<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 March 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: 1-16253

                       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.)

         12725 SW 66th Avenue, Suite 100
                Portland, Oregon                            97223
       -----------------------------------             ----------------
    (Address of principal executive offices)              (Zip Code)

                                 (503) 624-5799
                            ------------------------
              (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 [ ]

         APPLICABLE ONLY TO CORPORATE ISSUERS: State the number of shares
outstanding of each of the issuer's classes of common equity, as of the latest
practicable date: Common stock, par value $0.001, of which 107,397,378 shares
were issued and outstanding as of May 14, 2003.

<PAGE>

                       COMPUTERIZED THERMAL IMAGING, INC.

                                    FORM 10-Q

                                QUARTERLY REPORT

                                TABLE OF CONTENTS

                         PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements...................................................3

        Condensed Consolidated Balance Sheets as of March 31, 2003 and
        June 30, 2002 .........................................................3

        Condensed Consolidated Statements of Operations for the three and
        nine months ended March 31, 2003 and 2002 and for the period from
        inception on June 10, 1987 to March 31,2003 ...........................4

        Condensed Consolidated Statements of Cash Flows for the nine
        months ended March 31, 2003 and 2002 and for the period from
        inception on June 10, 1987 to March 31, 2003 ..........................5

        Notes to Condensed Consolidated Financial Statements...................7

ITEM 2. Management's Discussion and Analysis of Financial Condition and
        Results of Operations.................................................20

ITEM 3. Quantitative and Qualitative Disclosure of Market Risk................43

ITEM 4. Controls and Procedures...............................................43

                           PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings.....................................................44

ITEM 2. Changes in Securities.................................................46

ITEM 3. Defaults upon Senior Securities.......................................46

ITEM 4. Submission of Matters to a Vote of Security Holders...................46

ITEM 5. Other Information.....................................................46

ITEM 6. Exhibits and Reports on Form 8-K......................................46

SIGNATURES ...................................................................47

                                       2

<PAGE>
<TABLE>

PART I - FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

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

                                                                              March 31,           June 30,
ASSETS                                                                          2003               2002
                                                                            (UNAUDITED)
<S>                                                                         <C>                <C>
CURRENT ASSETS:
  Cash and cash equivalents                                                 $  1,180,786       $    936,796
  Investments available for sale                                                 632,215          8,002,969
  Accounts receivable-trade, net (less allowance for doubtful accounts
   of $3,199 and $96,115 for March 2003 and June 2002, respectively               16,137             47,145
  Accounts receivable-other, net                                                  20,613            116,617
  Inventories                                                                    379,385          1,078,437
  Prepaid expenses                                                               208,249            514,444
  Deferred Finance Costs                                                              --            366,837
                                                                            -------------      -------------
        Total current assets                                                   2,437,385         11,063,245
                                                                            -------------      -------------

PROPERTY AND EQUIPMENT, Net                                                      383,871          1,438,873
                                                                            -------------      -------------

INTANGIBLE ASSETS:
  Intellectual property rights, net (less accumulated amortization:
   March - $14,127; June - $10,994)                                               18,681             39,006
                                                                            -------------      -------------

TOTAL ASSETS                                                                $  2,839,937       $ 12,541,124
                                                                            =============      =============

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

CURRENT LIABILITIES:
  Accounts payable                                                          $    670,300       $    992,006
  Accrued liabilities                                                            419,618          1,426,072
  Accrued settlement reserve                                                     100,000          1,400,000
  Convertible Debenture                                                        1,327,281          2,257,076
  Deferred revenues                                                              425,244            419,906
                                                                            -------------      -------------
        Total current liabilities                                              2,942,443          6,495,060
                                                                            -------------      -------------

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,
    99,523,487 and 83,004,313 issued and outstanding on
    March 31, 2003 and June 30, 2002,  respectively                               99,523             83,004
  Additional paid-in capital                                                  92,869,606         88,644,442
  Other comprehensive income                                                         265             14,178
  Deficit accumulated during the development stage                           (93,071,900)       (82,695,560)
                                                                            -------------      -------------
        Total stockholders' equity(deficit)                                     (102,506)         6,046,064
                                                                            -------------      -------------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  (DEFICIT)                       $  2,839,937       $ 12,541,124
                                                                            =============      =============

            The accompanying condensed notes are an integral part of these consolidated financial statements.
</TABLE>

                                                      3

<PAGE>
<TABLE>
                                           COMPUTERIZED THERMAL IMAGING, INC.
                                              (A DEVELOPMENT STAGE COMPANY)
                                     CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                                       (UNAUDITED)

<CAPTION>
                                                                                                                        FROM
                                                                                                                    JUNE 10, 1987
                                                THREE MONTH PERIOD ENDED            NINE MONTH PERIOD ENDED         (INCEPTION)
                                                        MARCH 31,                          MARCH 31,                  THROUGH
                                                2003              2002              2003              2002         MARCH 31, 2003
                                            -------------     -------------     -------------     -------------     -------------
                                                                (RESTATED)                          (RESTATED)
<S>                                         <C>               <C>               <C>               <C>               <C>
INCOME:
  Product revenues                          $    372,086      $    287,812      $  1,153,987      $    656,390      $  2,787,499
  Service revenues                                18,500            26,401            95,500           100,762           342,982
  Cost of product revenue                       (212,527)         (210,317)       (1,146,800)         (462,220)       (2,321,695)
  Cost of service revenue                         (7,425)           (9,000)          (25,533)          (23,486)          (55,890)
                                            -------------     -------------     -------------     -------------     -------------

GROSS MARGIN                                     170,634            94,896            77,154           271,446           752,896
                                            -------------     -------------     -------------     -------------     -------------

OPERATING EXPENSES:
  General and administrative                     703,314         1,090,579         2,182,349           246,640        33,750,214
  Litigation Settlements                              --                --                --                --         2,697,434
  Research and development                       851,250         1,511,365         3,253,219         4,386,346        30,243,791
  Marketing                                      306,557           751,120         1,302,149         2,031,050         8,218,482
  Depreciation and amortization                   48,237           391,123           387,815         1,165,775         5,003,450
  Impairment loss                                     --                --           711,194                --        12,322,192
                                            -------------     -------------     -------------     -------------     -------------

Total operating expenses                       1,909,358         3,744,187         7,836,726         7,829,811        92,235,563
                                            -------------     -------------     -------------     -------------     -------------

OPERATING LOSS                                (1,738,724)       (3,649,291)       (7,759,572)       (7,558,365)      (91,482,667)
                                            -------------     -------------     -------------     -------------     -------------

OTHER INCOME (EXPENSE):
  Interest income                                 22,012           102,199           163,439           611,315         3,601,812
  Interest expense                            (1,851,869)         (109,801)       (2,780,207)         (123,798)       (5,172,713)
  Other                                               --                --                --                --           193,711
                                            -------------     -------------     -------------     -------------     -------------

Total other income (expense)                  (1,829,857)           (7,602)       (2,616,768)          487,517        (1,377,190)
                                            -------------     -------------     -------------     -------------     -------------

LOSS BEFORE EXTRAORDINARY ITEM                (3,568,581)       (3,656,893)      (10,376,340)       (7,070,848)      (92,859,857)

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

NET LOSS                                      (3,568,581)       (3,656,893)      (10,376,340)       (7,070,848)      (92,794,220)

OTHER COMPREHENSIVE INCOME (LOSS)
  Unrealized gain (loss) on investments
    available for sale                            (8,225)         (107,370)          (13,913)         (147,766)              265
                                            -------------     -------------     -------------     -------------     -------------

TOTAL COMPREHENSIVE  (LOSS)                 $ (3,576,806)     $ (3,764,263)     $(10,390,253)     $ (7,218,614)     $(92,793,955)
                                            =============     =============     =============     =============     =============

WEIGHTED AVERAGE SHARES
  OUTSTANDING                                 94,133,485        82,804,002        87,098,608        82,375,746
                                            =============     =============     =============     =============

BASIC AND DILUTED LOSS PER COMMON SHARE     $      (0.04)     $      (0.04)     $      (0.12)     $      (0.09)
                                            =============     =============     =============     =============

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


<PAGE>
<TABLE>

                                           COMPUTERIZED THERMAL IMAGING, INC.
                                              (A Development Stage Company)
                                     CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                       (UNAUDITED)
<CAPTION>

                                                                                                              FROM
                                                                          NINE MONTHS ENDED               JUNE 10, 1987
                                                                              MARCH 31,                     INCEPTION
                                                                    -------------------------------          THROUGH
                                                                         2003               2002          MARCH 31, 2003
                                                                                         (RESTATED)
<S>                                                                  <C>                <C>                <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss                                                           $(10,376,340)      $ (7,070,848)      $(92,794,220)
  Adjustments to reconcile net income (loss) to net cash
    used in operating activities:
  Depreciation and amortization                                           387,815          1,165,775          5,167,034
  Impairment loss an loss on sale of assets                               774,830                 --         12,385,828
  Bond amortization                                                        68,157             68,159             74,813
  Amortization bonds and deferred finance costs and discounts
    on notes payable                                                      609,761            109,889          2,037,499
  Conversion expense of convertible debenture                           1,776,839                 --          1,776,839
  Common stock, warrants, and options issued
    as compensation for services                                               --             27,415          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         (3,508,506)           354,355
  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                                    400,430                 --            687,594
  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                                                        (91,502)            94,649            416,010
  Changes in operating assets and liabilities:
    Accounts receivable - trade                                           122,510           (298,877)          (272,671)
    Accounts receivable - other                                            96,004            464,960            302,450
    Inventories                                                           699,052           (393,589)          (297,118)
    Prepaid expenses                                                      306,195             44,523            206,593
    Accounts payable                                                     (321,706)        (1,104,766)           238,323
    Accrued liabilities                                                  (925,777)           124,761            458,382
    Accrued litigation settlement                                      (1,300,000)                --         (1,200,000)
    Deferred revenues                                                       5,338            496,216            813,191
                                                                     -------------      -------------      -------------
           Net cash used in operating activities                       (7,739,231)        (9,780,239)       (56,543,928)
                                                                     -------------      -------------      -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Proceeds from sale of assets                                                 --                 --              4,790
  Capital expenditures                                                    (87,318)          (557,964)        (2,794,736)
  Acquisition of Thermal Imaging, Inc. common stock                            --                 --           (100,000)
  Purchase of software license                                                 --                 --         (3,850,000)
  Purchase of investments available for sale                                   --        (14,774,083)       (43,851,010)
  Proceeds from redemption of investments available for sale            7,288,684         16,625,549         42,837,857
  Acquisition of Bales Scientific common stock,
    net of cash acquired                                                       --                 --         (5,604,058)
                                                                     -------------      -------------      -------------
           Net cash provided by (used in)  investing activities         7,201,366          1,293,502        (13,357,157)
                                                                     -------------      -------------      -------------

   The accompanying condensed notes are an integral part of these consolidated financial statements.         (Continued)
</TABLE>
                                                           5


<PAGE>
<TABLE>

                                           COMPUTERIZED THERMAL IMAGING, INC.
                                              (A Development Stage Company)
                                    CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
<CAPTION>

                                                                                                         FROM
                                                                      NINE MONTHS ENDED             JUNE 10, 1987
                                                                          MARCH 31,                   INCEPTION
                                                               ------------------------------          THROUGH
                                                                   2003               2002          MARCH 31, 2003
                                                                                   (RESTATED)
<S>                                                            <C>                <C>                <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from issuance of common stock and warrants,
    net of offering costs                                       $    781,855      $  1,621,114       $ 63,976,580
  Advances to affiliate                                                   --                             (107,864)
  Advances from stockholders                                              --                --          2,320,738
  Preferential Dividend                                                   --                              (79,000)
  Proceeds from issuances from covertible debentures,
  net of finance costs                                                    --         2,180,208          5,756,339
  Payments on debt                                                        --                --         (1,177,190)
                                                                -------------     -------------      -------------
           Net cash provided by financing activities                 781,855         3,801,322         70,689,603
                                                                -------------     -------------      -------------
                                                                          --                --          82,069.00
NET INCREASE (DECREASE) IN CASH
  AND CASH EQUIVALENTS                                               243,990        (4,685,415)         1,180,786

CASH AND CASH EQUIVALENTS AT
  BEGINNING OF YEAR                                                  936,796         7,810,285                 --
                                                                -------------     -------------      -------------

CASH AND CASH EQUIVALENTS AT END OF YEAR                        $  1,180,786      $  3,124,870       $  1,180,786
                                                                =============     =============      =============

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                                                      $  1,653,827      $         --       $  1,653,827
  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 condensed notes are an integral part of these consolidated financial statements.
</TABLE>
                                                           6

<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 for the three-month and
nine-month periods ended March 31, 2003 and 2002 are unaudited. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation 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 Form 10-K. The consolidated results of operations for the
three-month and nine-month periods ended March 31, 2003 and 2002 are not
necessarily indicative of the results to be expected for the full years.

         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 make
estimates and assumptions, including for example, accounts receivable
allowances, inventory obsolescence reserves, deferred tax valuation allowances,
and reserves for pending or threatening 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, 2002, 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 convertible debentures, the 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.

         On December 31, 2001, we entered into an agreement under which we
issued a convertible debenture (the "Convertible Debenture"). The Convertible
Debenture balance, as of March 31, 2003, was approximately $1.3 million dollars.

         On March 19, 2003, we executed an amendment to that agreement that
modified the exercise price of the warrants issued in connection with the
Convertible Debenture at a price of $.09 per common share and the conversion
price for the Convertible Debenture to a variable conversion price at 94% of the
market price and recognized an interest charge of approximately $1.8 million
upon the price modification. The Company issued approximately 4.5 million shares
of common stock for the redemption of approximately $381 thousand in principal
and accrued interest (see exhibits to Form 8-K dated March 19, 2003). As of the
date of this document, we may not issue more shares under the Equity Line.

                                       7

<PAGE>

         The Company had $1.8 million in cash and marketable securities as of
March 31, 2003. While the Company is attempting to reduce its cash expenditures,
it is doubtful the Company will be able to reduce it cash requirements enough to
continue its operations without additional financing. As of April 25, 2003, our
current monthly expense rate is approximately $400` thousand; our expense rate
at our former full operation rate was approximately $1.1 million per month. We
have cash, accounts receivable and pre-paid expenses of approximately $1.75
million and current liabilities (excluding the debenture and deferred revenue)
of approximately $1.01 million. These current liabilities consist of
approximately $479 thousand of accounts payable, $491 thousand of accrued
liabilities, and $44 thousand of accrued employee costs. Accordingly, as of
April 25, 2003, unless we are able to secure additional funding from a third
party, we do not have sufficient working capital to sustain our operations,
which are already substantially reduced, for three or four months. Failure to
secure additional funding may result in further severe reductions in operations
or discontinuing operations altogether.

         The Company will have to secure additional financing through the sale
of equity, loans or the sale of assets or intellectual property. There can be no
assurance that capital will be available from any source or, available upon
acceptable terms and conditions. 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 our operations and the price of
our common stock.

         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 B. RECENTLY ISSUED ACCOUNTING STANDARDS

         In October 2002, the Financial Accounting Standards Board 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 are effective
on October 1, 2002. At this time we do not believe the adoption of SFAS 147 will
have any impact on the Company's consolidated financial statements.

         In December 2002, the Financial Accounting Standards Board 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

                                       8

<PAGE>

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 is continuing to account for stock-based
compensation according to APB 25, and has disclosed the effects of SFAS No. 123
on reported earnings in annual and interim financial statements in accordance
with FASB No. 148.

NOTE C. CONVERTIBLE DEBENTURE

         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 in the amount of $2.5 million
(the "Convertible Debenture") and secured an equity line of credit (the "Equity
Line") that would allow the Company to sell up to $20 million in common stock to
the Investor at 94 percent of the market price, as defined by the Agreement.
Based on its original terms, the Convertible Debenture was 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 is due on the conversion date and is payable, at
the option of the Company, in cash.

         In connection with the Agreement, the Company entered into a
registration rights agreement and subsequently filed a registration statement
(Registration No. 333-82016) with the SEC, which was declared effective on March
18, 2002. The Investor may require the Company to redeem all or a portion of the
Convertible Debenture if the average closing bid price of the Company's common
stock for the 90 consecutive trading days after the effective date of the
registration statement is less than $1.44 (a "Trigger Event"). The amount
redeemable is equal to 111% of the principal balance of the Convertible
Debenture and accrued interest (the "Redeemable Balance"). If a Trigger Event
occurs, the Investor is required to provide notice to the Company of its
election to force redemption and to specify the date (the "Redemption Due Date")
on which the Redeemable Balance is to be paid. If the Company does not pay the
Redeemable Balance in full by the Redemption Due Date, the Company is required
to issue registered unrestricted shares of common stock pursuant to a series of
mandatory put notices consistent with the terms of the Equity Line. If the
Redeemable Balance is not paid through the mandatory puts within six months of
the Investor's notice to force redemption, the unpaid portion of the Redeemable
Balance is required to be paid immediately in cash.

         On July 25, 2002, the Investor notified the Company that a Trigger
Event had occurred and the Redeemable Balance of the Convertible Debenture
became due. On the date of the Trigger Event, the Redeemable Balance was
approximately $2,898,000, which included principal of approximately $2,500,000,
$111,000 of accrued interest and $287,000 of penalty. The Company elected to
satisfy the Redeemable Balance through a series of mandatory put notices based
on the terms of the Equity Line. The terms of the Equity Line provide for one
mandatory put per month and a maximum put amount per put equal to the lesser of
$500,000 or 125 percent of the weighted average trading volume of the Company's
common stock for the 20 days immediately preceding the date of the mandatory put
notice. Because of the average trading volume restriction, we have only made
modest debt repayments and have not been able to extinguish the debt entirely.

                                       9

<PAGE>

         On December 16, 2002, the Company issued a put to the Investor pursuant
to the Equity Line for $467,000 and issued 1,500,000 shares of common stock on
December 24, 2002 and the remaining 1,455,083 shares of common stock on January
3, 2003. As of December 31, 2002, the Company recorded a subscription receivable
of $237,288 related to the 1,500,000 shares issued on December 24, 2002. The
Company received proceeds from the subscription receivable during January 2003.

         In connection with the Agreement, the Company issued 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, which expire December 31, 2004
and December 31, 2007, respectively. 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 bank for the purchase of 100,000 shares of
common stock at $1.87 per share in connection with the Debenture Offering. The
fair market value of these warrants and other related financing costs have been
recorded as deferred financing costs. Because of the Trigger Event discussed in
the preceding paragraph, the deferred financing costs and discount on the
Convertible Debenture were being amortized over the six-month period ending
January 25, 2003. Due to the complexities of the Convertible Debenture such as
the beneficial conversion feature, trigger events and interrelationship with the
attached warrants and Equity Line, it is impractical to estimate the fair value
of the debenture. During the nine months ended March 31, 2003, the effective
interest rate (excluding the penalty and the expense for the price modification
of the Convertible Debenture) the Company was paying on the $2.5 million
Convertible Debenture was 36%; however, this implied rate will decrease over the
next six-month period as the deferred finance costs and beneficial conversion
feature are fully amortized.

         Pursuant to the guidance under SFAS No. 123, the Company valued and
recorded as an expense the value of warrants issued in connection with the
Convertible Debenture, Equity Line and services rendered to assist the financing
("financing services"). The estimated fair value of the warrants were calculated
using the Black-Scholes valuation model and valued at approximately $36,000,
$99,000 and $18,000 for the Debenture warrants, Equity Line warrants and the
financing services warrants respectively. The value of the warrants is being
amortized to interest expense over the accelerated term of the DEBENTURE,
thereby raising the computed effective rate of interest. In valuing the warrants
the Company used an estimated volatility of 44.6% and an expected life of one
year.

         In connection with the convertible debenture's conversion feature, the
Company recorded a value for beneficial conversion feature in accordance with
EITF 00-27 APPLICATION OF ISSUE NO. 98-5 TO CERTAIN CONVERTIBLE INSTRUMENTS. The
intrinsic value of the beneficial conversion feature of approximately $245,000
is being amortized to interest expense over accelerated term of the debenture.
The total beneficial conversion discount related to the debenture was Recorded
at the transaction date as an increase in additional paid in capital and the
unamortized portion as a reduction to the debenture on the Company's Balance
Sheet. The unamortized portion of the beneficial conversion feature has been
amortized into interest expense, which was accelerated when the Company was
notified of the Trigger Event..

                                       10

<PAGE>

         On January 29, 2003, the Company received a Holder Redemption Notice
(the "Notice") from the Investor. The Notice, referencing the Debenture
Agreement, stated the Investor demanded payment of the Current Redeemable
Balance. Pursuant to the Debenture Agreement, the Company had five days to pay
the balance in cash. Because the Company did not pay the Redeemable Balance as
requested by the Holder, the Company is now in default as defined by Section
6.c.ix of the Debenture Agreement.

         The Redeemable Balance on March 31, 2003 was approximately $1.3
million. As of May 14, 2003, the Company reduced the Redeemable Balance to
approximately $412,000 by issuing approximately 7.9 million common shares at
prices ranging from $0.94 to $0.13 for the redemption of approximately $927,000
in principal and accrued interest. The mandatory put period, during which the
Company is required to redeem the Convertible Debenture through the issuance of
stock, expired February 2003, at which time, the Company was required to pay the
remaining balance in cash or negotiate other terms.

         On March 19, 2003, the Company executed an amendment that modifies the
exercise price of the warrants issued in connection with the Convertible
Debenture to $0.09 per common share and a variable conversion price for the
Convertible Debenture to equal the 94 percent of market price. On March 19,
2003, the Company issued approximately 4.5 million shares of common stock for
the redemption of approximately $381,000 in principal and accrued interest in
connection with modifying the conversion price of the debenture and exercise
price of the warrants (see exhibits to Form 8-K dated March 19, 2003). In
connection to the conversion, the Company recognized, on the date of the
acceptance offer, an expense of approximately $1.8 million dollars. In addition,
as of the date of this document, we may not issue any more shares under the
Equity Line.

         Based on our current cash balance, obligations, stock price and
remaining registered shares, the Company may not be able to repay the remaining
Redeemable Balance through cash payments or through puts under the Equity Line
without further modifying the Agreement with Beach Boulevard. Furthermore, there
is no assurance that Beach Boulevard will modify the Agreement.

         During the three months ended March 31, 2003, the Company issued
approximately 5.3 million common shares through mandatory put notices and
applied the proceeds of approximately $606,000 to redeem $463,000 of principal,
$83,000 of accrued interest, and $60,000 of penalty pursuant to requirements of
the Equity Line. The Company issued approximately 2.2 million shares of common
stock through voluntary put notices for approximately $210,000 pursuant to the
Equity Line, which was used to repay $183,000 of debenture principle, $6,000 of
interest and $21,000 of penalties. The Company issued approximately 4.2 million
common shares upon the partial conversion of the Convertible Debenture and
repaid approximately $351,000 of principal and $7,000 of interest. The Company
also issued approximately 260,000 common shares upon the conversion of the
debenture warrants and used the proceeds of approximately $23,000 to pay down
$21,000 of principal and $2,000 of interest.

                                       11

<PAGE>

         During the nine months ended March 31, 2003, the Company issued
approximately 6.2 million common shares through mandatory put notices and
applied the proceeds of approximately $1,062,000 to redeem $776,000 of
principal, $181,000 of accrued interest, and $105,000 of penalty pursuant to
requirements of the Equity Line. The Company issued approximately 2.2 million
shares of common stock for approximately $210,000 pursuant to the Equity Line,
which was used to repay $183,000of debenture principle, $6,000 of interest and
$21,000 of penalties. The Company issued approximately 4.2 million common shares
upon the partial conversion of the Convertible Debenture and redeemed
approximately $351,000 of principal and $7,000 of interest. The Company also
issued approximately 260,000 common shares upon the conversion of the debenture
warrants and used the proceeds of approximately $23,000 to pay down $21,000 of
principal and $2,000 of interest.

         From April 1, 2003 to May 19, 2003, the Company has issued 9.8 million
common shares and converted most of the remaining Redeemable Balance due under
the Convertible Debenture including accrued interest. As of May 19, 2003, the
Company owes the Investor approximately $157,000.

NOTE D. REVENUE RECOGNITION

         The Company recognizes revenue from product sales in accordance with
generally accepted accounting principles in the United States, including the
guidance in Staff Accounting Bulletin 101. The Company recognizes revenue from
its product sales 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 the
Company's obligations are fulfilled.

         Revenue from sales to distributors is recognized when collectibility is
ensured and fees are fixed or determinable. The Company considers collectibility
ensured and fees fixed and determinable only after payment from the distributor
has been received. Revenue from sales with payment terms extending beyond our
normal business terms is deferred and recognized when fees are considered fixed
and determinable, which occurs upon receipt of payment.

         The Company provides its domestic medical products customers net 30-day
terms. Its international medical products customers must pay cash before product
is shipped and the Company negotiates terms of up to 90 days with its industrial
products customers.

         Revenue from sales with continuing obligations and commitments are
recorded into deferred revenue until commitments and contingencies are
fulfilled. The Company has shipped products with customer acceptance provisions,
embedded warranties, training, accessory and installation obligations. Because
the Company recognizes sales when completed, the Company defers sales of shipped
products containing these obligations until such requirements have been
completed and fulfilled. During 2002 the Company shipped to and received payment
from Alstom for an industrial turbine blade inspection system, which contained
installation, embedded warranties, and customer acceptance provisions. Until
these contingencies were completed and fulfilled, the Company deferred the sale
of this system until the continuing obligation expired during the third quarter
of fiscal 2003.

         The Company does not sell products with "limited rights of return"
other than normal warranty returns. Service revenue is primarily derived from
non-destructive testing of turbine blades and other items. Service revenue is
recognized upon the completion of the services provided. Warranty revenue is
recognized ratably over the period of the agreement as services are provided.

                                       12

<PAGE>

NOTE E. DEFERRED REVENUE

         Deferred revenue of approximately $425,000 is comprised of products
that have been shipped but have not been recognized into revenue because of
continuing obligations to the buyer and consists of:

         Deferred Revenues            March 31,     June 30,
                                        2003          2002
                                     (Unaudited)
               Medical                $  2,599      $ 74,000
               Industrial              390,000       320,550
               Warranty                 32,645        25,356
                                      ---------     ---------
         Total Deferred Revenues      $425,244      $419,906
                                      =========     =========

         Medical product deferred revenue consists of a Photonic Stimulator
("PS") unit sold to a customer and will be recognized into revenue when
outstanding obligations are compete and the sales prices are considered fixed
and determinable.

         Industrial products deferred revenue consists of non-destructive
testing device shipped to Pratt & Whitney. The Company will recognize this sale
as a gain on sale of assets 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 first-in first-out. Inventories consist of the following:

                               MARCH 31,        JUNE 30,
                                 2003             2002
                              (UNAUDITED)
         Raw Materials        $   18,327      $  490,464
         Work-in process          15,175         102,178
         Finished goods          345,883         485,795
                              -----------     -----------

         Total                $  379,385      $1,078,437
                              ===========     ===========

                                       13

<PAGE>

         Finished goods inventory at March 31, 2003, consists of approximately
$267,000 of finished goods ready for sale, $110,000 of finished goods used for
demonstration purposes ready for sale and $2,000 of deferred costs relating to
deferred medical revenue of $3,000. The cost associated with the industrial
deferred revenue of $390,000 are approximately $147,000 and are included with
fixed assets as the machine was originally intended for internal use and
subsequently reapplied to fill a commercial order.

         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 and then
comparing forecast consumption to quantity on hand. Any difference between
inventory on hand and 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 expensed into the inventory reserves are
not reversed to income until the reserved inventory is sold or otherwise
disposed.

         During the quarter ending December 31, 2002, we concluded, after the
FDA's review panel recommended non-approval of our BCS, that our inventory
levels exceeded our forecast requirements and we recorded an additional excess
inventory charge of $390,000 in accordance with our policy.

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.  STOCK WARRANTS, OPTIONS, AND RESTRICTED STOCK

         In accordance with Accounting Principles Board Opinion (APB) No. 25
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES FOR STOCK-BASED COMPENSATION, and
Financial Accounting Standards Board Interpretation No. 44, ACCOUNTING FOR
CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION (AN INTERPRETATION OF APB 25),
during the nine months ended March 31, 2002, the Company recorded a decrease to
operating expenses of approximately $3,509,000 related to stock-based
compensation for variable stock options. This non-cash adjustment represents
changes in the difference between the exercise price of certain stock options
and the fair market value of the underlying security (the Company's common
stock). Because the value of a share of the Company's stock at March 31, 2002,
was less than the value of a share at June 30, 2001, the Company recorded a
decrease in previously recognized expense.

         For the nine months ended March 31, 2003, the Company recorded
approximately $7,000 of expense to complete amortization of the deferred
incentive compensation resulting from the Fiscal 2001 repricing. No expense was
recorded for the three months ending March 31, 2003. In future periods, the
Company may record stock-based compensation expense relating to options repriced
during Fiscal 2001 for 250,000 options if the Company's stock price exceeds
$1.50 per share, and for 125,000 options if the Company's stock price exceeds
$2.50 per share.

                                       14

<PAGE>

NOTE I. RESTATEMENT OF NET LOSS

         The Company restated its net loss for the three and nine months ended
March 31, 2002, by approximately $11,000 and $20,000 to $3,657,000 and
$7,071,000 respectively to reflect an increase to general and administrative
professional services expenses interest expense. The increase is attributable to
an adjustment to the volatility component of the Black Scholes calculation we
used to value options issued to consultants for services rendered, and warrants
issued in connection to the Convertible Debenture and Equity Line.

NOTE J. CONTINGENCIES

         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, alleged 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 believe caused significant damage to the shareholders
holding shares of our common stock at the time of these alleged
misrepresentations and omissions. The plaintiffs have not specified their
damages as of the date of this document. The Company believes the allegations
are without merit and intends to defend them vigorously. However, defending this
lawsuit has required, and in the future may require, significant additional
legal expenses to defend, may make fund raising more difficult if not impossible
and will distract certain members of management from day-to-day operations.

         On April 17, 2003, this litigation was dismissed without prejudice by
the United States District Court. In a written opinion, the U.S. District Judge
concluded that the statements made by the Company, that plaintiff's alleged were
misleading to investors, 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. On
May 8, 2003, the plaintiffs informed Company counsel that they would not replead
any claims. Instead, plaintiffs expressed their intention to appeal the court's
ruling following entry of the court's dismissal order. That order was filed May
13, 2003, and the plaintiffs have 30 days to file their notice of appeal. If the
notice of appeal is filed and the plaintiffs follow through on their efforts to
appeal the order of dismissal, we do not expect to receive a decision from the
appellate court for at least one year.

         In addition, the Company has been requested to provide certain
documents to the U.S. Securities and Exchange Commission and the U.S. Department
of Justice in connection with possible violations of the insider trading
prohibitions found in the federal securities laws. To date, we have incurred
approximately $451 thousand in legal costs in complying with these requests and
in conducting related internal investigations. We expect these legal costs to
exceed $650 thousand by the time the investigations are complete. The Company
also may be required to indemnify its officers and directors in connection with
fees incurred in connection with these investigations.

                                       15

<PAGE>

         Given our need to raise capital to fund our operations, history of
losses ($92.8 million since inception), the foregoing litigation risk, denial of
directors and officers coverage, forced redemption of the convertible debenture,
and our reliance upon securing FDA approval for our primary product, our
independent auditors opinion signed September 25, 2002, contains a paragraph
expressing its substantial doubt about the Company's ability to continue as a
going concern. Our efforts to raise additional funds to date have not been
successful except for $631 thousand in advances under the Equity Line with Beach
Boulevard. We cannot raise any additional funds under the Equity Line at this
time. If possible, we will obtain additional capital through capital
contributions from private investors or by selling or licensing our intellectual
property. As of June 30, 2002, we believed that we would receive a favorable
recommendation from the FDA panel and that if we received a favorable
recommendation we would be able to secure the capital we needed to execute our
operating plan. Since the FDA's decision regarding our PMA application, which
was to not approve the commercial use of our breast imaging system, in December
2002, we have contacted a number of parties who might be interested in investing
in or licensing our technology. Several parties have expressed interest in
purchasing licenses for our TIP and Photonic Stimulator products and/or
investing in the Company. These discussions are in an early stage and we cannot
guarantee that we will be able to successfully conclude any transaction.

         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 have breached the lease by failing to pay the rent specified under the
lease. The Landlord seeks damages of $667,277 plus interest and attorneys and
other fees. As the litigation was just recently filed, we have not had an
opportunity to respond to the complaint.

                                       16

<PAGE>

NOTE K. SEGMENTS

         Management evaluates the Company as two distinct lines of business:
medical and industrial products and services. The following unaudited tables
describe operations for each product segment for the three and nine-month
periods March 31, 2003 and 2002.

<TABLE>
<CAPTION>
                                     THREE MONTH PERIOD ENDED                          THREE MONTH PERIOD ENDED
                                             MARCH 31                                          MARCH 31
                                              2003                                               2002
Revenue                              Medical        Industrial         Total           Medical          Industrial        Total
-------                              -------        ----------         -----           -------          ----------        -----
<S>                               <C>              <C>              <C>              <C>              <C>              <C>
  Product Revenue                 $    68,036      $   304,050      $   372,086      $   287,812      $        --      $   287,812
  Service Revenue                          --           18,500           18,500               --           26,401           26,401
  Cost product revenue                (38,508)        (174,019)        (212,527)        (210,317)              --         (210,317)
  Cost of Service revenue                  --           (7,425)          (7,425)              --           (9,000)          (9,000)
                                  ------------     ------------     ------------     ------------     ------------     ------------
      Gross Margin                     29,528          141,106          170,634           77,495           17,401           94,896

General & Administration              569,684          133,630          703,314          883,369          207,210        1,090,579
Research & Development                732,746          118,504          851,250        1,278,170          233,195        1,511,365
Marketing                             248,311           58,246          306,557          608,407          142,713          751,120
Depreciation and amortization          44,855            3,382           48,237          354,363           36,760          391,123
Impairments                                --               --               --               --               --               --
                                  ------------     ------------     ------------     ------------     ------------     ------------
      Total Operating Expense       1,595,596          313,762        1,909,358        3,124,309          619,878        3,744,187
           Operating Loss         $(1,566,068)     $  (172,656)     $(1,738,724)     $(3,046,814)     $  (602,477)     $(3,649,291)
                                  ============     ============     ============     ============     ============     ============

                                      NINE MONTH PERIOD ENDED                          NINE MONTH PERIOD ENDED
                                            MARCH 31,                                         MARCH 31,
                                              2003                                               2002
Revenue                              Medical        Industrial        Total             Medical         Industrial        Total
-------                              -------        ----------        -----             -------         ----------        -----
  Product Revenue                 $   714,937      $   439,050      $ 1,153,987      $   656,391      $        --      $   656,391
  Service Revenue                          --           95,500           95,500               --          100,762          100,762
  Cost product revenue               (891,107)        (255,693)      (1,146,800)        (462,221)              --         (462,221)
  Cost of Service revenue                  --          (25,533)         (25,533)              --          (23,486)         (23,486)
                                  ------------     ------------     ------------     ------------     ------------     ------------
      Gross Margin                   (176,170)         253,324           77,154          194,170           77,276          271,446

General & Administration            1,767,703          414,646        2,182,349          199,778           46,862          246,640
Research & Development              2,573,283          679,936        3,253,219        3,588,515          797,831        4,386,346
Marketing                           1,054,741          247,408        1,302,149        1,645,150          385,900        2,031,050
Depreciation and amortization         342,377           45,438          387,815        1,107,399           58,376        1,165,775
Impairments                           540,558          170,636          711,194               --               --               --
                                  ------------     ------------     ------------     ------------     ------------     ------------
      Total Operating Expense       6,278,662        1,558,064        7,836,726        6,540,842        1,288,969        7,829,811
           Operating Loss         $(6,454,832)     $(1,304,740)     $(7,759,572)     $(6,346,672)     $(1,211,693)     $(7,558,365)
                                  ============     ============     ============     ============     ============     ============
</TABLE>

                                       17

<PAGE>

NOTE L. PRO FORMA STOCK BASED COMPENSATION

         Had compensation cost for the Company's stock option plan been
determined based on the fair value at the grate date consistent with the
provisions of SFAS 123 as amended by SFAS 148, the Company's net loss and not
loss per share for the three and nine months ended March 31, 2003 and 2002 would
have increased to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                       Three month period ended                 Nine month period ended
                                      March 31,         March 31,              March 31,         March 31,
                                        2003               2002                  2003               2002
                                        ----               ----                  ----               ----
<S>                                  <C>                <C>                  <C>                 <C>
Net loss applicable to common
     stockholders-as reported        (3,568,581)        (3,656,893)          (10,376,340)        (7,070,848)

Net loss applicable to common
     stockholders-pro forma          (3,647,230)        (3,846,044)          (10,749,955)       (11,168,867)

Basic and diluted net loss
     per share-as reported          $     (0.04)       $     (0.04)         $      (0.12)      $      (0.09)

Basic and diluted net loss
     per share-as reported          $     (0.04)       $     (0.05)         $      (0.12)      $      (0.14)
</TABLE>

         These pro forma disclosures are not necessarily representative of the
effects on reported net income of loss for future periods.

         The weighted average fair value of each option granted under the
various stock option plans for the three and nine months ended March 31, 2002 is
$0.28and $0.78 respectively. The fair value of each option grant is estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions for fiscal years 2002:

         1)       Risk free rate between approximately 5% and 7% depending on
                  the term of option;
         2)       No dividend yield;
         3)       No discount for lack or marketability; and
         4)       A volatility factor of the expected market price of the
                  Company's common stock from between approximately 2% to 68%
                  for the three and nine months ended March 2002.

No employee stock options have been granted in the nine months ended March 31,
2003.

NOTE M. FDA DEVELOPMENTS

         The Company's medical imaging and treatment products are subject to
regulation by the U.S. Food and Drug Administration ("FDA"). For the past five
years, the Company has sought approval for its Breast Cancer 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.

                                       18

<PAGE>

         On December 10, 2002, the Company presented the Breast Cancer System
2100(TM) ("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 order to obtain FDA approval in the future including: (a) performing a
new clinical trial, (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; that
if successfully completed may make the Company's PMA approvable with the FDA.

         The main issues cited by the FDA were 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") are
insufficient by themselves to constitute an adequate study, 3) enrollment was
not limited to mammographically visible masses, and 4) the number of exclusions
of enrolled subjects was excessive.

         The Company takes exception to and disagrees with these findings. We
have contacted the FDA's ombudsman and are attempting to negotiate a reversal of
the FDA's decision. We have met with the FDA since January, and as recently as
May 9, 2003 provided additional statistical analysis of the clinical trial data
previously submitted, which we believe may be helpful in obtaining FDA approval.
We have elected to take this relationship based approach but still have the
option of a formal scientific appeal or may avail ourselves of other remedies.
We do not know whether our negotiations or any appeal we might file will be
successful. Furthermore we cannot guarantee whether or when the FDA will approve
the BCS. As noted below, failure to obtain FDA approval is an event that has
raised significant concern about whether the Company may continue as a going
concern.

NOTE N. OTHER REGUALTORY MATTERS

         As with all medical devices, it is important that our BCS 2100
customers receive adequate reimbursements from third-party payers: insurance
companies, Medicare and Medicaid reimbursement agencies. We applied for a
reimbursement code from the American Medical Association during December 2001
for our BCS 2100. Our application will not be acted upon unless and until we
receive FDA approval for the BCS 2100.

                                       19

<PAGE>

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

         This document, and the documents incorporated by reference, contain
forward-looking statements within the meaning of the Securities Act of 1933 and
Securities Exchange Act of 1934. Forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of the Company 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
document are based on information available to the Company 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 Consolidated Financial Statements and Notes thereto contained in our
Form 10-K for the fiscal year ended June 30, 2002.

         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 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 most important 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 or highly liquid investments with an original
maturity of one year or less.

         REVENUE RECOGNITION-- Although we believe revenues recognized to-date
have been essentially immaterial to our financial statements, we also believe
revenue recognition is a significant business process that requires management
make estimates and assumptions. We recognize revenue from product sales upon
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 collectibility is probable. If these conditions are
not met, revenue is deferred until such obligations and conditions are
fulfilled. On occasion, we offer distributors extended payment terms beyond our
normal business practices. We consider fees on these extended terms agreements
not fixed and collectibility less than probable because demonstration equipment
may remain in the distributors use for some time, our resale prices have
declined over time and we credit price decreases to any balance due from a
distributor. If we retain an ongoing obligation under a sales arrangement, such
as an extended warranty arrangement, revenue is deferred until our obligations
and commitments are fulfilled.

                                       20

<PAGE>

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

         IMPAIRMENT OF LONG-LIVED ASSETS-- The Company follows the provisions of
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, then
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 Statement of Operations. In estimating impairments, management makes
assumptions about future cash flows and fair value that are inherently
uncertain, can significantly effect the results, and may differ from actual
future results.

         INVENTORY RESERVES - 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
and then comparing forecast consumption to quantity on hand. Any difference
between inventory on hand and 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.

         EMPLOYEE INCENTIVE PLANS--The Company is obligated under employment
agreements and provides other employees incentive compensation ranging from 5%
to 10% of salary and offers a discretionary 401(k) matching contribution, in
cash or common stock, of up to 5% of a participating employee's salary. Our
policy has been to accrue the maximum amount due pursuant to these incentive
plans throughout the calendar year, assuming a maximum bonus award or 401(k)
match, and adjust this balance as of December 31 of each year for actual
incentive paid in January of the following calendar year. Incentive plan
expenses are charged to each employee's specific department. The Company paid no
incentive compensation or 401(k) matching contributions during January 2003, and
therefore reversed it's accrued incentive compensation reserves of approximately
$484,000 for the nine months ended March 31, 2003. For the quarter ended March
31, 2003, we accrued no incentive compensation for the current calendar year.

         TRENDS/UNCERTAINTIES AFFECTING CONTINUING OPERATIONS

         We are exposed to the opportunities and risks usually associated with
marketing and manufacturing novel products, including staff recruiting and
retaining staff, 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.

                                       21

<PAGE>

         Our marketing efforts rely upon building relationships with
manufacturers, medical equipment dealers, physicians and clinical investigators.
We reach our target markets by attending trade shows and conferences, making
direct sales calls, and by sponsoring clinics, where we introduce and
demonstrate our products. 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, we plan to continue
investing resources in these programs, although we 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.

         To date, we have had limited operating revenues from the sale of our
products and services ($3.1 million in total revenues since inception). We
cannot assure you that we will achieve profitability in the future. Our
immediate priorities are to reconcile issues presented to us by the FDA Advisory
Panel on December 10, 2002, and raise additional funding. At this time, we are
unsure how much time and additional financing we will require to resolve these
issues with the FDA, which raises concern about the Company's ability to
continue as a going concern.

RISK FACTORS

INVESTMENT IN SHARES OF OUR COMMON STOCK IS SUBJECT TO A NUMBER OF RISK FACTORS
THAT, IF REALIZED OR COME TO FRUITION, MAY ADVERSELY AFFECT THE COMPANY'S
PROFITABILITY AND THE VALUE OF THESE SHARES WHILE HELD BY OUR SHAREHOLDERS.

THE FAILURE TO OBTAIN FDA APPROVAL OF OUR BREAST CANCER SYSTEM (BCS) HAS HAD A
MATERIAL ADVERSE IMPACT ON THE COMPANY.

         On January 24, 2003, the FDA concurred with the recommendation of the
Radiological Devices Advisory Panel to not approve our PMA application. We have
contacted the FDA's ombudsman and are attempting to negotiate a reversal of the
FDA's decision. We may formally appeal the FDA's non-approvable decision or
avail ourselves of other remedies. As of the date of this document, we do not
know whether our negotiations or any appeal we might file will be successful.
There is no assurance that we will receive FDA approval. Failure to secure FDA
approval would materially reduce or eliminate the market for our BCS 2100 and
would have a material adverse effect on the business.

WE ARE INVOLVED IN SUBSTANTIAL SHAREHOLDER LITIGATION, WHICH MAY HAVE AN ADVERSE
IMPACT ON US AND OUR SHAREHOLDERS.

         In 2002, five different lawsuits were filed against us in the United
States District Court in Oregon. Each suit, which was consolidated into a single
suit during September 2003, alleges in substance that the Company violated
Section 10(b) of the Securities Exchange Act of 1934, as amended, and
accompanying regulations and relevant case law by misleading shareholders

                                       22

<PAGE>

regarding such things as FDA approval and other matters, which the plaintiffs
believe caused significant damage to the shareholders holding shares of our
common stock at the time of these alleged misrepresentations and omissions. The
plaintiffs have not specified their damages as of the date of this document. We
believe the allegations are without merit and intend to defend them vigorously.
Defending these lawsuits will require additional legal expenses to defend, may
make fund raising more difficult if not impossible and will distract certain
members of management from day-to-day operations.

         Moreover, our insurance carrier has 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 and vigorously pursue coverage under these policies.

         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.

         On April 17, 2003, the litigation was dismissed without prejudice by
the United States District Court in Oregon and gave the plaintiffs until May 8
to replead certain claims. The plaintiffs have expressed their intention to
appeal that order rather than replead their claims. The plaintiff's may be
successful on appeal. The Court gave the plaintiffs until May 8, 2003 to replead
three of the nine claims if the plaintiffs have additional facts to overcome
their failure to state claims as to those three claims. On May 8, 2003, the
plaintiffs informed Company counsel that they would not replead any claims.
Instead, plaintiffs expressed their intention to appeal the court's ruling
following entry of the dismissal order, which was filed by the court May 13,
2003. The plaintiffs have 30 days to file their notice of appeal. If the notice
of appeal is filed and the plaintiffs follow through on their efforts to appeal
the order of dismissal, we do not expect to receive a decision from the
appellate court for at least one year, and expect the cost of defending this
litigation will be approximately $200,000 during that time.

         All of these financial impacts may have an adverse impact on the value
of our common stock.

WE NEED ADDITIONAL FINANCING AND, IF WE ARE UNABLE TO GET ADDITIONAL FINANCING,
WE MAY HAVE TO MATERIALLY CHANGE OUR OPERATIONS, WHICH COULD ADVERSELY AFFECT
OUR RESULTS FROM OPERATIONS AND SHAREHOLDER VALUE.

         For the year ended June 30, 2002, our auditors issued a going concern
qualification to the audit report. This means that, based on our expected cash
flow from operations and our existing current assets, our auditors believe that
we will not be able to sustain operations in their current form through the next
12 months. Until our operating results improve, we will have to rely on outside
financing to fund our business operations and satisfy our liabilities, including
the debenture payable to Beach Boulevard. We intend to use a combination of

                                       23

<PAGE>

equity and debt securities and instruments in order to secure additional
funding. The sale of equity securities or the use of equity securities to
satisfy our obligation to Beach Boulevard could dilute our existing
shareholders, and borrowings from third parties could result in assets being
pledged as collateral and loan terms that could restrict our operations. There
is no assurance that capital will be available from any source or, if available,
upon acceptable terms and conditions. Our agreement with Beach Boulevard does
not prohibit short selling, does not provide for a minimum price for our stock
and does not require that Beach Boulevard retain ownership of any shares issued
(except pursuant to federal securities law). Therefore, equity securities issued
to repay Beach Boulevard could be resold by Beach Boulevard and thereby create
downward pressure on the price of our common stock. If our losses continue and
we are unable to obtain additional third-party financing or proceeds from the
sale of certain of our assets, we will have to materially reduce or terminate
some or all of our operations, which could adversely affect us and our
shareholders. Since June 30, 2002, we have actively sought to obtain funding
from external sources and, except for funds we have raised through advances
under our Equity Line with Beach Boulevard, we have not been successful in
obtaining capital from any third party.

WE MAY SELL ASSETS OR REDUCE ACTIVITIES TO FUND OPERATIONS, WHICH COULD
ADVERSELY AFFECT SHAREHOLDER VALUE.

         If we are unable to secure adequate capital through the sales of
securities, or as part of a funding arrangement, we may seek to raise capital by
selling all or part of our intellectual property and know-how, entering into
license agreements for all or part of our intellectual property rights (which
might include manufacturing licenses) to third parties for certain territories
or business segments, terminate operations in any of our business segments to
reduce expenditures, or reduce our operations in any or all of our business
segments to preserve the business until funding is available. There can be no
guarantee that we will be successful in these efforts. If we are not successful,
we may have to severely reduce or terminate all or some of our operations,
either of which could severely reduce or completely eliminate any shareholder
value.

OTHER RISK FACTORS.

         The above mentioned risk factors should be read in conjunction with our
Audited Consolidated Financial Statements, Notes thereto and risk factors
contained in our Amended Form 10-K for the fiscal year ended June 30, 2002.

         GENERAL

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

         The Company has 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.

                                       24

<PAGE>

         Our research indicates that our equipment and technology is useful in
studying and diagnosing breast cancer, which is the most common cancer in women
after skin cancers. Our research and development efforts led to the creation of
our BCS. We are seeking FDA pre-market approval for this system as an adjunct to
mammography and clinical examinations, for use as a painless and non-invasive
technique for acquiring clinical information. To receive PMA approval, we must
establish the BCS'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 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 to the FDA's Radiological Devices Panel on
December 10, 2002, and the Panel voted against recommending approval of the BCS.
On January 23, 2003, the FDA concurred with the recommendation made by the Panel
and issued a letter to the Company to disapprove the BCS. The FDA's decision to
disapprove the BCS is 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 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") are insufficient by
themselves to constitute an adequate study, 3) enrollment was not limited to
mammographically visible masses, and 4) the number of exclusions of enrolled
subjects was excessive. The FDA's letter states specific actions we could take
to put the PMA into an approvable form including: a) performing a new pre-market
clinical trial, (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 Company takes exception to and disagrees with these findings. We
have contacted the FDA's ombudsman and are attempting to negotiate a reversal of
the FDA's decision. We have met with the FDA since January, and recently
provided additional statistical analysis of the clinical trial data previously
submitted, which we believe may be helpful in obtaining FDA approval. We have
elected to take this relationship based approach but still have the option of a
formal scientific appeal or may avail ourselves of other remedies. We do not
know whether our negotiations or any appeal we might file will be successful.
Furthermore we cannot guarantee whether or when the FDA will approve the BCS.

         We are publicly traded on the American Stock Exchange under the symbol
"CIO". On May 14, 2003, we had approximately 107 million shares of common stock
outstanding held by approximately 21,000 shareholders, primarily individuals. In
addition to common stock outstanding, we have approximately 11.4 million shares
of common stock underlying warrants and options that remain unexercised. On a
fully diluted basis, we have approximately 119 million common shares
outstanding, 22 percent of which are beneficially owned by insiders and
affiliates. Other than our wholly-owned subsidiary, Bales Scientific, Inc., we
have no other interest in any other entity.

                                       25

<PAGE>

         The Company uses capital to pay general corporate expenses, including
salaries, manufacturing costs, professional fees, clinical trials and technical
support costs, and general and administrative expenses. To date, the Company has
funded its business activities with funds raised through the private placement
of common stock, debt and warrants and the exercise of warrants and options.

RESULTS OF OPERATIONS

QUARTER ENDED MARCH 31, 2003, COMPARED TO QUARTER ENDED MARCH 31, 2002, (ROUNDED
IN THOUSANDS).

         REVENUES

         Revenues for the quarter ended March 31, 2003 increased approximately
$77,000, or 25%, from the same period last year to $391,000. Approximately
$68,000 of our revenues resulted from the sale of pain management products and
$323,000 of our revenues resulted from the sale of industrial products and
services.

         During the quarter ended March 31, 2003, medical segment revenues were
$68,000 compared to $288,000 from the same period last year a decrease of
$220,000, or 76%. This decrease is a result of reduced sales activity and a
reduction in sales and marketing personnel. We expect our sales activity to
increase somewhat in the fourth quarter; however, because we have cut back our
operations to reduce our cash outlays, we have limited resources, which may
impede our ability to sell medical products.

         During the quarter ended March 31, 2003, industrial segment revenues
were approximately $323,000 compared to $26,000 for the same period last year an
increase of $297,000. This increase is the result of recognizing the sale of a
turbine blade inspection system delivered to Alstom during Fiscal 2002, compared
to providing only inspection services during the prior year. We continue to
respond to inquiries from various industrial customers, however, because we have
reduced our sales staff and are emphasizing FDA approval for the BCS, we expect
industrial revenue to decline.

         Unfulfilled orders as of March 31, 2003 and 2002 were $425,000 and
$300,000, respectively. Backlog at March 31, 2003 is an order from Pratt and
Whitney for a TBIS. This order was shipped during Fiscal 2003 and will be
recognized as a gain on sale of an asset when all of our commitments and
obligations have been fulfilled. The June 2002 backlog represents one TBIS'
ordered by Alstom. We shipped one system during the second quarter of Fiscal
2002, did not recognize any revenue from that shipment until this quarter
because of an embedded warranty provision that expired during the quarter.

         Approximately $304,000, or 78%, of total revenues for the quarter are
attributable to foreign sales which consist of a $304,000 in industrial sales to
the UK for the three months ended March 31, 2003. For the comparable period last
year, approximately $64,000, or 20%, of total revenues related to foreign sales
consisting of $1,000 in medical sales to Canada and $63,000 in industrial sales
to the UK.

                                       26

<PAGE>

         COSTS AND EXPENSES

         Gross margins for the quarter ended March 31, 2003 were approximately
$171,000 compared to $95,000 for the same period last year. Total cost of goods
sold for the quarter ended March 31, 2003 were approximately $220,000 compared
to $219,000 for the same period last year.

         Gross margins for our Medical segment were approximately $30,000 and
$77,000 for the three months ended March 31, 2003 and 2002, respectively. Our
medical segment cost of goods sold were approximately $39,000 and $210,000 for
the three months ended March 31, 2003 and 2002, respectively. Medical gross
margins as a percentage of sales are 44% for three months ended March 31, 2003,
and 27% for the three months ended March 31, 2002.

         We do not believe gross margins for the quarter ended March 31, 2002,
are indicative of gross margins for future periods. We expect that unit prices
for our TIP and PS will decline as a prerequisite to increasing unit volumes and
as a result of competition. We expect prices to decline faster than we are able
to reduce manufacturing costs; therefore, our gross margins as a percent of
sales for our pain management products will decline. However, if we are able to
gain market acceptance and increase volume, total gross margin dollars may
improve. Demand for our pain management products and resulting revenues and
gross margins are dependant upon general economic conditions, insurance
reimbursements, insurance coverage offered by medical plans and our ability to
aggressively market and promote our products.

         Gross margins for the industrial segment were approximately $141,000
and $17,000 for three months ended March 31, 2003 and 2002, respectively, while
costs of goods sold were approximately $181,000 and $9,000 for the same periods,
respectively. In fiscal 2003, these costs represent the sale of a
non-destructive testing machine and services related to turbine blade
inspections. In fiscal 2002, these costs represent the cost of testing turbine
blades using our Turbine Blade Inspection System. Industrial gross margins as a
percentage of sales are 44% for three months ended March 31, 2003, and 65% for
the three months ended March 31, 2002.

         Industrial revenues and gross margins are unpredictable because of the
relatively poor condition of the power turbine and aerospace industries, the
custom content of each unit which affects both manufacturing costs and
implementation efforts, and general economic conditions. In April 2003, we
consolidated our Walnut Creek, California, operation into our Ogden, Utah,
facility to reduce costs, and believe this will improve our margins but we
cannot guarantee significant industrial segment margins in the future.

          General and administrative expenses for the quarter ended March 31,
2003, were approximately $703,000 compared to $1,091,000 for the same period
last year, a decrease of $388,000, or 36%. This decrease is primarily a result
of 1) a $285,000 decrease in wages from reducing staffing levels, incentive
compensation and other wage related expenses, 2) a $11,000 decrease in employee
benefits, 3) a $14,000 decrease in administrative and overhead expenses, 5) a
$56,000 decrease in other expenses, 6) a $5,000 decrease in temporary services,
and 7) a $38,000 decrease in travel expenses. These decreases relate to our
effort to curtail expenses. These decreases in expenses were partially offset by
increases of 1) $7,000 related to legal and other professional services and 2)
$14,000 increase in stock holder service costs. If we can obtain FDA approval or
funding to facilitate the steps suggested by the FDA, our expense level will
increase.

                                       27


<PAGE>

         Research and development expenses for the quarter ended March 31, 2003
were approximately $851,000 compared to $1,511,000 for the same period last year
a decrease of $660,000, or 44%. The decrease is primarily a result of 1) a
$379,000 decrease in wages related to reducing staffing levels and incentive
compensation, 2) a $25,000 decrease in employee benefits, 3) a $55,000 decrease
in the development expenses related to developing the BCS, 4) a $14,000 decrease
in clinical study expenses for the BCS and pain management products, 5) $26,000
decrease in expenses related to our pain management products, 6) a $84,000
decrease in industrial engineering expenses related to our development of the
industrial inspection systems, 7) a $68,000 decrease in overhead expense
primarily related to office expenses, rent and insurance, 8) a $20,000 decrease
in temporary services, 9) a $29,000 decrease in travel expenses, and 10) a
$9,000 decrease in other expenses primarily supplies, equipment, and stock
issued to the Company's 401(k) retirement plan. This reduction in expenses was
partially offset by a $49,000 increase in patent legal expenses. These decreases
relate to our effort to curtail expenses. If we can obtain FDA approval or
funding to facilitate the steps suggested by the FDA, our expense level will
increase.

         Because we believe securing a favorable recommendation from the FDA is
important to obtaining additional funding, we have retained staff to assist with
the BCS 2100 PMA review and continue to utilize the Battelle Institute and other
consultants to assist us with our negotiations and appeal of the FDA's
non-approval of the BCS 2100 and to ensure prompt, professional and complete
responses to any FDA inquiry regarding the BCS 2100.

         We plan to continue conducting clinical studies, utilizing the BCS
2100, with institutions and practitioners to obtain user feedback, test product
enhancements, to secure technical papers, and for training and educational
marketing purposes. Clinical studies are not the same as clinical trials, which
we conducted for FDA PMA approval purposes. During fiscal 2002, we entered into
a research relationship with McKay-Dee Hospital for a study of up to 70 patients
referred for biopsy of a single mass after undergoing conventional diagnostic
procedures. We conducted this study to acquire information about the
effectiveness of the BCS2100 for women age 60 presenting with a lesion described
as a mass. We concluded this study during the third quarter of fiscal 2003
without conclusion when it became apparent that the institution did not treat
sufficient patients to complete the study in a timely fashion. Also during
fiscal 2002, we also initiated a study at Massachusetts General Hospital,
Harvard Medical School's largest teaching hospital for a clinical study
involving up to 250 patients referred for biopsy of a single mass after
undergoing conventional diagnostic procedures. This study is intended to acquire
information to study the effectiveness of the BCS 2100 in women age 55 and under
who present with a lesion described as a mass. This study is ongoing. In
addition, these studies provide us with an opportunity to evaluate the form and
function of the BCS 2100 and develop product enhancements for next generation
products. We are currently conducting a study with the Photonic Stimulator,
evaluating its effect on neck and shoulder pain. This study is not yet complete.
We are not currently conducting clinical studies or trials for our Thermal
Imaging Processor.

                                       28

<PAGE>

         Marketing expenses for the quarter ended March 31, 2003 were
approximately $307,000 compared to $751,000 for the same period last year,
resulting in a decrease of $444,000, or 59%, from the prior year period. The
decrease is primarily a result of: 1) a $144,000 decrease in wages related to
reducing staffing levels and incentive compensation, 2) a $8,000 decrease in
employee benefits, 3) a $192,000 decrease in advertising and marketing related
to discontinuing most marketing and advertising activities, 4) a $54,000
decrease in administrative overhead and other costs and 5) a $ 49,000 decrease
in travel expenses. These decreases relate to our efforts to curtail expenses.
These decreases were partially offset by a $3,000 increase in other
miscellaneous costs.

         Depreciation and amortization expense for the quarter ended March 31,
2003 decreased $343,000 to $48,000, or 88%, compared to the prior year period.
During Fiscal 2002, we amortized our goodwill ratably over 10 years; however, we
wrote off essentially all of our intangible assets during the fourth quarter of
Fiscal 2002. In addition, we recorded an impairment during the quarter ended
December 31, 2002 of $711,000 relating to our medical and industrial assets. We
evaluate our property, plant and equipment for impairment whenever indicators of
impairment exist. Because of our limited cash balances, history of sustained
losses and the FDA's decision to disapprove the BCS, we reviewed our fixed
assets and impaired them to their estimated fair value.

         Accounting standards require 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, then 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 an impairment expense on
our statement of operations. In estimating impairments, management makes
assumptions about future cash flows and fair value that are inherently
uncertain, can significantly effect the results, and may differ from actual
future results. The impaired assets consist of computers, furniture, equipment,
leasehold improvements and software used in the medical and industrial segments.

         STOCK-BASED COMPENSATION. Stock-based compensation is variable option
accounting that is required because the Company repriced certain employee stock
options held be certain current and former executive offers and managers during
Fiscal 2001. The Company recorded no stock based compensation expense during the
three months ended March 31, 2003 and approximately $7,000 of stock-based
compensation during the 3 months ended March 31, 2002. In future periods, the
Company may record stock-based compensation expense relating to options repriced
during Fiscal 2001 for 250,000 options if the Company's stock price exceeds
$1.50 per share, and for 125,000 options if the Company's stock price exceeds
$2.50 per share.

         OPERATING INCOME / (LOSS)

         As a result of the foregoing, we recorded an operating loss of
($1,738,724) for the quarter ended March 31, 2003, compared to an operating loss
of ($3,656,893) for the quarter ended March 31, 2002.

                                       29

<PAGE>

         Medical segment operating losses were approximately ($1,566,068) and
($3,046,814) for the three months ended March 31, 2003 and 2002, respectively.
The improvement of $1,480,746 is related to a reduction in staffing levels,
marketing activities and litigation settlements. These decreases were offset by
impairments to fixed assets and to inventory reserves. These expense decreases
are a temporary measure to reduce our cash outflow if and until we receive
additional funding and are not sustainable if we obtain FDA approval.

         Industrial segment operating losses were approximately $172,656 and
$602,477 for the three months ended March 31, 2003 and 2002, respectively. The
$429,821 decrease in losses is primarily attributable to decreasing staffing
levels. The effect of reducing staffing levels was partially offset by asset
impairments, and we believe are a temporary measure to reduce cash outflows. As
of the date of this document, we have deemphasized our industrial segment and
consolidated our industrial operations into our Ogden, Utah facility to reduce
these losses further. If we can obtain sufficient funding and market conditions
become favorable, however, we plan to invest in this segment and expect to incur
losses until we are able to increase industrial revenues.

         OTHER INCOME / (EXPENSE)

         Net interest expense for the quarter ended March 31, 2003 increased
approximately $1,822,000 from the same quarter of 2002 to a net expense of
$1,830,000. This increase resulted from non-cash expenses recognized in
connection with amendments to our agreements with Beach Boulevard and
amortization of deferred finance costs: 1) a $1,770,000 interest expense charge
related to repricing the conversion price of the Convertible Debenture, 2) A
$6,900 charge for repricing the warrants attached to the Convertible Debenture,
3) interest on the balance of the debenture; 4) a $49,000 charge from
amortization of deferred finance cost and beneficial conversion feature discount
on the debenture over the life of the mandatory put period. The Company received
less cash interest income due to lower yields and decreased balances in
marketable securities available for sale.

                  NET INCOME/(LOSS)

         As a result of the foregoing, we recorded a net loss of ($3,568,581)
for the quarter ended March 31, 2003, compared to a net loss of ($3,656,893) for
the quarter ended March 31, 2002.

         For the quarter ended March 31, 2003, the loss attributable to common
shareholders was ($3,568,581), or ($0.04) per share, compared to a loss
attributable to common shareholders of ($3,656,893,) or ($0.04) per share, for
the quarter ended March 31, 2002.

                                       30

<PAGE>

NINE MONTHS ENDED MARCH 31, 2003 COMPARED TO NINE MONTHS ENDED MARCH 31, 2002
(ROUNDED IN THOUSANDS).

         REVENUES

         Revenues for the nine months ended March 31, 2003 increased
approximately $493,000, or 65%, from the same period last year to $1,250,000. Of
this amount, $715,000 resulted from the sale of pain management products and the
$535,000 resulted from the sale of industrial products and services.

         During the nine months ended March 31, 2003, medical segment revenues
were approximately $715,000 compared to $656,000 from the same period last year,
an increase of $59,000, or 9%. This increase in medical sales is a result of
increased foreign sales activity to China and Canada and increased activity in
PS unit sales due to decreased prices. The price of TIP units sold decreased 10%
while the quantity of units sold increased 67% during the first two quarters of
fiscal 2003 compared to the prior year period. However, TIP margins improved
somewhat on very low sales volume during the quarter ended March 31, 2003, and
as a result the average price and total quantity of TIP units sold remained flat
for the nine months ended March 31, 2003 compared to the same period last year.
The price of PS units sold decreased 48% while the quantity of units sold
increased 124% during the nine months ended March 31, 2003 compared to the prior
year period and represents essentially all of our year to date sales increase.

         During the nine months ended March 31, 2003, industrial segment
revenues were $535,000 compared to $101,000 from the same period last year,
resulting in an increase of $434,000, or 430%. This increase is the result of
the sale of two industrial testing products for $439,000 and non-destructive
testing services of $96,000. During the same period last year, we provided
$101,000 of non-destructive testing services, principally turbine blade
inspection services for Alstom, which ended when we shipped a turbine blade
inspection system to Alstom.

         Unfulfilled orders as of March 31, 2003 and 2002 were $425,000 and
$300,000, respectively. Backlog at March 31, 2003 is an order from Pratt and
Whitney for a TBIS. This order was shipped during Fiscal 2003 and will be
recognized as a gain on sale of an asset when all of our commitments and
obligations have been fulfilled. The June 2002 backlog represents one TBIS'
ordered by Alstom. We shipped one system during the second quarter of Fiscal
2002, did not recognize any revenue from that shipment until this quarter
because of an embedded warranty provision that expired during the quarter.

         For the nine months ended March 31, 2003, approximately $732,000, or
59%, of total revenues are attributable to foreign sales consisting of $357,000
in medical sales primarily to Canada and China and $375,000 in industrial sales
to the UK. For the nine months ended March 31, 2002, approximately $155,000, or
20%, of total revenues related to foreign sales consisting of $61,000 in medical
sales to Canada and $94,000 related to industrial sales to the UK.

                                       31

<PAGE>

         COSTS AND EXPENSES

         Gross margins for the nine months ended March 31, 2003 were
approximately $77,000 compared to $271,000 for the same period last year a
decrease of $194,000 or 72%. Total costs of goods sold for the nine months ended
March 31, 2002 were approximately $1,172,000 compared to $486,000 for the same
period last year.

         Gross margins for our Medical segment were approximately ($176,000) and
$194,000 for the nine months ended March 31, 2003, and 2002, respectively. Our
medical segment cost of goods sold were approximately $891,000 and $462,000 for
the nine months ended March 31, 2003 and 2002, respectively. Costs of goods sold
include the cost to manufacture our medical products and includes adjustments to
our inventory reserve of approximately $390000 for the nine months ended March
31, 2003. The inventory reserve represents management's estimate of excess and
obsolete inventory on hand. The adjustment recorded during the nine months ended
March 31, 2003 reflects the FDA's decision to not approve our PMA and the
probable impact that decision will have on the ability to sell our medical
products, particularly the TIP which is a component of the BCS. Medical gross
margins as a percentage of sales were (25%) for the nine months ended March 31,
2003 and 30% for the nine months ended March 31, 2002.

         We expect that unit prices for our TIP and PS will continue to decline
as a prerequisite to increasing market penetration and as a result of
competition. We also expect prices to decline faster than we are able to reduce
manufacturing costs; therefore, our gross margins as a percent of sales for our
pain management products will decline. However, if we are able to gain market
acceptance and increase volume, total gross margin dollars may improve. Demand
for our pain management products and resulting revenues and gross margins are
dependant upon general economic conditions, insurance reimbursements and our
ability to aggressively market and promote our products.

         Gross margins for the industrial segment were approximately $253,000
and $77,000 for the nine months ended March 31, 2003 and 2002, respectively,
while costs of goods sold were approximately $281,000 and $23,000 for the same
periods, respectively. In Fiscal 2003, these costs represent the sale of
non-destructive testing machines and services related to turbine blade
inspections. In Fiscal 2002, these costs represent the time spent testing
turbine blades using our Turbine Blade Inspection System. Industrial gross
margins as a percentage of sales were 47% for the nine months ended March 31,
2003 and 77% for the nine months ended March 31, 2002.

         Industrial revenues and gross margins are unpredictable because of the
relatively poor condition of the power turbine and aerospace industries, the
custom content of each unit and general economic conditions. In April 2003, we
consolidated our Walnut Creek, California, operation into our Ogden, Utah,
facility to reduce costs, and believe this will improve our margins but we
cannot guarantee significant industrial segment margins in the future.

                                       32

<PAGE>

         General and administrative expenses for the nine months ended March 31,
2003 were approximately $2,182,000 compared to $247,000 for the same period last
year, an increase of $1,935,000 from the same period last year. Stock-based
compensation for the nine months ended March 31, 2003 was $7,000. For the nine
months ended March 31, 2002, stock-based compensation was a benefit (expense
recovery) of $2,905,000. Because of the $2,905,000 recovery, we recorded a net
$247,000 expense in administrative expenses for the nine months ended March 31,
2002.

         Excluding stock-based compensation, general and administrative expenses
decreased $977,000 for the nine months ended March 31, 2003 compared to the same
period last year. This decrease is primarily a result of 1) a $554,000 decrease
in wages resulting from staff reductions of $374,000 and accrued incentive
compensation reductions of $180,000, 2) a $200,000 decrease in litigation
settlement expenses, 3) a $ 28,000 decrease in temporary services, 4) a $110,000
decrease in administrative overhead expenses primarily rent, insurance and
office expenses, 5) $242,000 decrease in other costs primarily bad debt,
supplies, equipment, and stock issuances for the Company's 401(k) retirement
plan, 5) a $119,000 decrease in travel. This reduction in expenses was partially
offset by 1) a $174,000 increase in legal and other professional expenses, 2) a
$12,000 increase in employee benefits and 3) a $74,000 increase in stockholder
service expenses. These net decreases relate to our effort to curtail expenses.
If we can obtain FDA approval or funding to facilitate the steps suggested by
the FDA, our expense level will increase.

         Research and development expenses for the nine months ended March 31,
2003 were approximately $3,253,000 compared to $4,386,000 for the same period
last year, resulting in a decrease of $1,133,000, or 26%. Excluding a non-cash
compensation benefit of $209,000 recorded during the first nine months of Fiscal
2002 from the recovery of stock-based compensation expense, research and
development expenses decreased during the first nine months of Fiscal 2003 by
$1,342,000, or 29%, compared to the prior year period. The decrease is primarily
a result of: 1) a $650,000 decrease in wages related to staff reductions of
$560,000 and accrued incentive compensation reductions of $90,000; 2) a $4,000
decrease in employee benefits, 3) a $184,000 decrease in research and
development expenses related to the development of the BCS, 4) a $137,000
decrease in clinical studies of our BCS 2100 and pain management products, 5) a
$107,000 decrease in research and development expenses related to the
development pain management products, 6) a $159,000 decrease in industrial
research and development expenses related to the design and development of our
industrial inspection systems, 7) a $30,000 decrease in temporary services, 8) a
$39,000 decrease in overhead expenses, primarily rent, insurance and office
expenses, 9) a $35,000 decrease in travel expenses, and 10) a $61,000 decrease
in other costs primarily supplies, equipment and stock issued to the Company's
401(k) retirement plan. This reduction in expenses was partially offset by a
$64,000 increase in patent expense. These net decreases relate to our effort to
curtail expenses. If we can obtain FDA approval or funding to facilitate the
steps suggested by the FDA, our expense level will increase.

         Because we believe securing a favorable recommendation from the FDA is
important to obtaining additional funding, we have retained staff to assist with
the BCS 2100 PMA review and continue to utilize the Battelle Institute and other
consultants to assist us with our negotiations and appeal of the FDA's
non-approval of the BCS 2100 and to ensure prompt, professional and complete
responses to any FDA inquiry regarding the BCS 2100.

                                       33

<PAGE>

         We plan to continue conducting clinical studies, utilizing the BCS
2100, with institutions and practitioners to obtain user feedback, test product
enhancements, to secure technical papers, and for training and educational
marketing purposes. Clinical studies are not the same as clinical trials, which
we conducted for FDA PMA approval purposes. During Fiscal 2002, we entered into
a research relationship with McKay-Dee Hospital for a study of up to 70 patients
referred for biopsy of a single mass after undergoing conventional diagnostic
procedures. We conducted this study to acquire information about the
effectiveness of the BCS2100 for women age 60 presenting with a lesion described
as a mass. We concluded this study during the third quarter of fiscal 2003
without conclusion when it became apparent that the institution did not treat
sufficient patients to complete the study in a timely fashion. Also during
fiscal 2002, we also initiated a study at Massachusetts General Hospital,
Harvard Medical School's largest teaching hospital for a clinical study
involving up to 250 patients referred for biopsy of a single mass after
undergoing conventional diagnostic procedures. This study is intended to acquire
information to study the effectiveness of the BCS2100 in women age 55 and under
who present with a lesion described as a mass. This study is ongoing. In
addition, these studies provide us with an opportunity to evaluate the form and
function of the BCS 2100 and develop product enhancements for next generation
products. We are currently conducting a study with the Photonic Stimulator,
evaluating its effect on neck and shoulder pain. This study is not yet complete.
We are not currently conducting clinical studies or trials for our Thermal
Imaging Processor

         Marketing expenses for the nine months ended March 31, 2003 were
$1,302,000, compared to $2,031,000 for the same period last year, resulting in a
decrease of $729,000, or 36%. Excluding the stock-based compensation benefit of
$378,000 for the nine months ended March 31, 2002, marketing expenses decreased
$1,107,000, or 46%, compared to the prior year period. The decrease is primarily
a result of a 1) a $145,000 decrease in wages, incentive compensation and
related expenses, 2) $920,000 decrease in advertising and marketing activities,
which includes the reduction of $81,000 to a marketing reserve for accrued
tradeshow services and activities, 3) a $17,000 in administrative overhead
expenses, primarily rent, insurance, and office expenses, 4) a $2,000 decrease
in other costs, and 5) a $41,000 decrease in travel expenses. These expenses
were partially offset by an $18,000 increase in employee benefits. These net
decreases reflect to our efforts to curtail expenses.

         Depreciation and amortization expense for the nine months ended March
31, 2003 decreased $788,000 to $388,000, or 67%, from the same six month period
in 2002. During Fiscal 2002, we amortized our goodwill ratably over 10 years;
however, we wrote off essentially all of our intangible assets during the fourth
quarter of Fiscal 2002.

         During the quarter ended December 31, 2002 we recorded an impairment
loss of $711,000 relating to our medical and industrial assets. We evaluate our
property, plant and equipment for impairment whenever indicators of impairment
exist. Because of our limited cash balances, history of sustained losses and the
FDA's decision to disapprove the BCS, we reviewed our fixed assets and impaired
them to their estimated fair value.

                                       34

<PAGE>

         Accounting standards require 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, then 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
statement of operations. In estimating impairments, management makes assumptions
about future cash flows and fair value that are inherently uncertain, can
significantly effect the results, and may differ from actual future results. The
impaired assets consist of computers, furniture, equipment, leasehold
improvements and software used in the medical and industrial segments.

         STOCK-BASED COMPENSATION. Stock-based compensation is variable option
accounting that is required because the Company repriced certain employee stock
options during Fiscal 2001.

         During fiscal 2001, we modified the price of the stock options of
certain executives and managers. As a result of these modifications, we are
subject to variable option accounting which requires that, if the Company's
stock price exceeds the option exercise price, we measure and record
compensation expense or recovery (reduced expense) equal to the change in the
Company's stock price times the number of options outstanding. If the option
exercise price was less than the Company's stock price on the date of grant, the
difference between the option exercise price and the closing price on the grant
date, times the number of option issued is recorded as compensation expense.

         Because our stock price decreased from $4.95 to $1.05 per common share
from June 30, 2001 to March 28, 2002, we recorded recovery (reduced expense) of
approximately $3.5 million. These employee stock options were modified in
connection with severance agreements or to align the interests of executives,
managers and shareholders. Because these repriced options have been surrendered
or because our stock price is below the exercise price of these repriced
options, variable option accounting has become immaterial, approximately $7,000
for the nine months ended March 31, 2003. In future periods, the Company may
record stock-based compensation expense relating to options repriced during
Fiscal 2001 for 250,000 options if the Company's stock price exceeds $1.50 per
share, and for 125,000 options if the Company's stock price exceeds $2.50 per
share.

         OPERATING INCOME / (LOSS)

         As a result of the foregoing, we recorded an operating loss of
approximately ($7,760,000) for the nine months ended March 31, 2003, compared to
an operating loss of $7,558,000) for the nine months ended March 31, 2002.
Excluding a non-cash compensation, the operating loss was approximately
($7,753,000) for the nine months ended March 31, 2003, compared to ($11,067,000)
for the same period in 2001, a decrease of $3,314,000, or 30%.

         Medical segment operating losses were approximately $6,455,000 and
$6,347,000 for the nine months ended March 31, 2003 and 2002 respectively.
Excluding stock-based compensation, medical segment losses were approximately
$6,263,000 and $9,227,000 for the nine months ended March 31, 2003 and 2002,
respectively. The improvement of approximately $2,961,000 is related to a

                                       35

<PAGE>

reduction in staffing levels, marketing activities and litigation settlement
charges. These decreases were offset by impairments to fixed assets and
increases in the inventory reserves. These expense decreases are a temporary
measure to reduce our cash outflow and are not sustainable if we obtain FDA
approval of our PMA.

         Industrial segment losses were approximately $1,305,000 and $1,211,000
for the nine months ended March 31, 2003 and 2002, respectively. Excluding
stock-based compensation, industrial segment losses were approximately
$1,490,000 and $1,840,000 for the first nine months of fiscal years 2002 and
2001, respectively. The $350,000 decrease in losses is primarily attributable to
increased revenues while reducing staffing levels, research and development
activity and industrial segment activity. These expense reductions are temporary
if we are able to secure sufficient additional funding to advance both our BCS
and industrial products. If we are able to secure additional funding, we plan to
continue investing in the industrial segments and may incur losses in this
segment.

         OTHER INCOME

         Net interest income for the nine months ended March 31, 2003 decreased
$3,105,000 from the same nine months of 2002, to a net expense of $2,617,000.
This decrease resulted from non-cash expenses recognized in connection with
amendments to our agreements with Beach Boulevard and amortization of deferred
finance costs: 1) a $1,770,000 interest expense charge related to repricing the
conversion price of the convertible debenture, 2) A $6,900 charge for repricing
the warrants attached to the Convertible Debenture, 3) $107,000 interest expense
charge related to interest on the balance of the debenture; 4) a $565,000 charge
from amortization of deferred finance cost and beneficial conversion feature
discount on the debenture over the life of the mandatory put period; 5) a
$286,000 charge to interest expense recorded to increase the redeemable balance
of the debenture by 11% pursuant to provisions of the Convertible Debenture (see
Agreement with Beach Boulevard LLC, below). The Company received less cash
interest income due to lower yields and decreased balances in marketable
securities available for sale.

         NET INCOME/(LOSS)

         As a result of the foregoing, we recorded a net loss of ($10,376,340)
for the nine months ended March 31, 2003, compared to a net loss of ($7,070,848)
for the nine months ended March 31, 2002. Excluding a non-cash compensation, the
net loss was ($10,369,060) for the nine months ended March 31, 2003, compared to
($10,579,345) for the same period in 2002, a decrease of ($210,285), or 2%.

         For the nine months ended March 31, 2003, the loss attributable to
common shareholders was $10,376,340, or ($0.12) per share, compared to a loss
attributable to common shareholders of $7,070,848, or ($0.09) per share, for the
nine months ended March 31, 2002.

                                       36

<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

         SOURCES AND USES OF LIQUIDITY

         Our funds used for operations have historically come from issuing
common stock, options and warrants, revenues generated from operations, sale 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, lease payments on
office space, legal and accounting fees for litigation and to comply with
securities registration and reporting requirements, costs of clinical trials and
studies and technical support, FDA consulting expenses, procurement of inventory
and supplies for developing, manufacturing and marketing our medical and
industrial applications.

         Net cash used in operating activities for the nine months ended March
31, 2003 was approximately $7,739,000 compared to $9,780,000 for the nine months
ended March 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, payable and accrued expense
balances. More specifically, $1.3 million of the accrued Packer settlement
reserve was paid during the nine months ended March 31, 2003.

          Net cash provided by investing activities for the nine months ended
March 31, 2003 was approximately $7,201,000, compared to net cash used in
investing activities of $1,294,000 in the nine months ended March 31, 2002. Net
cash provided by and used in investing activities primarily relates to selling
securities to fund operations or using cash to purchase securities
available-for-sale. We pulled $7.3 million from marketable securities to fund
operations during the nine months ended March 31, 2003.

         Net cash provided by financing activities was approximately $782,000 in
the nine months ended March 31, 2003 compared to $3,801,000 during the nine
months ended March 31, 2002. Net cash provided by financing activities for the
nine months ended March 31, 2003 was from selling stock to Beach Boulevard, LLC
pursuant to the Equity Line. Net cash provided from financing activities for the
nine months ended March 31, 2002 was primarily from the exercise of employee
options and investor warrants.

         As a result of the foregoing, the net cash outflow decreased by
approximately $244,000 in the nine months ended March 31, 2003 compared to a
decrease of $4,685,000 in the nine months ended March 31, 2002.

         Cash and cash equivalents at the end of the nine months ended March 31,
2003 were approximately $1,181,000 compared to $937,000 on June 20, 2002

         As of April 25, 2003, our current monthly expense rate is approximately
$400 thousand; our monthly expense rate at our former full operational level was
approximately $1.1 million. As of April 25, 2003, we had cash, accounts
receivable and pre-paid expenses of approximately $1.75 million and current
liabilities (excluding the debenture and deferred revenue) of approximately
$1.01 million. These current liabilities consist of approximately $479 thousand

                                       37

<PAGE>

of accounts payable, $491 thousand of accrued liabilities, and $44 thousand of
accrued employee costs. Accordingly, unless we are able to secure additional
funding from a third party, we have sufficient working capital to sustain our
operations, which are already substantially reduced, until between July and
September. Failure to secure additional funding may result in further severe
reductions in operations or discontinuing operations altogether.

         The following table summarizes the Company's contractual obligations
and commitments to make future payments as of March 31, 2003:

<TABLE>
<CAPTION>

                                                                     Payments due by period
                                                         Total     Less than 1 year  1-2 years   After 3 years
                                                         -----     ----------------  ---------   -------------
<S>                                                   <C>            <C>            <C>            <C>
Operating Leases                                      $  693,389     $  310,607     $  203,170     $  197,612
Convertible debenture net of conversion privilege      1,327,281      1,327,281             --             --
Interest on Debenture                                     92,910         92,910             --             --
                                                      -----------    -----------    -----------    -----------
Total                                                 $2,113,580     $1,730,798     $  203,170     $  197,612
                                                      ===========    ===========    ===========    ===========
</TABLE>

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 in the amount of $2.5 million
(the "Convertible Debenture") and secured an equity line of credit (the "Equity
Line") that would allow the Company to sell up to $20 million in common stock to
the Investor at 94 percent of the market price, as defined by the Agreement.
Based on its original terms, the Convertible Debenture is due on December 31,
2004. The terms of the Agreement permit 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 is due on the conversion date and is payable, at the
option of the Company, in cash.

         In connection with the Agreement, the Company entered into a
registration rights agreement and subsequently filed a registration statement
(Registration No. 333-82016) with the SEC, which was declared effective on March
18, 2002. The Investor may require the Company to redeem all or a portion of the
Convertible Debenture if the average closing bid price of the Company's common
stock for the 90 consecutive trading days after the effective date of the
registration statement is less than $1.44 (a "Trigger Event"). The amount
redeemable is equal to 111% of the principal balance of the Convertible
Debenture and accrued interest (the "Redeemable Balance"). If a Trigger Event
occurs, the Investor is required to provide notice to the Company of its
election to force redemption and to specify the date (the "Redemption Due Date")
on which the Redeemable Balance is to be paid. If the Company does not pay the
Redeemable Balance in full by the Redemption Due Date, the Company is required
to issue registered unrestricted shares of common stock pursuant to a series of
mandatory put notices consistent with the terms of the Equity Line. If the
Redeemable Balance is not paid through the mandatory puts within six months of
the Investor's notice to force redemption, the unpaid portion of the Redeemable
Balance is required to be paid immediately in cash.

                                       38

<PAGE>

         On July 25, 2002, the Investor notified the Company that a Trigger
Event had occurred and the Redeemable Balance of the Convertible Debenture
became due. On the date of the Trigger Event, the Redeemable Balance was
approximately $2,898,000, which included principal of approximately $2,500,000,
$111,000 of accrued interest and $287,000 of penalty. The Company elected to
satisfy the Redeemable Balance through a series of mandatory put notices based
on the terms of the Equity Line. The terms of the Equity Line provide for one
mandatory put per month and a maximum put amount per put equal to the lesser of
$500,000 or 125 percent of the weighted average trading volume of the Company's
common stock for the 20 days immediately preceding the date of the mandatory put
notice. Because of the average trading volume restriction, we have only made
modest debt repayments and have not been able to extinguish the debt entirely.

         On December 16, 2002, the Company issued a put to the Investor pursuant
to the Equity Line for $467,000 and issued 1,500,000 shares of common stock on
December 24, 2002 and the remaining 1,455,083 shares of common stock on January
3, 2003. As of December 31, 2002, the Company recorded a subscription receivable
of $237,288 related to the 1,500,000 shares issued on December 24, 2002. The
Company received proceeds from the subscription receivable during January 2003.

         In connection with the Agreement, the Company issued 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, which expire December 31, 2004
and December 31, 2007, respectively. 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 bank for the purchase of 100,000 shares of
common stock at $1.87 per share in connection with the Debenture Offering. The
fair market value of these warrants and other related financing costs have been
recorded as deferred financing costs. Because of the Trigger Event discussed in
the preceding paragraph, the deferred financing costs and discount on the
Convertible Debenture were being amortized over the six-month period ending
January 25, 2003. Due to the complexities of the Convertible Debenture such as
the beneficial conversion feature, trigger events and interrelationship with the
attached warrants and Equity Line, it is impractical to estimate the fair value
of the debenture. During the nine months ended March 31, 2003, the effective
interest rate (excluding the penalty and the expense for the price modification
of the Convertible Debenture) the Company was paying on the $2.5 million
Convertible Debenture was 36%; however, this implied rate will decrease over the
next six-month period as the deferred finance costs and beneficial conversion
feature are fully amortized.

         Pursuant to the guidance under SFAS No. 123, the Company valued and
recorded as an expense the value of warrants issued in connection with the
Convertible Debenture, Equity Line and services rendered to assist the financing
("financing services"). The estimated fair value of the warrants were calculated
using the Black-Scholes valuation model and valued at approximately $36,000,
$99,000 and $18,000 for the Debenture warrants, Equity Line warrants and the
financing services warrants respectively. The value of the warrants is being
amortized to interest expense over the accelerated term of the DEBENTURE,
thereby raising the computed effective rate of interest. In valuing the warrants
the Company used an estimated volatility of 44.6% and an expected life of one
year.

                                       39

<PAGE>

         In connection with the convertible debenture's conversion feature, the
Company recorded a value for beneficial conversion feature in accordance with
EITF 00-27 APPLICATION OF ISSUE NO. 98-5 TO CERTAIN CONVERTIBLE INSTRUMENTS. The
intrinsic value of the beneficial conversion feature of approximately $245,000
is being amortized to interest expense over accelerated term of the debenture.
The total beneficial conversion discount related to the debenture was Recorded
at the transaction date as an increase in additional paid in capital and the
unamortized portion as a reduction to the debenture on the Company's Balance
Sheet. The unamortized portion of the beneficial conversion feature has been
amortized into interest expense, which was accelerated when the Company was
notified of the Trigger Event..

         On January 29, 2003, the Company received a Holder Redemption Notice
(the "Notice") from the Investor. The Notice, referencing the Debenture
Agreement, stated the Investor demanded payment of the Current Redeemable
Balance. Pursuant to the Debenture Agreement, the Company had five days to pay
the balance in cash. Because the Company did not pay the Redeemable Balance as
requested by the Holder, the Company is now in default as defined by Section
6.c.ix of the Debenture Agreement.

         The Redeemable Balance on March 31, 2003 was approximately $1.3
million. As of May 14, 2003, the Company reduced the Redeemable Balance to
approximately $412,000 by issuing approximately 7.9 million common shares at
prices ranging from $0.94 to $0.13 for the redemption of approximately $927,000
in principal and accrued interest. The mandatory put period, during which the
Company is required to redeem the Convertible Debenture through the issuance of
stock, expired February 2003, at which time, the Company was required to pay the
remaining balance in cash or negotiate other terms.

         On March 19, 2003, the Company executed an amendment that modifies the
exercise price of the warrants issued in connection with the Convertible
Debenture to $0.09 per common share and a variable conversion price for the
Convertible Debenture to equal the 94 percent of market price. On March 19,
2003, the Company issued approximately 4.5 million shares of common stock for
the redemption of approximately $381,000 in principal and accrued interest in
connection with modifying the conversion price of the debenture and exercise
price of the warrants (see exhibits to Form 8-K dated March 19, 2003). In
connection to the conversion, the Company recognized, on the date of the
acceptance offer, an expense of approximately $1.8 million dollars. In addition,
as of the date of this document, we may not issue any more shares under the
Equity Line.

         Based on our current cash balance, obligations, stock price and
remaining registered shares, the Company may not be able to repay the remaining
Redeemable Balance through cash payments or through puts under the Equity Line
without further modifying the Agreement with Beach Boulevard. Furthermore, there
is no assurance that Beach Boulevard will modify the Agreement.

                                       40

<PAGE>

         During the three months ended March 31, 2003, the Company issued
approximately 5.3 million common shares through mandatory put notices and
applied the proceeds of approximately $606,000 to redeem $463,000 of principal,
$83,000 of accrued interest, and $60,000 of penalty pursuant to requirements of
the Equity Line. The Company issued approximately 2.2 million shares of common
stock through voluntary put notices for approximately $210,000 pursuant to the
Equity Line, which was used to repay $183,000 of debenture principle, $6,000 of
interest and $21,000 of penalties. The Company issued approximately 4.2 million
common shares upon the partial conversion of the Convertible Debenture and
redeemed approximately $351,000 of principal and $7,000 of interest. The Company
also issued approximately 260,000 common shares upon the conversion of the
debenture warrants and used the proceeds of approximately $23,000 to pay down
$21,000 of principal and $2,000 of interest.

         During the nine months ended March 31, 2003, the Company issued
approximately 6.2 million common shares through mandatory put notices and
applied the proceeds of approximately $1,062,000 to redeem $776,000 of
principal, $181,000 of accrued interest, and $105,000 of penalty pursuant to
requirements of the Equity Line. The Company issued approximately 2.2 million
shares of common stock for approximately $210,000 pursuant to the Equity Line,
which was used to repay $183,000of debenture principle, $6,000 of interest and
$21,000 of penalties. The Company issued approximately 4.2 million common shares
upon the partial conversion of the Convertible Debenture and redeemed
approximately $351,000 of principal and $7,000 of interest. The Company also
issued approximately 260,000 common shares upon the conversion of the debenture
warrants and used the proceeds of approximately $23,000 to pay down $21,000 of
principal and $2,000 of interest.

         From April 1, 2003 to May 19, 2003, the Company has issued 9.8 million
common shares and converted most of the remaining Redeemable Balance due under
the Convertible Debenture including accrued interest. As of May 19, 2003, the
Company owes the Investor approximately $157,000.

CAPITAL REQUIREMENTS/PLAN OF OPERATION

         Our capital requirements may vary from our estimates and depend upon
numerous factors including, but not limited to: a) progress in our research and
development programs; b) results of pre-clinical and clinical testing; c) costs
of technology; d) time and costs involved in obtaining 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; and i) litigation costs.

         Since inception, we have generated significant losses from operations
($92.7 million) and, although we have generated some revenues ($3.1 million), we
are still a development stage enterprise. We have taken actions to reduce our
expenses and cash consumption; we expect to incur additional operating losses.
Our working capital requirements in the foreseeable future will depend on a
variety of factors and assumptions. In particular, that we can acquire
additional financing through additional equity and/or debt financings or through
the sale of assets or intellectual property during fiscal year 2003. If
additional funds are raised through the issuance of equity securities, our
stockholders may experience significant dilution that would aversely affect 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 stockholders.
If financing is not available when required or is not available on acceptable
terms, we may be required to curtail our operating plan and may not continue
operations as a going concern.

                                       41

<PAGE>

         On December 10, 2002, and the FDA's Advisory Panel voted to not
recommend approval of the BCS. On January 23, 2003, the FDA concurred with the
recommendation made by the Panel and issued a letter. The FDA's decision to
disapprove the BCS is 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 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") are insufficient by
themselves to constitute an adequate study, 3) enrollment was not limited to
mammographically visible masses, and 4) the number of exclusions of enrolled
subjects was excessive. The FDA letter also states specific actions the Company
could take to put the PMA into an approvable form, including a new pre-market
clinical study, extensive analysis of existing clinical information, and revised
indications for use of the device. Taking such actions, however, will require
additional capital and may require that we substantially change our operations,
including the sale of our assets.

         On April 17, 2003, the United States District Court dismissed
shareholder litigation without prejudice. In a written opinion, the U.S.
District Judge concluded that the statements made by the Company that
plaintiff's alleged were misleading to investors 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 if the plaintiffs have additional facts to overcome
their failure to state claims as to those three claims. On May 8, 2003, the
plaintiffs informed Company counsel that they would not replead any claims.
Instead, plaintiffs expressed their intention to appeal the court's ruling
following entry of the dismissal order, which was filed by the court May 13,
2003. The plaintiffs have 30 days to file their notice of appeal. If the notice
of appeal is filed and the plaintiffs follow through on their efforts to appeal
the order of dismissal, we do not expect to receive a decision from the
appellate court for at least one year, and expect the cost of defending this
litigation will be approximately $200,000 during that time.

         Moreover, our insurance carrier has denied there is insurance coverage
for the plaintiff's claims and, accordingly, has indicated it will not cover the
costs of defending the claims or pay any resulting damages we may suffer if the
plaintiff's are successful. We have retained insurance counsel who is vigorously
pursuing coverage under our Directors and Officers insurance policies.

         Finally, under our bylaws and contractual agreements we are required to
indemnify our current and former officers and directors who are a party to the
litigation by providing legal defense through our or their own attorneys and
covering all damages they may suffer if the plaintiffs are successful.

         We do not have sufficient capital to cover: 1) the expected costs of
additional clinical studies as required by the FDA; 2) the potential damages of
the shareholder litigation without insurance coverage; or 3) to fund our
business plans 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 or sale of 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.

                                       42

<PAGE>

         As of March 31, 2003, we believe that we have sufficient liquidity to
sustain current operations for three or four months. Our monthly expense rate as
of March 31 averaged $400 thousand. We had cash, marketable securities, accounts
receivable and pre-paid expenses of approximately $2.1 million 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
6 months) we believed we would need to raise additional capital or curtail our
operation.

         We have selectively reduced expenses by eliminating expenditures for
certain regional trade shows and conferences; reducing or eliminating
administrative staff, purchased services, the level of certain employee benefit
programs, and 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.

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 fluctuation
and inflation.

         At March 31, 2002, we had invested approximately $1.8 million 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

         Within the 90 days prior to the filing date of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures, as defined in Rules 13a-14 and 15d-14 under the Securities and
Exchange Act of 1934, as amended. Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that the Company's disclosure
controls and procedures are effective to ensure that information required to be
disclosed by the Company in reports that it files or submits under the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported within the time periods specified in Securities and Exchange
Commission rules and forms.

                                       43

<PAGE>

         There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect these disclosure
controls, subsequent to the date of this evaluation.

PART II-- OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

SALAH AL-HASAWI ADVISORY SERVICES CLAIM
---------------------------------------

         On March 29, 2000, Salah Al-Hasawi ("Plaintiff"), 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
Plaintiff in connection with the private placement of our securities. Shortly
thereafter, the Plaintiffs 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. Plaintiff seeks 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.

         We have denied all of Plaintiffs claims and have affirmatively alleged
that all amounts due have been paid in full. We are currently engaged in
discovery and no trial date has yet been set.

SHAREHOLDER SECURITIES LITIGATION
---------------------------------

         A lawsuit filed against us in the United States District Court in
Oregon alleges the Company misled shareholders regarding such things as FDA
approval and other matters, which the plaintiffs believe caused significant
damage to the shareholders holding shares of our common stock at the time of
these alleged misrepresentations and omissions. On September 24, 2002, the Court
appointed a lead plaintiff and consolidated these lawsuits into a single action;
and on November 5, 2002, the plaintiffs filed an amended consolidated complaint
against the Company and certain current and former officers. The Company filed a
motion to dismiss the litigation on December 19, 2002. On April 17, 2003, this
litigation was dismissed without prejudice by the United States District Court.
In a written opinion, the U.S. District Judge concluded that the statements made
by the Company that plaintiff's alleged were misleading to investors 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 if the plaintiffs have additional facts
to overcome their failure to state claims as to those three claims. On May 8,
2003, the plaintiffs informed Company counsel that they would not replead any

                                       44

<PAGE>

claims. Instead, plaintiffs expressed their intention to appeal the court's
ruling following entry of the dismissal order, which was filed by the court on
May 13, 2003. The plaintiffs have 30 days to file their notice of appeal. If the
notice of appeal is filed and the plaintiffs follow through on their efforts to
appeal the order of dismissal, we do not expect to receive a decision from the
appellate court for at least one year.

         Our insurance carrier has denied coverage for the plaintiffs' claims
and, accordingly, has indicated it will not cover the costs of defending the
claims or pay any resulting damages we may suffer if the plaintiffs are
successful. We have retained counsel to vigorously pursue coverage under our
insurance policies.

         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.

OTHER LEGAL PROCEEDINGS
-----------------------

         On December 12, 2002 the Company was issued a subpoena to deliver
certain documents to the grand jury for the U.S. District Court for the Southern
District of New York. A subpoena was also served on the Chairman, Richard V.
Secord. The documents requested relate to corporate documents and records as
well as activities occurring over the period of the period from July 1, 2002
until the date the documents are produced. Both the Company subpoena and the
Chairman's subpoena request information that relates primarily to activities and
events surrounding or relating to the application to the Food and Drug
Administration for Pre Market Approval of the CTI Breast Imaging System.

         On December 12, 2002 the Company also received a letter from the U.S.
Securities and Exchange Commission (SEC) requesting information and on February
3, 2003 the Company received a subpoena from the SEC requesting certain
documents. The information and documents requested relate to the same
information as described above. The Company has not been named as a defendant or
subject of any administrative proceeding or inquiry.

         To date, we have incurred approximately $451 thousand in legal costs in
complying with above mentioned requests and in conducting related internal
investigations. We expect these legal costs to exceed $650 thousand by the time
the investigations are complete. The Company also may be required to indemnify
its officers and directors in connection with fees incurred in connection with
these investigations.

         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 have breached the lease by failing to pay the rent specified under the
lease. The Landlord seeks damages of $667,277.08 plus interest and attorneys and
other fees. As the litigation was just recently filed, we have not had an
opportunity to respond to the complaint.

                                       45

<PAGE>

ITEM 2.  CHANGES IN SECURITIES

         None

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

         On January 29, 2003, the Company received a Holder Redemption Notice
(the "Notice") from Beach Boulevard, LLC. The Notice demands payment of the
Current Redeemable Balance. Because the Company has not fully paid the
Redeemable Balance as requested by Beach Boulevard, LLC, the Company is now in
default (See Note C to the Consolidated Financial Statements for a further
explanation.

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

         None.

ITEM 5.  OTHER INFORMATION

         As with all medical devices, it is important that our BCS 2100
customers receive adequate reimbursements from third-party payers: insurance
companies, Medicare and Medicaid reimbursement agencies. We applied for a
reimbursement code from the American Medical Association during December 2001
for our BCS 2100. Our application will not be acted upon unless and until we
receive FDA approval for the BCS 2100.

ITEM 6.

Exhibit No.       Identification of Exhibit
-----------       -------------------------

99.1              Certification of Computerized Thermal Imaging, Inc. Chief
                  Executive and Chief Financial Officer pursuant to Section 906
                  of the Sarbanes-Oxley Act of 2002.

99.2              Certification of Computerized Thermal Imaging, Inc. Chief
                  Executive and Chief Financial Officer pursuant to Section 302
                  of the Sarbanes-Oxley Act of 2002.

(b)      REPORTS ON FORM 8-K

                  Report on Form 8-K filed February 10, 2003 reporting a change
                  in Certifying Accountants.

                  Form 8-K filed March 24, 2003 (Item 5 Other Events.
                  Convertible Debenture Amendment Agreement)

                  Form 8-K filed May 8, 2003 (Item 9 Regulation FD Disclosure)

                                       46

<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    May 20, 2003             ---------------------------------
                                  Richard V. Secord
                                  Chairman & Chief Executive Officer

                                  /s/Bernard J. Brady
Dated    May 20, 2003             ---------------------------------
                                  Bernard J. Brady
                                  Chief Financial Officer, Secretary & Treasurer

                                       47