed
consolidated financial statements.


                                       6

<PAGE>

         In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148 ("SFAS 148"), ACCOUNTING FOR STOCK-BASED COMPENSATION -
TRANSITION AND DISCLOSURE, which amends Statement of Financial Accounting
Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. SFAS 148 provides
alternative methods of transition for a voluntary change to the fair value-based
method of accounting for stock-based employee compensation and requires more
prominent and more frequent disclosures in the financial statements of the
effects of stock-based compensation. The provisions of SFAS 148 are effective
for fiscal years ending after December 15, 2002 and the interim disclosure
provisions are effective for interim periods beginning after December 15, 2002.
The Company began providing the required interim and annual disclosures
beginning in the quarter ended March 31, 2003.

         In February 2003, the FASB issued Statement of Financial Accounting
Standards No. 149 ("SFAS 149"), ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS
WITH CHARACTERISTICS OF LIABILITIES AND EQUITY, which became effective at the
beginning of the first interim period beginning after March 15, 2003. SFAS 149
establishes standards for the Company's classification of liabilities in the
financial statements that have characteristics of both liabilities and equity.
The Company does not believe the adoption of SFAS 149 will have a material
effect on the Company's consolidated financial position or results of
operations.

         In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150 ("SFAS 150") ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH
CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY, which is effective the first
interim period beginning after June 15, 2003. SFAS 150 establishes standards for
how the Company classifies and measures in its statement of financial position
certain financial instruments with characteristics of both liabilities and
equity. The Company does not believe the adoption of SFAS 150 will have a
material effect on the Company's consolidated financial position or results of
operations.

NOTE C. CONVERTIBLE DEBENTURE

Financing Agreement with Beach Boulevard, LLC.

         On December 31, 2001, the Company entered into a financing agreement
(the "Agreement") with Beach Boulevard, LLC (the "Investor"), pursuant to which
the Company issued a 7% convertible debenture (the "Convertible Debenture") in
the amount of $2.5 million (the "Debenture Offering") and secured an equity line
of credit (the "Equity Line") for $20 million that allowed the Company to sell
up to $20 million of common stock to the Investor at 94% of the market price, as
defined by the Agreement. The Convertible Debenture was originally due on
December 31, 2004. The terms of the Agreement permitted the Investor to convert
the Convertible Debenture into 2,100,694 shares of common stock at a conversion
price of $1.44 per share at any time during the term of the Agreement. Interest
on the Convertible Debenture was due on the conversion date and was payable, at
the option of the Company, in cash or common stock.

         In connection with the Agreement, the Company issued to the Investor
warrants for the purchase of 260,417 shares of common stock at $2.03 a share and
641,026 shares of common stock at $1.95 a share. The proceeds from the Debenture
Offering were allocated between the Convertible Debenture, the beneficial
conversion feature and the warrants issued to the Investor. The Company also
issued separate warrants to an investment banking firm for the purchase of
100,000 shares of common stock at $1.87 per share. The fair market value of
these warrants and other related financing costs were recorded as deferred
financing costs and were originally being amortized over the three-year term of
the Agreement. However, because of the occurrence of the redemption of the
Convertible Debenture discussed below, the deferred financing costs and
beneficial conversion feature associated with the Convertible Debenture were
amortized over the six-month period ended January 25, 2003.

         On July 25, 2002, the Investor notified the Company that a "Trigger
Event" had occurred, which obligated the Company to redeem the Convertible
Debenture. On the date of the Trigger Event, the Company's redemption obligation
was equal to approximately $2.9 million, which included principal of $2.5
million, $111 thousand of accrued interest and $287 thousand of penalty. The
Company elected to satisfy its redemption obligation through a series of put
notices based on the terms of the Equity Line. During the period from July 1,
2002 through January 29, 2003, the Company issued 5,009,083 shares of common
stock pursuant to a series of mandatory put notices. The proceeds were applied
to redeem approximately $685,000 of the Convertible Debenture and to pay accrued
interest and penalties totaling $176,000 and $95,000, respectively.

                                       7

<PAGE>

         On February 5, 2003, the Company received approximately $210,000 from
the issuance of 2,234,043 shares of common stock pursuant to the terms of the
Equity Line. The proceeds were used to redeem approximately $183,000 of the
Convertible Debenture and to pay accrued interest and penalties totaling $6,000
and $21,000, respectively.

         On or about February 21, 2003, the Company entered into an agreement
with the Investor which was formalized on March 19, 2003 (the "Amendment"),
whereby the Company agreed to reduce the conversion price in the Convertible
Debenture from $1.44 per share to an amount equal to the lower of (a) $1.44 (the
"Fixed Conversion Price") or (b) ninety-four percent (94%) of the average of the
lowest closing bid prices (not necessarily consecutive) for any three trading
days during the ten trading days period immediately preceding the conversion
date. The Company also agreed to reduce the exercise price of the warrants that
were issued to the Investor in connection with the Agreement to $0.087733 per
share, which was the average of the lowest closing bid prices for any of the
three trading days during the ten trading days period immediately preceding the
Amendment. Pursuant to the Amendment, the Investor exercised warrants to
purchase 260,417 shares of common stock at an agreed-upon exercise price of
$0.087733 per share and (2) converted approximately $86,000 in principal of the
Convertible Debenture into 977,244 shares of common stock at the agreed-upon
conversion price of $0.087733 per share. The proceeds from the exercise of the
warrants totaling approximately $23,000 were applied to redeem approximately
$20,000 of the Convertible Debenture and to pay accrued interest of
approximately $2,000. In connection with the modification of the conversion
terms of the Convertible Debenture, which was considered to be an inducement to
convert the Convertible Debenture, and the reduction of the exercise price of
the Investor's warrants, the Company recorded an interest expense totaling
approximately $1,770,000 during the quarter ended March 31, 2003.

         The Company issued 1,212,956 shares of common stock to the Investor
pursuant to a mandatory put notice on February 21, 2003. The proceeds were
applied to redeem approximately $91,000 of the Convertible Debenture and to pay
accrued interest and penalties totaling $5,000 and $11,000, respectively. On
March 19, 2003, the Company entered into an agreement with the Investor (the
"Amendment Agreement") that formalized the terms reached in the Amendment. In
connection with the Amendment Agreement, the Investor also agreed to defer its
demand for immediate payment of the full amount due under the Convertible
Debenture for at least 90 days and agreed to not file suit against CTI, its
officers, employees, partners or agents for a period of 90 days. Upon execution
of the Amendment Agreement, the Investor converted $272,000 in principal of the
Convertible Debenture, including $7,000 of interest, into 3,224,146 shares of
common stock.

         During the period March 20, 2003 through May 19, 2003, the Investor
converted approximately $1,181,000 of the remaining redeemable balance of the
Convertible Debenture, including interest of $11,000, into 9,805,161 shares of
common stock. As of June 30, 2003, the Company owed the Investor approximately
$157,000 under the Convertible Debenture, which consisted of the unpaid portion
of the penalty. In July 2003, the Company issued approximately 200,000 shares of
common stock to redeem the remaining balance of the Convertible Debenture. The
July 2003 transaction represented the final issuance of shares of common stock
under the Equity Line, and the Company does not anticipate issuing additional
shares of common stock thereunder.

PRIVATE OFFERING - THERFIELD HOLDINGS LTD

         On July 10, 2003 the Company closed a private placement under
Regulation S of the Securities Act of 1933, as amended, and sold 3,344,482
shares of common stock to Therfield Holdings LTD ("Therfield"), for $1 million.
The Company entered into negotiations with Therfield in early June 2003 and
offered a 15% discount off the then prevailing market price. The transaction
process took over 30 days to conclude and the Company received the funds from
the private placement on July 10, 2003.

         In order to pursue its existing plan of operations, the Company will
have to secure additional financing through the sale of equity, the incurrence
of debt or the sale of assets, possibly including the Company's intellectual
property. There can be no assurance that capital will be available from any
source or, if available, that the terms and conditions associated with such
capital will be acceptable to the Company. If the Company raises equity or debt
capital, the sale of these securities could dilute existing shareholders, and
borrowings from third parties could result in assets being pledged as collateral
and could provide loan terms that could adversely affect the Company's
operations and the price of the Company's common stock.

                                       8

<PAGE>

         The accompanying consolidated financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amounts and classification of liabilities that might be necessary
if the Company is unable to continue as a going concern.


NOTE D. REVENUE RECOGNITION

         The Company generates revenues from sales of its products and from
services provided to its customers. The Company sells its products to
independent distributors and to end customers. With the exception of sales
transactions in which a customer may return defective products, the Company does
not provide its customers with other rights to return products.

         The Company recognizes revenue from its product sales to end customers
upon shipment of products when persuasive evidence of an agreement exists,
delivery of the product has occurred, no significant Company obligations remain,
the fee is fixed or determinable, and collectibility is probable. If these
conditions are not met, revenue is deferred until such obligations and
conditions are fulfilled. If the Company retains an ongoing obligation under a
sales arrangement, revenue is deferred until all of the Company's obligations
are fulfilled.

         Effective July 1, 2001, the Company adopted the practice of deferring
revenue on shipments to distributors until cash payment from the distributor is
received by the Company, which is generally when the product is sold by the
distributor to the end customer. Prior to that date, revenue on shipments to
distributors was recognized upon shipment to the distributor if all of the
criteria for revenue recognition were satisfied. The Company believes that
deferral of revenue on shipments to distributors until cash payment is received
is a more meaningful measurement of results of the Company's operations.

         Certain of the Company's products contain software that is not
considered incidental to the product. Sales of those products are subject to the
provisions of AICPA Statement of Position No. 97-2, SOFTWARE REVENUE
RECOGNITION, as amended, which requires the deferral of revenue from certain
multiple-element arrangements. The Company defers revenue from multiple-element
arrangements until all elements have been delivered.

         Service revenue is derived from non-destructive testing of turbine
blades and other items. Service revenue is recognized upon the completion of the
services provided. The Company offers extended warranties on certain of its
products. Warranty revenue is recognized ratably over the period of the
agreement as services are provided.

NOTE E. DEFERRED REVENUE

         At December 31, 2003 the Company's deferred revenues were approximately
$1,158,000, and consisted of $25,000 of deferred medical revenues, $660,000 of
deferred revenues from the Nanda licensing and manufacturing agreement, $24,000
of deferred warranty revenues and $449,000 of deferred industrial revenues and
deposits relating the Company's TBIS shipped to Pratt & Whitney. At June 30,
2003 the Company's deferred revenues were approximately $787,000, and consisted
of $10,000 of deferred medical revenues, $300,000 of deferred revenues
associated with a manufacturing/licensing agreement (the "Nanda Agreement")
executed between the Company and NanDa Thermal Medical Technology, Inc.
("Nanda"), $28,000 of deferred warranty revenues and $449,000 of deferred
industrial revenues and deposits relating the Turbine Blade Inspection System
("TBIS") the Company shipped to Pratt & Whitney.

DEFERRED REVENUES
                     DEFERRED REVENUES

                                                  December 31,      June 30,
                                                      2003            2003
                                                 -----------------------------
               Medical Products                  $   10,000      $   10,000
               Nanda Licensing                      660,000         300,000
               Industrial Products                  449,000         449,000
               Warranty Revenue                      18,000          28,000
                                                 ----------      ----------
                     Total Deferred Revenue      $1,137,000      $  787,000
                                                 ==========      ==========


                                       9

<PAGE>

         Medical product deferred revenues consist of Photonic Stimulator ("PS")
units sold to a customer and will be recognized into revenue when outstanding
obligations are compete and the sales prices are considered fixed and
determinable. Also included is one half month's rental on six Thermal Imaging
Processors ("TIP") cameras the Company has placed with Boothroyd, a Canadian
customer.

         The Nanda Agreement is billed in stages. Upon the execution of the
Nanda Agreement in June 2003, the Company billed Nanda $300,000; however, the
amount of the initial billing remained unpaid as of June 30, 2003 and was
collected in the quarter ended December 31, 2003. In addition, the Company
billed and collected an additional $360,000 under the Nanda Agreement during the
quarter ended December 31, 2003. The Nanda Agreement obligates the Company to
provide training services in the United States and in China. Although the
training was completed in the United States, the Company will not recognize any
revenue from the Nanda Agreement until its obligations are performed and the
Company has completed its training in China.

         Industrial products deferred revenue consists of non-destructive
testing devices shipped to Pratt & Whitney. The Company will recognize these
sales when it has completed its obligations under the purchase agreements with
Pratt & Whitney.

NOTE F. INVENTORIES

         Inventories are stated at the lower-of-cost or market with cost
determined using the first-in first-out method of accounting. As of the dates
set forth below, the Company's inventories consisted of the following:

                             INVENTORY

                                                 December 31,     June 30,
                                                     2003           2003
                                                 ---------------------------

                    Raw materials                $  617,749      $  673,833
                    Inventory reserve              (595,339)       (594,674)
                    Work-in process                 147,560          19,286
                    Finished goods                  194,446         207,419
                                                 -----------     -----------
                    Total                        $  364,416      $  305,864
                                                 ===========     ===========

         Finished goods inventory at December 31, 2003 and June 30, 2003
consisted of approximately $194,000 and $207,000, respectively, of finished
goods ready for sale, a 6% decrease, due, primarily, to sales of existing
photonic stimulator inventory, $148,000 and $19,000 respectively in the
manufacturing process, a 679% increase which consisted primarily of four TIP
cameras in the process to sell to Nanda, and $618,000 and $674,000 of raw
materials, an 8% decrease, due primarily to the attempt to reduce inventory to
preserve cash. In their report on the Company's condensed consolidated financial
statements for the year ended June 30, 2003, the Company's auditors expressed
concern regarding the Company's ability to continue its operations as a going
concern. As a result of that concern, coupled with FDA's decision to not approve
the BCS 2100, the Company has treated its inventories as impaired assets on its
condensed consolidated financial statements for the quarter ended December 31,
2003. The impairment is held in a reserve account in the amount of $595,000 and
represents about 62% of all inventories.

         The Company reserves for excess and obsolete inventory by comparing
inventory on hand to estimated consumption during the next twelve months.
Consumption is estimated by annualizing trailing three or six -month sales
volumes, adjusting those volumes for known activities and trends, then comparing
forecast consumption to quantity on hand. Any difference between inventory on
hand and greater than estimated consumption is recorded to cost of revenues and
an excess and obsolete reserve, which is included as an element of net inventory
reported on the Company's condensed consolidated balance sheet. Amounts charged
to the inventory reserves are not reversed to income until the reserved
inventory is sold or otherwise disposed. The Company felt no need to impair
additional inventory in the quarter ended December 31, 2003


                                       10

<PAGE>

NOTE G. INCOME TAXES

         The Company accounts for income taxes using the liability method. Under
this method, the Company records deferred income taxes to reflect future year
tax consequences of temporary differences between the tax basis of assets and
liabilities and their financial statement amounts. The Company has reviewed its
net deferred tax assets, together with net operating loss carry-forwards, and
has provided a valuation allowance to reduce its net deferred tax assets to
their net realizable value.

NOTE H. CONTINGENCIES

         AL-HASAWI LITIGATION -- On March 29, 2000, Salah Al-Hasawi, a citizen
and resident of Kuwait, filed an action in the United States District Court for
the Southern District of New York, against the Company and its former Chief
Executive Officer, alleging violations under Section 10(b) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, for commissions
allegedly due to the plaintiff in connection with the private placement of the
Company's securities. Shortly thereafter, the lawsuit was dismissed without
prejudice and on April 12, 2000 the plaintiff filed a similar complaint in the
United States District Court for the District of Utah. The plaintiff's complaint
sought specified damages of $15.5 million, attorney fees and unspecified damages
pursuant to five separate causes of action including breach of contract, fraud
and unjust enrichment.

         In December 2003, the Company reached a settlement with the plaintiff,
pursuant to which the Company agreed to pay the aggregate amount of $100,000 in
three installments ($50,000 paid in December, 2003, $25,000 paid in January 2004
and $25,000 to be paid in February 2004) and the plaintiff agreed to dismiss the
litigation with prejudice. The settlement is set forth in a Settlement Agreement
and Mutual Release, which provides for the filing with the court of dismissal
pleadings upon the Company's payment of the final installment in February 2004.

         CLASS ACTIONS -- In 2002, five different lawsuits were filed against
the Company in the United States District Court in Oregon. The lawsuits, which
were consolidated into a single class action, allege in substance that the
Company violated Section 10(b) of the Securities Exchange Act of 1934, as
amended, and accompanying regulations by misleading shareholders regarding such
things as FDA approval and other matters, which the plaintiffs allege caused
significant damage to the holders of our common stock at the time of these
alleged misrepresentations and omissions.

         On April 17, 2003, the consolidated litigation was dismissed without
prejudice by the United States District Court. In a written opinion, the U.S.
District Judge concluded that the alleged misstatements were either not
material, not misleading, or not pled by plaintiffs with sufficient
particularity to constitute a claim. The Court gave the plaintiffs until May 8,
2003 to replead three of the nine claims. Plaintiffs did not replead, so the
judge dismissed the case with prejudice on May 13, 2003, On May 22, 2003, the
plaintiffs filed for appeal, and on September 3, 2003 the plaintiffs filed their
memorandum in support of their appeal. On October 20, 2003, we filed our
response in support of the District Court's opinion. We do not expect to receive
a decision from the appellate court for at least one year. The likelihood of an
unfavorable outcome or the extent of any potential loss is not presently
determinable.

         SEC INVESTIGATION -- In December 2002, the Company was requested to
provide certain documents to the U.S. Securities and Exchange Commission and the
U.S. Attorney for the Southern District of New York in connection with their
investigation of possible violations by the Company's Chairman of the Board and
Chief Executive Officer of the insider trading prohibitions found in the federal
securities laws. During the year ended June 30, 2003 the Company incurred
approximately $658 thousand in legal costs in complying with these requests.
During the period between June 30, 2003 and December 31, 2003, the Company
incurred approximately $168 thousand in additional legal costs associated with
these investigations. The Company also may be required to indemnify its officers
and directors for fees incurred for these investigations. For the year ended
June 30, 2003, such indemnification obligations totaled approximately $36
thousand, and during the period between June 30, 2003 and December 31, 2003 the
Company incurred approximately $12 thousand in additional indemnification
obligations which are included in the previous figures.


                                       11

<PAGE>

         ST. PAUL PROPERTIES -- On April 11, 2003, St. Paul Properties, Inc.
(the "Landlord") filed suit against the Company in the Circuit Court for
Clackamas County. The Landlord alleges that the Company breached its prior
corporate office lease by failing to pay the rent specified under the lease. The
Landlord seeks damages of approximately $667,000 plus interest and attorneys and
other fees. The Company has filed an answer and affirmative defenses alleging
that St. Paul Properties failed to use reasonable efforts to mitigate its
damages. In addition, the Company is aware that much of the vacant space has
been relet to a third party tenant, substantially reducing the damage claim. The
Company has offered the sum of $40,000 to settle the matter. That offer was
rejected by the landlord, with no counter offer made by the landlord. The
Company intends to continue efforts to resolve the matter.

         INDEMNIFICATION -- Under the Company's bylaws and contractual
agreements the Company may be required to indemnify its current and former
officers and directors who are parties to litigation or other proceedings by
providing legal defense through the Company's attorneys (or reimbursing the
parties for their own attorneys) and covering all damages the parties may suffer
if the plaintiffs are successful.

         The Company is involved in certain other litigation matters in the
normal course of business which management currently believes are not likely to
result in any material adverse effects on the financial position, results of
operations, or net cash flows of the Company.

NOTE I. FDA DEVELOPMENTS

         The Company's medical imaging and treatment products are subject to
regulation by the U.S. Food and Drug Administration ("FDA"). Over the past few
years, the Company has sought approval for its breast cancer detection system
through the FDA's Pre-Market Approval process ("PMA"), which requires rigorous
clinical efficacy testing, manufacturing and other data. The Company utilized
the FDA's modular submission method and submitted its application for approval
on five modules for review.

         On December 10, 2002, the Company presented the Breast Cancer System
2100TM ("BCS") to the FDA's Radiological Devices Panel ("Panel"), which
recommended by a vote of 4 to 3 against recommending approval of the BCS to the
FDA. On January 23, 2003, the FDA sent the Company a letter concurring with the
panel's recommendation. The letter provided specific actions the Company could
take in an effort to obtain FDA approval in the future including: (a) performing
a new pre-market clinical study, (b) modifying the indication for use, (c)
performing a reproducibility study to take into account variations encountered
in clinical practice, and (d) providing a validated daily quality assurance
procedure.

         The main issues cited by the FDA were the Panel's conclusion that 1)
the proposed indications for use were revised on the basis of a retrospective
analysis of the results in the original PMA, 2) the additional clinical data in
the "post-PMA" ("PPMA") was insufficient to constitute an adequate study, 3)
enrollment in the Company's studies was not limited to mammographically visible
masses, and 4) the number of exclusions of enrolled subjects was excessive.

         Representatives of the Company met with the FDA Deputy Commissioner and
the FDA Chief Counsel on July 9, 2003. The Company was asked to provide to the
Commissioner's staff a scientific document addressing the FDA's reasons for
non-approval of the Company's application. The scientific document was sent on
July 29, 2003. Another follow-up meeting was held with the FDA on January 15,
2004 reviewing the process. The Company is currently awaiting a response from
the FDA.

NOTE M - OTHER REGULATORY MATTERS

         The Company's TIP camera is a thermal imaging device that reads
temperature (such as an external thermometer) and is noninvasive. In connection
with SARS screening activities, Canada and China have used the cameras
in-airport terminals as a first-line defense measure for identifying travelers
with elevated facial temperatures. Due to the noninvasive nature of the camera,
as well as the fact that the Company has not marketed or promoted the TIP camera
as an SARS screening device, both Canada and China have required minimal
governmental regulation. The Company believes that all regulatory matters
associated with the sale and shipment of these TIP cameras were met according to
the Canadian and Chinese governments.


                                       12

<PAGE>

NOTE N - SEGMENTS

         The Company's operations have historically been reported in two
segments: medical products and industrial products. Results of the Company's
operations for the two segments during the three-month and six-month periods
ended December 31, 2003 are as follows:

                            THREE MONTH PERIOD ENDED
                                  DECEMBER 31,
                                      2003

                                        Medical       Industrial        Total
                                      ------------   ------------   ------------
Revenue                               $    87,308    $     6,337    $    93,645
Cost of Revenues                          (13,800)        (6,730)       (20,530)
                                      ------------   ------------   ------------
      Gross Margin                         73,508           (393)        73,115

General & Administration                  479,839             --        479,839
Research & Development                    296,794             --        296,794
Marketing                                  97,073             --         97,073
Depreciation and amortization              40,903             --         40,903
Impairments                                    --             --             --
                                      ------------   ------------   ------------
      Total Operating Expense             914,609             --        914,609
                                      ------------   ------------   ------------
         Operating Loss               $  (841,101)   $      (393)   $  (841,494)
                                      ============   ============   ============


                             SIX MONTH PERIOD ENDED
                                  DECEMBER 31,
                                      2003

                                         Medical       Industrial        Total
                                      ------------   ------------   ------------
Revenue                               $   139,099    $    17,243    $    56,342
Cost of Revenues                          (40,250)       (22,682)       (62,932)
                                      ------------   ------------   ------------
      Gross Margin                         98,849         (5,439)        93,410

General & Administration                1,024,816             --      1,024,816
Research & Development                    663,700             --        663,700
Marketing                                 251,128             --        251,128
Depreciation and amortization              45,560             --         95,700
Impairments                                    --             --             --
                                      ------------   ------------   ------------
      Total Operating Expense           1,985,204             --      2,035,344
                                      ------------   ------------   ------------
          Operating Loss              $(1,886,355)   $    (5,439)   $(1,941,934)
                                      ============   ============   ============

Because the Company's principal efforts during the three and six-month periods
identified above have been focused on obtaining FDA approval of the Company's
BCS application, as well as resolution of pending litigation and the SEC
investigation regarding the Company's Chairman of the Board and Chief Executive
Officer, no overhead cost allocations to the industrial segment are reflected in
the tables set forth above.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

GENERAL

         Computerized Thermal Imaging, Inc. ("we", "us", "CTI" or the "Company")
designs, manufactures and markets thermal imaging devices and services used for
clinical diagnosis, pain management and industrial testing. We market our
products through an internal sales force and a network of independent
distributors.

         We have developed thermal imaging technology and equipment and methods
for applying our proprietary technology. We believe our thermal imaging systems
generate data, difficult to obtain or not available using other imaging methods,
which is useful to health care providers in the detection of certain diseases
and disorders and useful to the industry for product quality testing.


                                       13

<PAGE>

         Our research indicates that our equipment and technology is useful in
studying and diagnosing breast cancer, which is the second most common cancer in
women. Our research and development efforts led to the creation of our breast
imaging system, known as the "BCS 2100." We are seeking FDA pre-market approval
for the BCS 2100 as an adjunct to mammography and clinical examinations for use
as a painless and non-invasive technique for acquiring clinical information. To
receive pre-market approval ("PMA") from the FDA, we must establish the BCS
2100's ability to consistently distinguish between malignant and benign tissue
and thereby reduce the number of breast biopsies performed on benign tissue. We
have received acceptance on four of the five modules required for PMA approval.
We submitted the fifth module, which includes clinical trial results and
efficacy claims, during June 2001.

         We presented the BCS 2100 to the FDA's Radiological Devices Panel (the
"Panel") on December 10, 2002 and the Panel voted against approval of the BCS
2100. On January 23, 2003, the FDA concurred with the recommendation made by the
Panel and issued to the Company a non-approval letter with respect to the BCS
2100. We believe the FDA's decision was based on technical and statistical
issues regarding the clinical trial and analysis of the clinical trial data. The
main issues cited by the FDA were 1) the Panel concluded that the proposed
indications for use were revised on the basis of a retrospective analysis of the
results in the original PMA, 2) the additional "post-PMA" clinical data was
deemed insufficient to constitute an adequate study, 3) enrollment in the
Company's studies was not limited to mammographically visible masses, and 4) the
Panel concluded that the number of exclusions of enrolled subjects was
excessive. The FDA's letter states specific actions we could take in an effort
to put the PMA into an approvable form including: a) performing a new pre-market
clinical study, (b) modifying the indication for use, (c) performing a
reproducibility study to take into account variations encountered in clinical
practice, and (d) providing a validated daily quality assurance procedure.

         Our management met with the FDA Deputy Commissioner and the FDA Chief
Counsel on July 9, 2003. We were asked to provide to the Deputy Commissioner's
staff a scientific document addressing the FDA's reasons for non-approval. The
scientific document was sent on July 29, 2003, and we are currently waiting for
a response. Another follow-up meeting was held with the FDA on January 15, 2004
for the purpose of reviewing the process. We are currently awaiting a response
from the FDA.

         Our common stock is traded on the American Stock Exchange under the
symbol "CIO." As of January 31, 2003, we had approximately 113 million shares of
common stock outstanding. In addition to common stock, there are outstanding
exercisable warrants and options to acquire approximately 10.4 million shares at
exercise prices ranging from $0.38 to $5.00. Of the approximately 123.4 million
fully-diluted common shares outstanding, 13.5 million are beneficially owned by
insiders and affiliates. Other than our wholly-owned subsidiary, Bales
Scientific, Inc., we have no interest in any other entity.

         We use our capital to pay general corporate expenses, including
salaries, manufacturing costs, professional fees, clinical study and technical
support costs, and general and administrative expenses. We are a development
stage company and, to date, we have funded our business activities with funds
raised through the private placement of common stock, debt and warrants, and the
exercise of warrants and options.

         This report contains forward-looking statements within the meaning of
the Securities Act of 1933, as amended, and Securities Exchange Act of 1934, as
amended. Forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause our actual results, performance
or achievements to be materially different from any expected results,
performance or achievements. When used in this document the words "expects",
"anticipates," "intends," "plans," "may," "believes," "seeks," "estimates," and
similar expressions generally identify forward-looking statements. All
forward-looking statements included in this report are based on information
available to us on the date hereof, and we assume no obligation to update any
forward-looking statements except to the extent required under applicable
securities laws.

         The following discussion and analysis of our consolidated financial
condition and results of operations should be read in conjunction with our
audited condensed consolidated financial statements and notes thereto contained
in our Annual Report on Form 10-K for the fiscal year ended June 30, 2003.


                                       14

<PAGE>

CRITICAL ACCOUNTING POLICIES

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

         We believe the following are our critical accounting policies. That is,
they are both important to the portrayal of our financial condition and results,
and they require management to make judgments and estimates about matters that
are inherently uncertain.

         CASH AND CASH EQUIVALENTS-- Cash and cash equivalents include cash in
checking accounts and short-term highly liquid investments with an original
maturity of one year or less.

         REVENUE RECOGNITION -- Although we believe revenues recognized to date
have been immaterial to our financial statements, we also believe revenue
recognition is a significant business process that requires management to make
estimates and assumptions. We recognize revenue from product sales after
shipment when persuasive evidence of an agreement exists, delivery of the
product has occurred, no significant obligations remain, the price or fee is
fixed or determinable, and collection is probable. If these conditions are not
met, revenue is deferred until such obligations and conditions are fulfilled.

         Our standard domestic terms for sales of our medical products to
end-user customers are "net 30 days," and our standard international terms for
sales of our medical products require payment in cash or placement of a letter
of credit before shipment. On occasion, we offer extended payment terms beyond
our normal business practices, usually in connection with providing an initial
order of demonstration equipment to a new domestic distributor. We consider fees
on these extended terms agreements not fixed and collectibility less than
probable and defer the revenue until receipt of payment. Our sales prices have
declined over time and we credit price decreases to any balance due from a
distributor. We sell separate extended warranty contracts for our Thermal Image
Processor ("TIP") and Photonic Stimulator and recognize revenue from those
arrangements ratably over the contract life. We do not offer rights or return
privileges in sales agreements.

         Industrial sales are made pursuant to individually negotiated
commercial contracts which specify payment terms that have ranged from 60 to 90
days from shipment or service completion. With industrial products, even if
delivery and payment have occurred, we may retain a significant ongoing
obligation under a sales arrangement for the delivery of components or
customized software and customer testing, and we defer recognizing revenue until
all the multiple elements of the sale are completed.

         RESEARCH AND DEVELOPMENT EXPENSES -- We expense as incurred the direct,
indirect and purchased research and development costs associated with our
products. We believe this method is conservative given the product and market
acceptance risk inherent to our products and reduces administrative burden and
cost.

         IMPAIRMENT OF LONG-LIVED ASSETS -- We follow the provisions of
Financial Accounting Standards Board ("FASB") SFAS No. 141, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF,
which requires that if the sum of the future cash flows expected to result from
the assets, undiscounted and without interest charges, is less than a company's
reported value of the assets, the asset is not recoverable and the company must
recognize an impairment. The amount of impairment to be recognized is the excess
of the reported value of the assets over the fair value of those assets and is
recorded as impairment expense on our statements of operations. In estimating
impairments, management makes assumptions about future cash flows and fair value
that are inherently uncertain, can significantly affect the results and may
differ from actual future results.


                                       15

<PAGE>

         INVENTORY RESERVES -- We establish reserves for excess and obsolete
inventory by comparing inventory on hand to estimated consumption during the
subsequent twelve-month period. Consumption is estimated by annualizing trailing
three or six-month sales volumes, adjusting those volumes for known activities
and trends, and comparing forecast consumption to quantity on hand. Any
difference between inventory greater than estimated consumption is recorded to
cost of revenues and an excess and obsolete reserve, which is included as an
element of net inventory reported on our balance sheet. Amounts charged to the
inventory reserves are not reversed to income until the reserved inventory is
sold or otherwise disposed.

         EMPLOYEE INCENTIVE PLANS -- We have terminated our discretionary 401(k)
plan. All CTI common stock formerly held in our 401(k) plan was sold and the
proceeds were placed in funds as selected by each individual employee. We are in
the process of issuing lump sum distributions and qualified plan rollovers for
each participant. The process is nearly complete at time of this filing.

TRENDS/UNCERTAINTIES AFFECTING CONTINUING OPERATIONS

         We are exposed to the opportunities and risks usually associated with
marketing and manufacturing novel products, including staff retention and
recruiting, market acceptance of our products, product warranty, bad debts and
inventory obsolescence. We expect to earn revenues from the sale of our
products, but there is no guarantee that these revenues will recover all the
costs of marketing, selling and manufacturing our products.

         Our marketing efforts rely upon building relationships with
manufacturers, medical equipment dealers, physicians and clinical investigators.
We communicate with our target markets by attending trade shows and conferences,
making direct sales calls, and sponsoring clinics where we introduce and
demonstrate our products. Although most recently all marketing efforts have been
placed on hold until FDA approval for our medical product can be obtained. We
believe marketing medical products through trade shows, conference
presentations, direct mail and inside sales augmented with dealers provides a
low-cost, high-leverage approach to diagnostic imaging and pain management
practitioners. To the extent possible, which is extremely limited at present, we
plan to continue investing resources in these programs, although there can be no
assurance they will lead to market acceptance of our products.

         We organize clinical studies with institutions and practitioners to
obtain user feedback and to secure technical papers for training and marketing
purposes. These strategies represent a significant investment of time and
resources and have provided useful information; however, there can be no
guarantee that these strategies will lead to market acceptance of our products.
At the time of filing this report, our only existing clinical study with
Massachusetts General Hospital has been placed on hold until FDA approval can be
obtained.

         To date, we have had limited operating revenues from the sale of our
products and services ($3.6 million in total revenues since inception). We
cannot provide any assurance that we will achieve profitability in the future.
Our immediate priorities are to reconcile issues presented to us by the Panel on
December 10, 2002 and FDA administrators in subsequent meetings, most recently
January 15, 2004, and the pursuit of additional funding. At this time, we are
unsure how much time and additional financing we will require to resolve these
issues with the FDA. We are also unsure about our ability to raise additional
financing that will be required to continue our business operations. These
uncertainties, among others, raise doubts about our ability to continue as a
going concern. Furthermore, based on our expected cash flow from operations and
our limited current assets, our auditors have expressed their view, in their
report on our financial statements for the year ended June 30, 2003, that they
did not believe we would be able to continue our operations as a going concern
through the end of our 2004 fiscal year.

FACTORS THAT MAY AFFECT FUTURE RESULTS

         Our operating results and financial condition are subject to
substantial risks and uncertainties. These risks and uncertainties include, but
are not limited to, the following:

         For the years ended June 30, 2003 and 2002, our auditors issued their
audit report with a going concern qualification. This means that, based on our
expected cash flow from operations and our existing current assets, our auditors
did not believe that we would be able to continue our operations in their
then-existing form through the end of our 2004 fiscal year. We can provide no
assurance that we will ever generate sufficient revenues to continue our
operations.

                                       16

<PAGE>

         Our failure to raise additional capital could cause us to severely
curtail operations, which would adversely affect shareholder value, or cease
operations entirely, which would likely eliminate any value in our common stock.

         Our failure to obtain FDA approval of our BCS 2100 would have a
material adverse impact on our results of operation and financial condition, and
may result in cessation of our operations entirely.

         On January 29, 2004 we received a letter from the American Stock
Exchange ("AMEX") giving notification of AMEX decision to delist trading of our
common stock on their exchange. We do not currently meet the requirements for
continued listing on AMEX. In particular, we do not currently maintain the
required level of shareholder equity, we have incurred operating losses for two
of the past three years, and our financial condition is impaired. We have filed
an appeal in hopes of persuading AMEX that we will be able to restore our
compliance with the exchange's requirements. If our common stock is delisted,
there may be no trading market for our common stock.

         We are involved in substantial shareholder litigation, which may have
an adverse impact on us and our shareholders.

         We have limited revenues from operations and may never have substantial
revenue from operations.

         Failure to obtain insurance reimbursement codes for our BCS 2100 may
make the BCS 2100 unmarketable, thereby adversely affecting shareholder value.

         We expect to continue to incur losses, deficits, and deficiencies in
liquidity for the foreseeable future. Unless we are able to reverse those
trends, we will likely be unable to continue our operations.

         We may sell assets or reduce activities to fund operations, which could
adversely affect shareholder value.

         The recent volatility in the market price of our common stock could
continue and adversely affect shareholder value.

         We could issue preferred stock or sell other securities or other
financing instruments, including convertible debt, which could result in
significant dilution to existing shareholders.

         We rely on third parties in the development and manufacture of key
components for our products. If they fail to perform, product development,
and/or production could be substantially delayed.

         If we are unsuccessful in preventing others from using our intellectual
property, we could lose a competitive advantage.

         We do not have product liability insurance; if we are made subject to a
products liability claim, whether or not the claim is meritorious, our results
of operation and financial condition may be adversely affected.

OTHER FACTORS THAT MAY AFFECT FUTURE RESULTS.

         The foregoing factors should be read in conjunction with our audited
consolidated financial statements, notes thereto and risk factors set forth in
our Annual Report on Form 10-K for the fiscal year ended June 30, 2003 (the
"Form 10-K"). Many of the risks identified above are discussed in greater detail
in the Form 10-K.

RESULTS OF OPERATIONS

QUARTER ENDED DECEMBER 31, 2003, COMPARED TO QUARTER ENDED DECEMBER 31, 2002.

REVENUES

         Revenues for the three and six months ended December 31, 2003 decreased
$501 and $703 thousand, or 84% and 82%, respectively, from the same period last
year to $94 and $156 thousand; $34 thousand (three months) and $81 thousand (six
months) of our revenues resulted from the sale of pain management products; $35
thousand (three months) and $37 thousand (six months) from the rental of our TIP
camera to a Boothroyd, a Canadian customer using the camera for monitoring the
skin surface temperatures of passengers as they pass through airport security
screening areas; $6 thousand (three months) and $10 thousand (six months) was
recognition of warranty revenue; the remaining $19 thousand (three months) and
$28 thousand (six months) was other and industrial services. The decrease in
revenue was due primarily to a decrease in pain management products sales that
partly can be attributed to the reduction in sales force.

                                       17

<PAGE>

         During the three and six months ended December 31, 2003, medical
segment revenues were $87 thousand (three months) and $139 thousand (six
months), compared to $396 thousand (three months) and $647 thousand (six months)
from the same periods last year, resulting in an decrease of $309 thousand
(three months) and $508 thousand (six months), or 78% (three and six months)
(six months). This decrease reflected decreased sales of our pain management
products, due to a reduced sales force and decreased marketing efforts. The sale
of Photonic Stimulator units decreased approximately 76% in the three months and
63% in the six months ended December 31, 2003, compared to the same period of
2002, and sales of the TIP Camera decreased over 86% in the three months and 91%
in the six months ended December 31, 2003, compared to the same two periods in
2002.

         During the three and six months ended December 31, 2003, industrial
segment revenues were $6 thousand (three months) and $17 thousand (six months),
compared to $199 thousand (three months) and $212 thousand (six months) for the
same periods of last year, resulting in a decrease of $193 thousand (three
months) and $195 thousand (six months), a 97% (three months) and 92% (six
months) decrease. There was one primary sale of a TIP camera made to
Dresser-Rand in the six -month period ended December 31, 2002, and no comparable
sale in the six -month period ended December 31, 2003.

         During the three and six months ended December 31, 2003, no overhead
expenses were allocated to the industrial segment of our operations, due to our
reduction in sales staff and decreased development in the segment and the shift
in focus of management to obtaining FDA approval of our BCS 2100, as well as
resolution of ongoing litigation and governmental investigations.

         There was one unfulfilled order for a TIP camera for $47 thousand as of
December 31, 2003. This camera was shipped and invoiced in January 2004 and we
are awaiting payment.

         We recognized $35 thousand, or 37% of total revenue, in foreign sales,
consisting primarily of fees generated from the rental of a TIP camera to a
Canadian customer, during the quarter ended December 31, 2003, compared to
approximately $215 thousand, primarily revenues generated from product sales to
a Chinese customer, or 36% of total revenues, for the quarter ended December 31,
2002.

COSTS AND EXPENSES

         Gross margins for the three and six months ended December 31, 2003 were
$73 thousand (three months) and $93 thousand (six months), compared to losses of
$153 thousand (three months) and $93 thousand (six months) for the same periods
of the prior year. Total cost of goods sold for the three and six months ended
December 31, 2003 was $21 thousand (three months) and $63 thousand (six months),
compared to $748 thousand (three months) and $952 thousand (six months) for the
same periods last year, which included an allowance for obsolete inventory of
approximately $350 thousand.

         We expect that unit prices for our TIP System and Photonic Stimulator
will continue to decline as a prerequisite to increasing market penetration. We
also expect prices to decline faster than we will be able to reduce
manufacturing costs; therefore, we anticipate our gross margins as a percentage
of sales for our pain management products will also decline. Declining demand
for our pain management products and the resulting revenues and gross margins
are dependant upon a number of factors, including general economic conditions,
insurance reimbursements, insurance coverage offered by medical plans and our
ability to market and promote our products.

         General and administrative expenses for the three and six months ended
December 31, 2003 were $380 thousand (three months) and $925 thousand (six
months), compared to $646 thousand (three months) and $1,479 thousand (six
months) for the same period last year, a decrease of $266 thousand (three
months) and $554 thousand (six months), or 41% (three months) and 37% (six
months). The decrease reflects our effort to reduce costs and preserve cash. The
decrease consisted of declines in salary expense ($20 thousand for three months;
$248 thousand for six months), office expense ($49 thousand for three months;
$116 thousand for six months), and professional services and legal expense ($67
thousand for three months -- excluding a $100 thousand litigation settlement for
the Al-Hasawi case; $60 thousand for six months), shareholder service costs ($74
thousand for three months and $94 thousand for six months) equipment supplies
($35 thousand for three months; $55 thousand for six months) and other expenses
($21 thousand decrease for three months; $19 thousand increase for six months).


                                       18

<PAGE>

         Research and development expenses for the three and six months ended
December 31, 2003 were $297 thousand (three months) and $663 thousand (six
months), compared to $1,154 thousand (three months) and $2,401 thousand (six
months) for the same periods last year, a decrease of $857 thousand (three
months) and $ 1,739 thousand (six months), or 74% (three months) and 72% (six
months). The reduction in research and development expense reflects our efforts
to preserve cash. Reductions in salary expense accounted for $327 thousand
(three months) and $903 thousand (six months) of the decrease and reductions in
medical research services resulted in decreases of $162 thousand (three months)
and $224 thousand (six months). In addition, reductions in rent ($45 thousand
three months; $120 six months thousand), clinical trial expenses ($23 thousand
three month and $31 thousand six month) and office, travel, insurance and other
expenses ($300 thousand three month and $461 thousand six month) contributed to
the decrease.

         Marketing expenses for the three and six months ended December 31, 2003
were $97 thousand (three months) and $251 thousand (six months), compared to
$387 thousand (three months) and $996 thousand (six months) for the same periods
last year, a decrease of $290 thousand (three months) and $744 thousand (six
months), or 75% (three and six months), from the same periods last year.
Reduction in salaries accounted for $170 thousand (three months) and $426
thousand (six months) of the decrease. The decrease also reflected decreased
travel expenses ($63 thousand for three months; $98 thousand for six months),
reduced office expense and rent ($38 thousand for three and six months), and
reduced insurance expense ($25 thousand for three months; $45 thousand for six
months). The decrease reflected management's efforts to preserve our cash
position.

         We believe securing a favorable recommendation from the FDA is critical
to obtaining additional funding. Due, however, to the delay in FDA response, we
have been forced to conserve cash by reducing expenses throughout the Company.
We feel it is not wise to continue development of a product that has not yet
been approved by the FDA.

         We plan to continue conducting clinical studies at a much reduced
level, utilizing the BCS 2100, with institutions and practitioners to obtain
user feedback, test product enhancements as they become available, secure
technical papers and for training and educational marketing purposes. The only
study we currently are conducting at Massachusetts General Hospital was placed
on hold in January 2004. Clinical studies are not the same as clinical trials,
which we conducted for FDA PMA approval purposes.

         Depreciation and amortization expense for the quarter ended December
31, 2003 decreased $135 thousand and $244 thousand to $41 thousand and $96
thousand, or 77% and 72%, respectively, compared to the same periods of the
prior year. During fiscal 2003, we impaired all assets to reflect possible
recovery values due to the concern expressed by our auditors that we may not be
able to continue as a going concern. There was no additional impairment in the
three and six-month periods ended December 31, 2003.

OPERATING INCOME / LOSS

         Principally as a result of the foregoing, we recorded operating losses
of $841 thousand and $1,942 thousand for the three and six-month periods ended
December 31, 2003, respectively, compared to operating losses of $3.2 million,
respectively, for the three and six-month periods ended December 31, 2002. Sales
in the medical segment accounted for most of our revenue in the three and six
months ended December 31, 2003. Our activities in the industrial segment during
the three and six months resulted primarily in service revenues and related
labor costs. By reducing expenses we have been able to reduce our losses;
however, revenue growth has suffered consequently.

OTHER INCOME

         Net interest expense for the three and six-month periods ended December
31, 2003 decreased $161 thousand and $786 thousand, respectively, from the same
periods of 2002, to an income of $2 thousand and expense of $1 thousand,
respectively. These decreases resulted primarily from the retirement of a
convertible debenture.


                                       19

<PAGE>

NET INCOME/(LOSS)

         We recorded a net loss of $839 thousand and $1,943 thousand for the
three and six months ended December 31, 2003, compared to a net loss of 3.4
million and $6.9 million for the same periods in 2002. For the three and six
months ended December 31, 2003, the loss attributable to common shareholders was
$839 thousand, or ($0.01) per share, and $1,943 thousand or ($0.02) per share,
compared to a loss attributable to common shareholders of $3.4 million, or
($0.04) per share, and $6.9 million or ($0.08) per share for the same periods in
2002. The decreased loss per share is in part due to the retirement of the Beach
Boulevard debenture and equity line, diluting shareholder ownership by
increasing shares from 83 million shares to 113 million and the to the reduction
in costs.

LIQUIDITY AND CAPITAL RESOURCES

SOURCES AND USES OF LIQUIDITY

         Our sources of funds used for operations have historically come from
selling common stock, as well as the issuance and exercise of options and
warrants, revenues generated from operations, sales of marketable securities,
interest earned from marketable securities available for sale and debt
assumption.

         Our cash requirements include, but are not limited to, general
corporate expenses including employee salaries and benefits, defense of
shareholder lawsuits and response to regulatory investigations, indemnification
of employees, lease payments on office space, legal and accounting fees for
litigation, compliance with securities registration and reporting requirements,
costs of clinical trials and studies and technical support, FDA consulting
expenses, procurement of inventory and supply expenses associated with our
efforts to develop, manufacture and market our medical and industrial
applications. We have reduced many of these costs in an effort to preserve cash;
however, a significant amount of these costs are attributable to activities that
are necessary to continue our operations and obligations.

         Net cash used in operating activities for the six months ended December
31, 2003 was $1.02 million, compared to $6.2 million for the six months ended
December 31, 2002. The decrease in cash used in operating activities was
primarily a result of our efforts to decrease our expenses and cash outlays and
is affected by fluctuations in accounts receivable, accounts payable and accrued
expense balances.

         Excluding an allowance for doubtful accounts of $64 thousand for the
six months ended December 31, 2003, accounts receivable decreased approximately
$343 thousand from $424 thousand to $81 thousand at December 31, 2003, compared
to June 30, 2003. This decrease in receivables relate primarily to one invoice
to NanDa Thermal Technology, Inc. ("NanDa") for $300 thousand associated with a
prepayment required by the contract. We have deferred our recognition of revenue
under the NanDa agreement until we have satisfied our obligations under the
agreement.

         Net cash provided by investing activities for the six months ended
December 31, 2003 was $4 thousand, compared to net cash used in investing
activities of $5.5 million in the six months ended December 31, 2002. Net cash
provided by and used in investing activities was provided by the sale of fixed
assets in connection with our office consolidation process for fiscal 2003,
whereas net cash in 2002 was from the sale of securities.

         Net cash provided by financing activities was $1 million for the six
months ended December 31, 2003, compared to $314 thousand during the six months
ended December 31, 2002. On July 9, 2003 we closed a private placement pursuant
to Regulation S of the Securities Act, and sold 3,344,482 shares of our common
stock to Therfield Holdings LTD., a limited liability company formed under the
laws of the British Virgin Islands, for $1 million. Net cash provided by
financing activities for the six months ended December 31, 2003 was from net
cash provided from selling shares of common stock pursuant to an equity line of
credit.

         As a result of the foregoing, our net cash outflow decreased by $8
thousand during the six months ended December 31, 2003, compared to a $438
thousand decrease in the six months ended December 31, 2002.

         Cash and cash equivalents at December 31, 2003 were $447 thousand,
compared to $454 thousand at June 30, 2003.

                                       20

<PAGE>

         As of February 1, 2004, our current monthly expense rate is under $200
thousand; our monthly expense rate at our former full operational level was
approximately $1,100 thousand. As of February 1, 2004 , we had cash, accounts
receivable and pre-paid expenses of approximately $188 thousand and current
liabilities (excluding the debenture and deferred revenue) of approximately $957
thousand. These current liabilities consisted of approximately $495 thousand of
accounts payable, $400 thousand of accrued liabilities, and $62 thousand of
accrued employee costs. Accordingly, unless we are able to secure additional
funding from a third party, we do not currently have sufficient working capital
to sustain our operations at current levels, which are already substantially
reduced, beyond February or March 2004. Our failure to secure additional funding
may result in further severe reductions in our operations or the discontinuance
of our operations altogether.

         The following table summarizes our contractual obligations and
commitments to make future payments as of December 31, 2003:
<TABLE>
                                                  Payments due by period

                                Total     less than 1 year   1-2 years  after 3 years
                              -------------------------------------------------------
<S>                           <C>            <C>              <C>            <C>
Oswego operating lease        $535,159       $535,159         $0             $0
Al-Hasawi settlement           $50,000        $50,000         $0             $0
Garvey Shubert settlement      $10,000        $10,000         $0             $0

</TABLE>

CAPITAL REQUIREMENTS/PLAN OF OPERATION

         Our capital requirements may vary from our estimates and will depend
upon numerous factors including, but not limited to: a) FDA approval process; b)
results of pre-clinical and clinical testing; c) costs of technology; d) time
and costs involved in obtaining other regulatory approvals; e) costs of filing,
defending and enforcing any patent claims and other intellectual property
rights; f) the economic impact of developments in competing technology and our
markets; g) competing technological and market developments; h) the terms of any
new collaborative, licensing and other arrangements that we may establish; i)
litigation costs; and j) costs we incur in responding to inquiries and
investigations conducted by the Commission and other governmental entities.

         Since inception, we have generated significant losses from operations
($96.1 million) and, although we have generated some revenues ($3.6 million), we
are still a development stage enterprise. We have taken actions to reduce our
expenses and cash consumption; however, we expect to incur additional operating
losses for the indefinite future. Our working capital requirements in the
foreseeable future will depend on a variety of factors and assumptions. In
particular, we will need to obtain additional financing through additional
equity and/or debt financings or through the sale of assets (including our
intellectual property) during fiscal year 2004. If we raise additional funds
through the issuance of equity securities or other financing instruments which
are convertible for equity securities, our shareholders may experience
significant dilution that would aversely affect the price of our common stock.
If we raise debt capital, the lenders may require us to pledge our assets as
collateral and could insist on loan terms that could adversely affect our
operations and the price of our common stock. Furthermore, there can be no
assurance that additional financing will be available when needed or at all, or
that if available, such financing will be on terms favorable to us or our
shareholders. If financing is not available when required or is not available on
acceptable terms, we may be required to curtail our operating plan and will
likely not be able to continue operations as a going concern.

         We do not have sufficient capital to cover: 1) the expected costs of
additional clinical studies if required by the FDA; 2) the potential damages of
pending shareholder litigation; or 3) the anticipated expense of funding our
business plan over the next year. We will have to obtain additional capital
within the fiscal year through issuance of securities, assumption of loans, sale
of assets (including our intellectual property). Furthermore, these factors have
made it difficult if not impossible to raise the required capital needed to
continue operations. If we are not successful, we will have to scale back our
business plans and may have to discontinue operations.


                                       21

<PAGE>

         As of December 31, 2003, we believed that we had sufficient liquidity
to sustain current operations for next two months. Our monthly expense rate at
that time averaged $250 thousand, we had cash, marketable securities, accounts
receivable and pre-paid expenses of approximately $447 thousand and current
liabilities (excluding the debenture and deferred revenue) of approximately $1.2
million. On a short -term basis, we believed we would be able to fund our
operations with cash on hand and the proceeds of our receivables and current
sales activities; however, to fund our operations over the long term (more than
2 months) we believed we would need to raise additional capital or curtail our
operation.

         As of February 1, 2004, we have reduced operating expenses and
curtailed operating activities. Overall, we have reduced our monthly cash
consumption to under $200 thousand, which we currently believe will be adequate
to sustain our operations at current levels only through February 2004 or March
2004. We have selectively reduced expenses by eliminating expenditures for
certain regional trade shows and conferences; reducing or eliminating
administrative staff, reducing purchased services and the level of certain
employee benefit programs, delaying salary increases and consolidating
operations. If we are unable to secure additional capital, we may need to
further reduce our operations or discontinue operations entirely. On February 4,
2004, we received $220 thousand in connection with an agreement with a private
investor, which our anticipate will generate up to $1 million in additional
capital to be used for CTI's continuing operations, pursuit of regulatory
approvals and product development. Pursuant to the stock purchase arrangement,
the balance is payable in future installments. In exchange for the amounts paid
and payable to us, we have agreed to issue to the investor an aggregate of
4,545,455 shares.


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         We are a development stage enterprise. We believe we are not subject to
market risks beyond ordinary economic risks, such as interest rate fluctuations
and inflation.

         At December 31, 2003, we had invested approximately $200 thousand in
cash and available-for-sale marketable securities, including investments in
United States government securities and corporate bonds. Although we believe the
issuers of these marketable securities are solvent and are favorably rated by
recognized rating agencies, there is the risk that such issuers may not have
sufficient liquid assets to satisfy their obligations at the time such
obligations become due. If such were to occur, we may not be able to recover the
full amount of our investment.

         Each of our marketable securities has a fixed rate of interest.
Accordingly, a change in market interest rates may result in an increase or
decrease in the market value of our marketable securities. If we liquidate any
of our marketable securities prior to the time of their maturity, we could
receive less than the face value of the security.

ITEM 4. CONTROLS AND PROCEDURES

         An evaluation was performed under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer, or CEO, and the Company's Chief Financial Officer, or CFO, of
the effectiveness of the Company's disclosure controls and procedures as of
December 31, 2003. Based on that evaluation, the Company's management, including
its CEO and CFO, concluded that the Company's disclosure controls and procedures
are effective to ensure that information required to be disclosed by the Company
in reports filed or submitted by the Company under the Securities Exchange Act
of 1934, as amended, is recorded, processed, summarized and reported as
specified in the SEC's rules and forms. There have been no significant changes
in the Company's internal controls or in other factors that could significantly
affect internal controls subsequent to the evaluation.



                                       22

<PAGE>

PART II -- OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

SALAH AL-HASAWI ADVISORY SERVICES CLAIM

         On March 29, 2000, Salah Al-Hasawi, a citizen and resident of Kuwait,
filed an action in the United States District Court for the Southern District of
New York, against us and our former Chief Executive Officer, alleging violations
under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated thereunder, for commissions allegedly due to the plaintiff in
connection with the private placement of our securities. Shortly thereafter, the
lawsuit was dismissed without prejudice and on April 12, 2000 the plaintiff
filed a similar complaint in the United States District Court for the District
of Utah. The plaintiff's complaint sought specified damages of $15.5 million,
attorney fees and unspecified damages pursuant to five separate causes of action
including breach of contract, fraud and unjust enrichment.

         In December 2003, we reached a settlement with the plaintiff, pursuant
to which we agreed to pay the aggregate amount of $100,000 in three installments
($50,000 paid on December 17, 2003, $25,000 paid in January 2004 and $25,000 to
be paid in February 2004) and the plaintiff agreed to dismiss the litigation
with prejudice. The settlement is set forth in a Settlement Agreement and Mutual
Release, which provides for the filing with the court of dismissal pleadings
upon our payment of the final installment in February 2004.

SHAREHOLDER CLASS ACTION

         In 2002 five different lawsuits were filed against us in the United
States District Court in Oregon. The lawsuits, which were consolidated into a
single class action, allege in substance that CTI violated section 10(b) of the
Securities Exchange Act of 1934, as amended, and accompanying regulations by
misleading shareholders regarding such things as FDA approval and other matters,
which the plaintiffs allege caused significant damage to the holders of our
common stock at the time of these alleged misrepresentations and omissions. The
plaintiffs have not specified their damages. On April 17, 2003, the consolidated
litigation was dismissed without prejudice by the United States District Court.
In a written opinion, the U.S. District Judge concluded that the alleged
misstatements were either not material, not misleading, or not plead by
plaintiffs with sufficient particularity to constitute a claim. The Court gave
the plaintiffs until May 8, 2003 to replead three of the nine claims. Plaintiffs
did not replead, so the judge dismissed the case with prejudice on May 13, 2003.
On May 22, 2003, the plaintiffs filed for appeal, and on September 3, 2003 the
plaintiffs filed their memorandum in support of their appeal. On October 20,
2003, we filed our response in support of the District Court's opinion. We do
not expect to receive a decision from the appellate court for at least one year.

         We believe the plaintiffs' allegations are without merit and intend to
defend them vigorously. Defending these lawsuits will require additional legal
expenses, may make fundraising more difficult if not impossible and will
distract members of management from day-to-day operations. Moreover, our
insurance carrier has previously denied coverage for the plaintiffs' claims and,
accordingly, has indicated it will not cover the costs of defending the claims
and will not pay any resulting damages we may suffer if the plaintiffs are
successful. We have retained insurance counsel to advise us in this matter,
which is in its early stages. In addition, under our bylaws and contractual
agreements we are required to indemnify our current and former officers and
directors who are parties to the litigation by providing legal defense through
our attorneys (or reimbursing them for their own attorneys) and covering all
damages they may suffer if the plaintiffs are successful.

SEC AND DEPARTMENT OF JUSTICE INVESTIGATIONS

         In December 2002, we were requested to provide certain documents to the
U.S. Securities and Exchange Commission and the U.S. Attorney for the Southern
District of New York in connection with their investigation of possible
violations by our Chairman of the Board and Chief Executive Officer of the
insider trading prohibitions found in the federal securities laws. During the
year ended June 30, 2003, we incurred approximately $658 thousand in legal costs
in complying with these requests. During the period between June 30, 2003 and
December 31, 2003, we incurred approximately $168 thousand in additional legal
costs associated with these investigations. We also may be required to indemnify


                                       23

<PAGE>

our officers and directors for fees incurred for these investigations. For the
year ended June 30, 2003, such indemnification obligations totaled approximately
$36 thousand, and during the period between June 30, 2003 and December 31, 2003
we incurred approximately $12 thousand in additional indemnification obligations
which are included in the previous figures. It is difficult to place a dollar
value on the time spent by executives, board members, and employees in dealing
with this issue. However, considerable time has been spent in testifying,
interviews, and document location and preparation by many of our staff,
executives and board members.

ST. PAUL PROPERTIES

         On April 11, 2003, St. Paul Properties, Inc. (the "Landlord") filed
suit against us in the Circuit Court for Clackamas County. The Landlord alleges
that we breached our prior corporate office lease by failing to pay the rent
specified under the lease. The Landlord seeks damages of approximately $667,000
plus interest and attorneys and other fees. We have filed an answer and
affirmative defenses alleging that St. Paul Properties failed to use reasonable
efforts to mitigate its damages. In addition, we are aware that much of the
vacant space has been relet to a third party tenant, substantially reducing the
damage claim. We have offered the sum of $40,000 to settle the matter. That
offer was rejected by the landlord, with no counter offer made by the landlord.
We intend to continue efforts to resolve the matter.

INDEMNIFICATION

         Under our bylaws and contractual agreements, we may be required to
indemnify our current and former officers and directors who are parties to
litigation or other proceedings by providing legal defense through our attorneys
(or reimbursing the parties for their own attorneys) and covering all damages
the parties may suffer if the plaintiffs are successful.

OTHER LEGAL PROCEEDINGS

         We are involved in certain other litigation matters in the normal
course of business which management currently believes are not likely to result
in any material adverse effects on our financial position, results of
operations, or net cash flows.

ITEM 2. CHANGES IN SECURITIES

         On January 22, 2004, in connection with an October 17, 2003 settlement
with a law firm the Company issued 25,000 shares of stock in exchange for a
reduction of approximately $30 thousand in a payable to the law firm. The
settlement was for an outstanding amount of approximately $110 thousand for cash
of $80 thousand (40 thousand in October 2003 and $10 thousand a month for 4
months) plus the $25,000 shares of common stock. We anticipate that we will pay
the final installment of $10 thousand in February 2004.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

  31.1   Certification of Chief Executive Officer
  31.2   Certification of Chief Financial Officer
  32.1   Certification of Chief Executive Officer
  32.2   Certification of Chief Financial Officer

(b) REPORTS ON FORM 8-K

Current Report on Form 8-K filed October 3, 2003 (reporting the resignation of
John M. Brenna as Chief Operating Officer and a director of CTI).

Current Report on Form 8-K filed October 20, 2003 (reporting the appointment of
BJ Mendenhall as Chief Financial Officer of CTI).

Current Report on Form 8-K filed February 9, 2004 (reporting the Company's
appeal to American Stock Exchange notice to delist and private placement as the
first step to restore compliance).




                                       24

<PAGE>
SIGNATURES

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

COMPUTERIZED THERMAL IMAGING, INC.
(Registrant)

/s/ Richard V. Secord
-----------------------------
Dated February 13, 2004
Richard V. Secord
Chairman & Chief Executive Officer

/s/ BJ Mendenhall
-----------------------------
Dated February 13, 2004
BJ Mendenhall
Chief Financial Officer