UNITED STATES
                 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 September 30, 1996

[ ] 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 0-19360


                     MERIS LABORATORIES, INC.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)


   California                                      77-0274078
--------------------------------------------------------------------------------
(State or other jurisdiction of                 (I.R.S. Employer
 incorporation or organization)                Identification No.)


      2890 Zanker Road, San Jose, California                  95134
--------------------------------------------------------------------------------
      (Address of principal executive offices)               (Zip Code)


      408-434-9200
--------------------------------------------------------------------------------
      (Registrant's telephone number, including area code)

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

     The number of shares  outstanding of the issuer's common stock is 8,010,535
shares as of November 8, 1996.


                                       1
<PAGE>


                             MERIS LABORATORIES, INC.
                                      INDEX
                            



                                                                         PAGE
PART I.    FINANCIAL INFORMATION                                          NO.

Item 1.    Financial Statements (Unaudited, except for the Condensed
           Consolidated Balance Sheet at December 31, 1995):

           Condensed Consolidated Balance Sheets
           at September 30, 1996 and December 31, 1995...................  3

           Condensed Consolidated Statements of Operations for the
           Three and Nine Month Periods ended September 30, 1996 and 1995. 4

           Condensed Consolidated Statements of Cash Flows for the Nine
           Month Periods ended September 30, 1996 and 1995...............  5

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

Item 2.    Management's Discussion and Analysis of Financial Condition
           and Results of Operations..................................... 12


PART II.   OTHER INFORMATION

Item 1.    Legal Proceedings............................................. 23

Item 3.    Defaults Upon Senior Securities............................... 30

Item 5.    Other Information............................................. 31

Item 6.    Exhibits and Reports on Form 8-K.............................. 32


SIGNATURES .............................................................. 33













                                        2
<PAGE>  
Item 1.
<TABLE>
<CAPTION>
                            MERIS LABORATORIES, INC.
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (In thousands)
                                                              Sept.30,   Dec.31,
                                                                1996      1995
                                                             --------- ---------
                                                            (Unaudited)
<S>                                                          <C>       <C>
ASSETS
Current assets:
   Cash and cash equivalents ............................... $     26  $  1,490
   Restricted cash .........................................    1,964     1,585
   Accounts receivable, net ................................    7,968    11,270
   Income tax refund receivable ............................       -        384
   Supplies inventory ......................................      475       749
   Prepaid expenses and other current assets ...............      634       548
                                                             --------  --------
     Total current assets ..................................   11,067    16,026
Property and equipment, net ................................    1,798     2,283
Intangible and other assets, net ...........................   23,308    25,165
                                                             --------  --------
       Total assets ........................................ $ 36,173  $ 43,474
                                                             ========  ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
   Bank borrowings ......................................... $     -   $  7,657
   Notes Payable ...........................................    8,300        -    
   Convertible subordinated debt ...........................   10,894        - 
   Current portion of long-term obligations ................      615       544
   Accounts payable ........................................    6,064     3,767
   Accrued expenses ........................................    3,129     3,115
   Note payable to Former Executive ........................    1,526     1,526
   Accrued litigation and investigation charges ............    5,721     3,940
                                                             --------  --------
     Total current liabilities .............................   36,249    20,549
                                                             --------  --------
Convertible subordinated debt ..............................       -     10,824
Long-term obligations, less current portion ................      224       469
                                                             --------  --------
Commitments and contingencies (Notes 6 and 7) ..............     --        --
                                                             --------  --------
Shareholders' equity:
   Common stock ............................................   37,157    37,136
   Additional paid-in capital ..............................      826       826
   Accumulated deficit .....................................  (38,283)  (26,330)
                                                             --------  --------
     Total shareholders' equity ............................     (300)   11,632
                                                             --------  --------
       Total liabilities and shareholders' equity .......... $ 36,173  $ 43,474
                                                             ========  ========
</TABLE>
     See accompanying notes to Condensed Consolidated Financial Statements
                                       3                                     
<PAGE>
<TABLE>
<CAPTION>


                            MERIS LABORATORIES, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                      (In thousands, except per share data)



                                        Three Months            Nine Months
                                           Ended                   Ended
                                        September 30,          September 30,
                                    ---------------------  ---------------------        
                                       1996        1995       1996       1995
                                    ----------  ---------  ---------  ----------
                                                    (Unaudited)
<S>                                 <C>         <C>        <C>        <C>    
                                                                            
Net revenues                         $ 8,344     $ 9,853    $27,728    $32,240
                                    ----------  ---------  ---------  ----------
Cost of services:
  Salaries, wages and benefits         3,016       3,399      9,142     10,036
  Supplies                             1,172       1,314      3,938      3,797
  Depreciation and amortization          785       1,057      2,537      3,412
  Other cost of services               1,869       2,030      5,519      6,065
                                     ---------  ---------  ---------  ----------
     Total cost of services            6,842       7,800     21,136     23,310
Selling, general and              
  administrative expenses              3,093       2,825      8,662      8,734
Provision for doubtful accounts        1,215         653      4,789      3,227
Litigation and investigation charges   2,500          -       2,750        700
Write-down of intangible assets          115          -         665         -
                                     ---------  ---------  ---------  ----------
Operating loss                        (5,421)     (1,425)   (10,274)    (3,731)
Interest expense                        (655)       (513)    (1,815)    (1,518)
Interest and other income, net            90          15        136         36
                                     ---------  ---------  ---------  ----------
Loss before income taxes              (5,986)     (1,923)   (11,953)    (5,213)
Provision for income taxes                -           -          -          36
                                     ---------  ---------  ---------  ----------
Net loss                             $(5,986)   $ (1,923)  $(11,953)  $ (5,249)
                                     =========  =========  =========  ==========
Net loss per share                   $ (0.75)   $  (0.24)  $  (1.49)  $  (0.66)
                                     =========  =========  =========  ==========
Weighted average shares outstanding    8,011       7,961      7,998      7,944
                                     =========  =========  =========  ==========


</TABLE>

     See accompanying notes to Condensed Consolidated Financial Statements



                                        4
<PAGE>

<TABLE>
<CAPTION>

                            MERIS LABORATORIES, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)



                                                          Nine Months Ended
                                                             September 30,
                                                        ---------------------
                                                           1996       1995
                                                        ----------  ---------
                                                              (Unaudited)

<S>                                                     <C>         <C>
Net cash used in operating activities                     $(1,087)    $ (289)
                                                        ----------  ---------
Cash flows from investing activities:
   Cash expenditure for customer lists
     and other assets related to acquisitions                (348)    (2,258)
   Purchase of property and equipment,net                    (199)      (427)
                                                        ----------  ---------
     Net cash used in investing activities                   (547)    (2,685)
                                                        ----------  ---------
Cash flows from financing activities:
   Issuance of common stock for option exercises               21        132
   Proceeds from bank borrowings                            2,429      5,000
   Payments on bank borrowings                            (10,086)    (3,131)
   Proceeds from notes payable                              8,200         - 
   Payments on long-term obligations                         (394)      (530)  
   Payment of distribution payable to related parties           -       (267)
                                                        ----------  ---------
     Net cash provided by financing activities                170      1,204
                                                        ----------  ---------
Net decrease in cash and cash equivalents                  (1,464)    (1,770)
Cash and cash equivalents at beginning of period            1,490      3,115
                                                        ----------  ---------
Cash and cash equivalents at end of period                  $  26     $1,345
                                                        ==========  =========

</TABLE>






      See accompanying notes to Condensed Consolidated Financial Statements




                                        5
<PAGE>

                            MERIS LABORATORIES, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

NOTE 1 - BASIS OF PRESENTATION:

     The   accompanying   condensed   consolidated   balance   sheet   of  Meris
Laboratories,  Inc.  (the  "Company")  at September  30, 1996 and the  condensed
consolidated  statements of operations  and of cash flows for the three and nine
months  ended  September  30, 1996 and 1995,  are  unaudited.  In the opinion of
management, these statements have been prepared on the same basis as the audited
consolidated  financial statements and include all adjustments,  consisting only
of normal  recurring  adjustments,  necessary for the fair  presentation  of the
interim information. The data disclosed in these notes to condensed consolidated
financial statements for these periods are unaudited. The condensed consolidated
financial statements for the periods ended September 30, 1996 have been prepared
assuming  that  the  Company  will  continue  as  a  going  concern.  Management
recognizes  that the  Company  will have to improve  its  operating  results and
generate  additional cash from operations.  The Company continues its efforts to
increase revenues and decrease costs.

NOTE 2 - NET LOSS PER SHARE:

     Net loss per share is computed using the weighted average common shares and
common stock equivalents when dilutive.  Common stock equivalents consist of the
Company's  common  stock  issuable  upon  exercise of stock  options  (using the
treasury stock method, except when antidilutive).  The convertible  subordinated
debentures  were not considered in the calculation of net loss per share because
their effect is antidilutive.

NOTE 3 - RESTRICTED CASH:

     During 1994,  in  accordance  with the terms of the  unsecured  convertible
senior subordinated  debentures,  the Company purchased a certificate of deposit
in the  amount  of  $1,585,000  representing  the full  amount  to  satisfy  the
Company's  obligations  owing to a former  executive  (the  "Former  Executive")
pursuant to and in connection with a promissory note dated October 28, 1992 (see
Note 5).  Since the Company  believes  the Former  Executive  is indebted to the
Company  in an  amount in excess  of the  amount  of the  final  payment  in the
promissory note, the Company continues to hold the balance in a separate account
pending  the  outcome of the  litigation.  On  February  21,  1996,  the Company
deposited  $379,000 (150% of the amount of the $253,000 judgement as required by
the court) to an account with a bank to perfect its appeal in connection  with a
wrongful  termination  suit.  See Part II.  Other  Information  - Item 1.  Legal
Proceedings.  Since  both  deposits  are  assets of the  Company,  they are also
subject to any applicable security interests of the Company's creditors.

NOTE 4 - BANK BORROWINGS/NOTES PAYABLE:

     On  November  14,  1994,  the  Company  obtained  a $6.0  million  accounts
receivable line of credit (the "Line of Credit") with a bank. In April 1995, the


                                        6
<PAGE>

                            MERIS LABORATORIES, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

Company  entered  into a one-year  agreement to increase the Line of Credit from
$6.0 million to the lesser of $10.0  million or the  borrowing  base  calculated
based upon eligible accounts  receivable.  On July 27, 1995, the Company entered
into a loan modification  agreement in which the bank agreed to issue letters of
credit in an aggregate  amount not to exceed (i) the lesser of the total Line of
Credit or the qualifying borrowing base minus (ii) any amounts outstanding under
the Line of Credit,  provided that the amount of  outstanding  letters of credit
should not in any case exceed $2.0 million.

     On December 8, 1995, the Company  obtained a revision of certain  covenants
consisting of a minimum  quick ratio,  a minimum  tangible net worth,  a maximum
senior liabilities to annualized earnings before interest,  taxes,  depreciation
and amortization  (EBITDA) ratio, and a restricted amount of loss for the fiscal
year  end of  1995.  Borrowings  under  the  Line  of  Credit  were  secured  by
substantially  all of the  Company's  assets.  The  interest  rate  increased or
decreased  based upon the Company's  quarterly  operating  results.  The Line of
Credit expired on April 20, 1996 and on June 4, 1996,  the Company  entered into
an amendment to the Line of Credit agreement (the "Amended Agreement").  Subject
to the terms of the Amended  Agreement and in  accordance  with the terms of the
debenture  agreement (the  "Debenture  Agreement")  (see Note 5), the Company is
prohibited from making any further  payments of accrued interest or principal on
account of the  convertible  subordinated  debt. The Amended  Agreement  further
stated that the bank would forbear from  exercising  its remedies under the Line
of Credit  agreement  until  August  15,  1996,  notwithstanding  the  Company's
existing  defaults.  On August 14, 1996, the Company  entered into a forbearance
agreement with the bank which included an extension of the forbearance period to
September 15, 1996.

     As of  September  20,  1996,  the  Company's  borrowings  under the Line of
Credit,  including unpaid interest and costs, were $8.2 million. Such amount was
substantially  in excess of its  available  Line of  Credit.  Additionally,  the
Company was in default of all the financial  covenants under the Line of Credit.
Interest on borrowings  under the Line of Credit was charged at the bank's prime
rate plus 3% (11.25% as of September 20, 1996). On September 20, 1996,  pursuant
to a privately  negotiated  transaction,  the bank assigned the Company's entire
debt  outstanding  as of such  date of $8.2  million  to a private  lender  (the
"Lender").  The Lender  acquired  from the bank any and all  rights,  claims and
causes of action under the Amended  Agreement.  In conjunction  with discussions
with the Lender  regarding a proposed  financing and the  assignment of the Bank
borrowings,  the Company  issued a  promissory  note to the lender for  $100,000
representing a commitment fee relating to such financing.

SUBSEQUENT EVENTS: On October 4, 1996, the Lender advanced additional  operating
funds to the Company,  and the Company issued a promissory  note (the "Note") to
the Lender in the amount of $575,000 payable on demand.  The Note bears interest
at 24% per annum.


                                       7
<PAGE>

                            MERIS LABORATORIES, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

     The Company and the Lender are in the process of negotiating  amendments to
the terms of the Amended  Agreement,  however,  under the terms of the  existing
Amended Agreement,  the Lender may, without notice to the Company,  exercise any
of the remedies available to it under such agreement.  There can be no assurance
that such  negotiation  will be  concluded  or, if  concluded,  will be on terms
acceptable to the Company.

NOTE 5 - CONVERTIBLE SUBORDINATED DEBT:

     On  November  14 and  December  5, 1994,  the  Company  completed a private
placement consisting of the sale of $11,000,000 of unsecured  convertible senior
subordinated debentures (the "Debentures").  The Debentures carry a 10% interest
rate and require interest to be paid monthly. In addition, the Debentures mature
three years from the date of issue and are convertible  sixty days from the date
of issuance, at the option of the holders,  into approximately  3,188,000 shares
of  the  Company's   common  stock  at  a  conversion  price  based  on  certain
antidilution provisions in the Debenture Agreement.  The Board of Directors have
reserved an  aggregate  of 3,188,000  shares of the  Company's  common stock for
issuance upon conversion of the  Debentures,  provided that the number of shares
reserved  for  issuance  may be  subject  to change in the event of any  further
adjustment in the conversion price of the Debentures.

     If the  Debentures  are repaid at maturity and have not been converted into
common stock,  the Company is required to issue  warrants to purchase  shares of
common stock equal to the number of shares into which the Debentures outstanding
would have been  converted  upon  maturity.  The warrants  would be  exercisable
immediately, generally expire four years following the maturity date and have an
exercise price equal to the conversion price at maturity.

     Subject to the prior payment of certain  senior  indebtedness,  the Company
may call the  Debentures  at any time.  However,  if the  Debentures  are called
within 30 months of the date of issue,  or if the Company's  common stock trades
below 200% of the conversion price for 20 days within a period of 30 consecutive
trading  days  immediately  prior  to the  Company  giving  notice  to call  the
Debentures,  the Company must issue warrants to purchase  shares of common stock
equal to the number of shares into which the Debentures  outstanding  could have
been  converted.  The  warrants  would be  exercisable  immediately,  expire  on
November 1, 1999 and have an exercise  price  equal to the  conversion  price in
effect on the date of the call. The Company  ascribed a value of $280,000 to the
warrants  issuable  upon the payment of the  Debentures  at maturity.  The value
ascribed to the warrants was computed based upon an estimated spread between the
cost of funds associated with the Company's senior and subordinated  borrowings,
recognizing  the overall higher level of risk assumed by the Debenture  holders.
This amount was recorded as a debt discount and is reflected as an offset to the
proceeds  from the sale of the  Debentures  and is being  amortized  as interest
expense over three years.



                                       8
<PAGE>

                            MERIS LABORATORIES, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

     Upon a change of control of the Company, the Debenture holders have a right
to "put" the  Debentures  back to the Company at a price that will achieve a 30%
internal  rate of return,  including  interest.  To the extent any warrants have
been issued as a result of previous calls,  the warrant holders may "put" all or
part of the  warrants  to the  Company  at a price  that  will  result  in a 30%
internal rate of return,  including interest.  However, in either instance,  the
premium  shall  not  exceed  150%  of  the  original  principal  amount  of  the
Debentures.

     The  Debentures  also  require that  certain  criteria be met,  including a
minimum earnings before income taxes to interest  expense ratio,  limitations on
minimum consolidated net worth and maximum senior  indebtedness,  limitations on
payment of other indebtedness  junior to the Debentures,  limitations on merging
or selling all, or substantially all, of the property or business of the Company
and a restriction on the repurchase of the Company's  common stock.  At December
31,  1995,  the  Company was in default of the  minimum  consolidated  net worth
covenant  for which the  Company  obtained  a waiver  of the  default  effective
through  January  1, 1997 from the  Debenture  holders  provided  the  Company's
minimum consolidated net worth remained greater than $9 million. As of September
30, 1996,  the Company was in default of the amended  minimum  consolidated  net
worth  criteria.  

     Additionally,  as of September 30, 1996,  the Company was in default of all
the  financial  covenants  under  the  Line  of  Credit.  Such  Line  of  Credit
arrangement was assigned by the bank to a Lender on September 20, 1996 (see Note
4). The Lender  acquired from the bank any and all rights,  claims and causes of
action  under the Line of Credit  including  the terms of the Amended  Agreement
entered  into by the Company and its bank on June 4, 1996 (see Note 4).  Subject
to the terms of the Amended  Agreement and in  accordance  with the terms of the
Debenture  Agreement,  the Company ceased making any further payments of accrued
interest or principal on accounts of the Debentures  effective May 1, 1996. Such
nonpayment  is an event of default under the  Debenture  Agreement  resulting in
assessment of interest on any unpaid  interest and a decrease in the  conversion
price of the debentures by 1% per month until the overdue amounts have been paid
in full. As a result, at September 30, 1996, the Debentures are convertible into
3,188,000  shares of the Company's  common  stock.  The Company is attempting to
obtain  waivers of default from the  Debenture  holders.  In the event that such
waivers are not  received,  the  convertible  subordinated  debt becomes due and
payable  and  adjustments  to  the  conversion  price  of the  Debenture  become
effective. The Company has recognized the Debenture as a current liability as of
September  30,  1996.  Interest  expense  has been  recorded  and is included in
accrued expenses at September 30, 1996.

     As long as an original investor or certain transferee holds any Debentures,
any warrants issued in connection therewith or any shares of common stock issued
on conversion of the Debentures, the Company will have, as a member of its Board


                                       9
<PAGE>
                            MERIS LABORATORIES, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


of Directors,  a director  designated by such holders.  The Debenture  Agreement
provides for certain  registration  rights with respect to the  Debentures,  the
warrants issuable in connection therewith and the common stock issuable upon the
conversion of the Debentures.  The Debenture Agreement also requires the Company
to place in escrow all  remaining  amounts  due to the Former  Executive  of the
Company under a promissory  note issued to him. Such amount has been recorded as
restricted cash at September 30, 1996. See Note 3 and Part II. Other Information
- Item 1. Legal Proceedings.

NOTE 6 - LITIGATION AND INVESTIGATION CHARGES:

     On May 6, 1994, the Company was subpoenaed to furnish certain  documents to
the  Department  of Health  and  Human  Services  ("HHS")  with  respect  to the
Company's Medicare and Medicaid billing practices. On July 18, 1994, the Company
was  subpoenaed to furnish  certain  documents to the Department of Defense with
respect to the  Company's  Civilian  Health  and  Medical  Program of  Uniformed
Services  ("CHAMPUS")  billing  practices.  The Company  believes  these matters
relate to the  investigations  of such practices being conducted with respect to
other laboratories.  On August 28, 1995, the Company was notified that a Qui Tam
action had been filed by two former  employees  under the False  Claims Act. The
Company believes the Qui Tam action and billing  investigations are related. The
investigations  relate to billing  certain panels and profiles,  adding tests to
recognized  panels and  profiles,  billing for tests  deemed not to be medically
necessary,  improper coding, billing for tests not performed, double billing and
other  alleged  improper  practices.  Through the fourth  quarter of 1995,  as a
result  of the  initial  and  continuing  correspondence  and  discussions  with
government agencies relating to certain issues under investigation,  the Company
recorded  an  aggregate  charge of  approximately  $2,250,000.  The  Company has
produced the documents  subpoenaed by the government  agencies.  The Company and
the government  agencies have discussed a proposed settlement  agreement.  While
the actual  agreement  has not been  finalized,  the  Company  recorded a charge
during the third quarter of 1996 of $2,000,000  based on preliminary  estimates.
Such amount, when aggregated with previously recorded accruals,  bring the total
estimated accrual to $4,250,000.  However,  based on the ultimate outcome of the
proposed settlement agreement, additional charges may be recorded in the future.
Additionally, subsequent to the finalization of an agreement, noncompliance with
any terms of such an agreement  could result in the  acceleration  of any unpaid
amounts or imposition of additional payments, fines and penalties.

     As a  consequence  of the  Company's  review of the  reimbursements  it has
received from Medicare  with respect to chemistry  panels and certain  questions
raised during the  investigation,  the Company determined that Medicare overpaid
the Company  approximately  $960,000  with  respect to matters that were not the
subject of the  original  investigations.  This amount was  charged  against net
revenues  during  September  1995. The Company repaid $350,000 of this amount in
1995 and is repaying the remaining  balance in monthly  installments  of $50,000
commencing January 2, 1996.


                                       10
<PAGE>
                           MERIS LABORATORIES, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

NOTE 7 - CONTINGENCIES:

     The Company is involved in various  other  lawsuits  which are described in
detail under Part II - Other Information - Item 1. Legal Proceedings.


NOTE 8 - CURRENT ACCOUNTING PRONOUNCEMENTS:

         In June 1995, the American  Institute of Certified  Public  Accountants
(the  "AICPA")  issued the AICPA  Audit and  Accounting  Guide for  Health  Care
Organizations  (the  "Guide") to assist  providers  of health  care  services in
accounting and preparation of financial statements.  The provisions of the Guide
are effective for financial statement periods beginning after June 15, 1996. The
Company expects to adopt the provisions of the Guide effective  January 1, 1997.
The Company has not  evaluated the  financial  statement  impact of adopting the
Guide.

































                                       11
<PAGE>
Item 2.

Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operations

Results of Operations

General

     The  Company's   principal  objective  is  to  be  a  leading  provider  of
high-quality,  low-cost clinical  laboratory testing services in California.  To
achieve this  objective,  the Company has focused its efforts on (i)  continuing
implementation of technological  improvements in its San Jose laboratory,  which
the  Company  hopes will  further  reduce  operating  costs per test and enhance
levels of  service,  and (ii)  increasing  its  volume of  testing  (accessions)
through the  acquisition of  laboratories  and customer lists as well as through
internal  growth.  However,  notwithstanding  these  efforts,  the  Company  has
incurred  substantial losses during the first nine months of 1996 and in each of
its last three fiscal  years.  Increases in net revenues  and/or  reductions  in
operating   costs   continue  to  be  necessary   for  the  Company  to  achieve
profitability.  The Company must  experience  growth in testing  volume  through
acquisitions  and/or internal growth. The Company's growth through  acquisitions
has been severely curtailed as a result of difficulties in securing  acquisition
financing and, despite its marketing  efforts,  accessions  (volume of business)
are decreasing.  In addition, net revenues per test may continue to decrease and
be lower than the  Company's  historical  net  revenues per test.  Finally,  the
Company may also, from time to time,  record charges  relating to the write-down
of intangible  assets should the revenue stream related to acquisitions be below
the carrying value of such intangible  assets.  Unless revenues can be increased
and operating costs reduced, the Company may not remain financially viable.

     Given the increasing  importance of managed care and other cost containment
arrangements  in the health  care  industry  in  California,  the  Company  must
strategically  pursue  laboratory  service contracts with managed care providers
such as  health  maintenance  organizations.  The  Company  anticipates  that an
increasing portion of its business will be attributable to these contracts. Such
contracts  typically  provide for payment on the basis of capitated  fees rather
than  fees for  actual  tests  performed.  Such  contracts  result  in lower net
revenues per test, however, the Company believes that these contracts could also
result in  identifiable  referrals on a  fee-for-service  basis from the clients
participating  in the managed  care  contracts,  thereby  improving  the overall
performance of the arrangements.  

     The  Company's  business  mix has  changed  with a shift away from  patient
billing and fee-for-service.  An increasing percentage of the Company's business
is expected to be in managed  care  contracts  and with third party payors where
reimbursements  are less  than at  patient  prices  resulting  in an  increasing
portion of the Company's  business  being subject to contractual  discounts.  In
addition,  third  party  payor  reimbursement  rates have and will  continue  to
decrease.  Throughout  the  first  nine  months  of  1996,  certain  of the HMOs
previously contracted with the Company chose to utilize other laboratory service
providers.  Conversely,  the Company was successful in obtaining  additional HMO



                                      12
<PAGE>
contracts.  The Company believes it will continue to face increasing competition
with respect to obtaining and retaining  managed care  contracts.  To the extent
that reimbursement rates continue to decrease, contractual discounts continue to
increase and  utilization  under  managed care  arrangements  increases  (or the
identifiable  fee-for-service  revenues  decrease),  net  revenues  per test and
profitability  will be  adversely  impacted.  As stated  above,  if these trends
continue,  and the Company fails to meet its objectives in increasing the volume
of accessions and/or decreasing costs,  management believes the viability of the
Company  would  be  adversely  impacted.   Additionally,  as  a  result  of  the
requirement that effective  January 1, 1997, the Company adopt the AICPA's Audit
and  Accounting  Guide for Health  Care  Organizations,  (see Note 8 of Notes to
Condensed Consolidated  Financial  Statements),  which precludes the grouping of
identifiable  fee-for-service  revenue with  capitation  premiums for purpose of
assessing the overall  profitability under capitated  arrangements,  the Company
may, in the future,  record loss  acruals  for  existing  and/or new  contracts,
adversely impacting its results of operations.
  
     The Company's net revenues and results of operations  are impacted in large
part by  statutes  and  regulations  governing  Medicare  and  Medi-Cal  and the
reimbursement  policies of insurance  companies  and other  third-party  payors.
Pursuant to the Stark Bill,  which became effective in early 1992, as amended by
the Omnibus Budget and  Reconciliation  Act of 1993,  clinical  laboratories are
generally  prohibited  from  billing the  Medicare  program or,  effective as of
January 1, 1995,  Medi-Cal  programs  or the  patient  or any other  payor,  for
testing performed for Medicare or Medi-Cal patients when the physician  ordering
the test  (or a  relative  of such  physician)  has an  investment  interest  or
compensation  arrangement  with the laboratory.  Legislation was also enacted in
California  which made it  unlawful,  as of January 1, 1995,  for a physician to
refer a patient or specimen to a clinical  laboratory in which the physician has
an  ownership  interest  or from  which  the  physician  receives  compensation,
regardless of the source of payment for such  testing.  Although it is difficult
to quantify,  the Company  believes these statutes and regulations have resulted
in less referrals to the Company.

Acquisition Program

     A major  element of the  Company's  business  strategy  has been to acquire
clinical  laboratories and customer lists. Future  acquisitions,  internal sales
growth and retention of existing business are necessary to achieve growth in net
revenues,  attain  profitability  in the future and to  leverage  the  Company's
technological  improvements.  However,  as a result of  difficulties in securing
adequate  financing and other  impediments  resulting  from the  litigation  and
investigations (see Part II. Other Information - Item 1. Legal Proceedings), the
Company's  acquisition  program has been severely  curtailed.  Furthermore,  the
supply of  potential  acquisition  candidates  could be  adversely  affected  by
changes in the regulatory environment in which the Company operates.








                                       13
<PAGE>
Statement of Operations Data

     The  following  represents  selected  Statement  of  Operations  data  as a
percentage of net revenues:
<TABLE>
<CAPTION>
                                         Three Months           Nine Months
                                             Ended                 Ended
                                         September 30,          September 30,
                                       ------------------   -------------------
                                         1996      1995       1996       1995
                                       --------   -------   --------  ---------
                                                      (Unaudited)           
<S>                                    <C>        <C>        <C>       <C>    
Net revenues                            100.0%     100.0%     100.0%    100.0%
                                       --------   --------   --------  --------
Cost of services:
  Salaries, wages and benefits           36.1       34.5       33.0      31.1
  Supplies                               14.0       13.3       14.2      11.8
  Depreciation and amortization           9.4       10.7        9.1      10.6
  Other cost of services                 22.4       20.6       19.9      18.8
                                       --------  ---------   --------  --------
     Total cost of services              81.9       79.1       76.2      72.3
Selling, general and administrative      37.1       28.7       31.2      27.1
Provision for doubtful accounts          14.6        6.6       17.3      10.0
Litigation and investigation charges     30.0         -         9.9       2.2 
Write-down of intangible assets           1.4         -         2.4        -
                                       --------  ---------   --------  --------
Operating loss                          (65.0)%    (14.4)%    (37.0)%   (11.6)%
                                       ========  =========   ========  ========
</TABLE>
     Three  Months  Ended  September  30, 1996  Compared to Three  Months  Ended
September 30, 1995

Net Revenues. Net revenues decreased 15.3% to $8.34 million for the three months
ended September 30, 1996 from $9.85 million for the same period in 1995.  During
the three months ended  September  30,  1995,  the Company  recorded a charge of
approximately  $780,000  associated  with  certain  overpayments  received  from
Medicare  during  1994 and  1995.  Excluding  the  effect  of the 1995  Medicare
adjustment,  net  revenues  decreased  21.5% from  $10.63  million for the three
months ended  September 30, 1995. The decrease in net revenues  reflects a 15.8%
decrease in testing  volume  resulting  partly from  increased  competition  and
decreased  utilization  of the  Company's  laboratory  services by patients  and
clients. The general trend toward increased contractual  discounts,  including a
reduction in the composite Medicare  reimbursement rate in 1996 of approximately
4% and an increase in discounts associated with a shift to more contract payors,
also contributed to the decrease in net revenues per accession.

Cost of  Services.  Cost of services  decreased  12.3% to $6.84  million for the
three months ended  September 30, 1996 from $7.80 million for the same period in
1995. The decrease in cost of services,  including  reference  laboratory  fees,
courier  costs  and  operating  expenses  for  PSCs and  STAT  laboratories,  is



                                       14
<PAGE>
attributable  to the decrease in overall costs in relation to testing  volume as
well as the cost  containment  programs  put in place in the latter part of 1995
through September 30, 1996.  Salaries,  wages and benefits decreased as a result
of a 17.8%  reduction  in the number of  employees.  The  decrease  in  supplies
expense, primarily for reagents and testing consumables, is the net effect of an
increase  in  supplies  expense  as a result of the  Company  bringing  in-house
approximately  17 tests  throughout 1995 and 1996 offset by a decrease  directly
resulting from a decrease in testing volume.  The decrease in  depreciation  and
amortization  expense  is a result of the full  depreciation  of  certain  fixed
assets and the  write-down  of certain  intangible  assets during the year ended
December  31, 1995 and through the period  ended June 30,  1996.  Excluding  the
effect of the 1995 Medicare  adjustment  to net revenues,  cost of services as a
percent of net revenues  increased to 81.9% for the three months ended September
30, 1996 from 73.4% for the same period during 1995.

Selling,   General   and   Administrative   Expenses.   Selling,   general   and
administrative  expenses increased by 9.5% to $3.09 million for the three months
ended  September  30, 1996 from $2.83  million for the same period in 1995.  The
increase in selling,  general and administrative expenses is the net result of a
reduction in commission  expense as a direct result of the  modification  of the
Company's  commission  structure as well as decreased net revenues  offset by an
increase in facility rent,  utility and property costs.  Excluding the effect of
the 1995 Medicare adjustment,  selling, general and administrative expenses as a
percentage  of net  revenues  increased  to 37.1%  for the  three  months  ended
September 30, 1996 from 26.6% for the corresponding period in 1995.

     Provision  for Doubtful  Accounts.  The  provision  for  doubtful  accounts
increased  86.1% to $1.22 million for the three months ended  September 30, 1996
from  $653,000  for the same  period in 1995.  Excluding  the effect of the 1995
Medicare adjustment, the provision for doubtful accounts, as a percentage of net
revenues,  increased  to  14.6%  of net  revenues  for the  three  months  ended
September  30,  1996  from  6.1% of net  revenues  for the  three  months  ended
September  30, 1995. Of the increase in bad debt expense in the third quarter of
1996 over the same period in 1995,  approximately  $500,000 reflects an increase
in management's  estimate,  resulting from modification of the estimation basis,
in determining  amounts which may not be ultimately  collected.  The increase is
also attributable to the Company's efforts,  commencing in early 1996, to reduce
its  investment in accounts  receivable  and increase  cash flow by  identifying
accounts  with  inaccurate  billing or  incomplete  information.  The  Company's
initial efforts  resulted in the resubmission of certain accounts to third party
payors for  payment  and  obtaining  more  accurate  data for patient and client
accounts.  As a result of the resubmissions and the Company's continuing efforts
in pursuing the  collection  of  outstanding  receivable  balances,  the Company
continues to identify accounts  receivable deemed to be uncollectible due to the
application of payor time constraints and the Company's  current  limitations in
financial and personnel resources to pursue collection of such accounts.

Litigation  and  Investigation  Charges.  The Company  recorded  litigation  and
investigation   charges  during  the  three  months  ended  September  30,  1996
aggregating  $2,500,000.  Of the total amount,  $500,000  reflects  accruals for
estimated  professional  fees and other  costs to be  incurred  in  relation  to
existing litigation and investigations. The estimated costs are determined based



                                       15
<PAGE>
on actual costs incurred to date and  management's  best estimates as to amounts
to be  incurred  in the  foreseeable  future.  The  remaining  $2,000,000,  when
aggregated  with an existing  accrual of  $2,250,000,  represents  the Company's
estimate of the total  potential  liability  related to the Department of Health
and Human Services investigation. (See Note 6 of notes to Condensed Consolidated
Financial Statements).

Write-Down of  Intangible  Assets.  During the three months ended  September 30,
1996, the Company  recorded a write-down for the impairment of certain  customer
lists,  covenants   not-to-compete,   and  goodwill  aggregating   approximately
$115,000.  Recognition  of such  impairment is in accordance  with  Statement of
Financial  Accounting  Standards  No. 121,  "Accounting  for the  Impairment  of
Long-Lived  Assets and for Long-Lived  Assets to Be Disposed Of," which requires
that long-lived assets and certain identifiable  intangibles held and used by an
entity be reviewed for impairment  whenever  events or changes in  circumstances
indicate that the carrying amount of an asset may not be  recoverable.  Relating
to acquired  customers lists to the extent that assessing volume decreases,  the
Company may , in future  periods,  record  additional  write-downs of intangible
assets.

Interest  Expense.  Interest  expense  increased 27.7% to $655,000 for the three
months ended  September 30, 1996 from $513,000 for the same period in 1995.  The
increase  is  primarily  the  result  of  increased  borrowings  resulting  from
decreased cash collections coupled with higher interest rates.

     Nine  Months  Ended  September  30,  1996  Compared  to Nine  Months  Ended
September 30, 1995

Net Revenues. Net revenues decreased 14.0% to $27.73 million for the nine months
ended  September 30, 1996 from $32.24  million for the same period in 1995.  The
decrease in net revenues  reflects a 12.6% decrease in testing volume  resulting
partly from  increased  competition  and decreased  utilization of the Company's
laboratory services by patients and clients.  The general trend toward increased
contractual   discounts,   including  a  reduction  in  the  composite  Medicare
reimbursement  rates in 1996 of  approximately  4% and an increase in  discounts
associated  with a shift  to  more  contract  payors,  also  contributed  to the
decrease in net revenues per accession.

Cost of Services. Cost of services decreased 9.3% to $21.14 million for the nine
months ended September 30, 1996 from $23.31 million for the same period in 1995.
The decrease in cost of services,  including reference  laboratory fees, courier
costs and operating expenses for PSCs and STAT laboratories,  is attributable to
the decrease in overall costs in relation to testing  volume as well as the cost
containment  programs put in place in the latter part of 1995 through  September
30,  1996.  Salaries,  wages  and  benefits  decreased  as a  result  of a 17.8%
reduction  in the  number  of  employees.  The  increase  in  supplies  expense,
primarily for reagents and testing consumables, is the net effect of an increase
in supplies expense as a result of the Company bringing  in-house  approximately
17 tests throughout 1995 and 1996 offset by a decrease directly resulting from a
decrease in testing  volume.  The  decrease  in  depreciation  and  amortization
expense is a result of the full  depreciation  of certain  fixed  assets and the
write-down of certain  intangible assets during the year ended December 31, 1995
and through the period ended June 30, 1996.


                                       16
<PAGE>
Selling,   General   and   Administrative   Expenses.   Selling,   general   and
administrative  expenses  decreased by 0.8% to $8.66 million for the nine months
ended  September  30, 1996 from $8.73  million for the same period in 1995.  The
decrease in selling,  general and administrative expenses is the net result of a
reduction in labor costs as a result of a $200,000  severance charge in the nine
months ended  September  30, 1995,  and a reduction in  commission  expense as a
direct result of the modification of the Company's  commission structure as well
as decreased net revenues  offset by an increase in facility  rent,  utility and
property costs.

Provision for Doubtful  Accounts.  The provision for doubtful accounts increased
48.4% to $4.79  million for the nine months ended  September 30, 1996 from $3.28
million for the same period in 1995.  Of the increase in bad debt expense in the
third  quarter  of 1996  over the same  period in 1995,  approximately  $500,000
reflects an increase in management's  estimate,  resulting from  modification of
the  estimation  basis,  in  determining  amounts  which  may not be  ultimately
collected.  For the nine months ended  September 30, 1996,  approximately  $2.83
million represents estimated uncollectible accounts due to the payor's inability
to pay. The  remaining  $1.96 million is largely  attributable  to the Company's
efforts,  commencing  in early  1996,  to  reduce  its  investment  in  accounts
receivable  and  increase  cash flow by  identifying  accounts  with  inaccurate
billing information.  The Company's initial efforts resulted in the resubmission
of certain  accounts  to third  party  payors for  payment  and  obtaining  more
accurate data for patient and client accounts.  As a result of the resubmissions
and the Company's  continuing  efforts in pursuing the collection of outstanding
receivable  balances,  the  Company  identified,   and  accordingly  recorded  a
provision  for,  accounts  receivable  deemed  to be  uncollectible  due  to the
application of payor time constraints and administration problems due in part to
financial and personnel constraints.

Litigation and Investigation Charges. During the nine months ended September 30,
1996 and 1995, the Company  recorded  $750,000 and $700,000,  respectively,  for
estimated  professional  fees and other  costs to be  incurred  in  relation  to
existing litigation and investigations. The estimated costs are determined based
on actual costs incurred to date and  management's  best estimates as to amounts
to be  incurred in the  foreseeable  future.  Also during the nine months  ended
September 30, 1996, the Company recorded an additional  $2,000,000  which,  when
aggregated  with an existing  accrual of  $2,250,000,  represents  the Company's
estimate of the total  potential  liability  related to the Department of Health
and Human Services investigation. (See Note 6 of notes to Condensed Consolidated
Financial Statements).

Write-Down  of  Intangible  Assets.  During the nine months ended  September 30,
1996, the Company  recorded a write-down for the impairment of certain  customer
lists,  covenants   not-to-compete,   and  goodwill  aggregating   approximately
$665,000.  Recognition  of such  impairment is in accordance  with  Statement of
Financial  Accounting  Standards  No. 121,  "Accounting  for the  Impairment  of
Long-Lived  Assets and for Long-Lived  Assets to Be Disposed Of," which requires
that long-lived assets and certain identifiable  intangibles held and used by an
entity be reviewed for impairment  whenever  events or changes in  circumstances
indicate that the carrying amount of an asset may not be  recoverable.  




                                       17
<PAGE>

Interest Expense. Interest expense increased 19.6% to $1.82 million for the nine
months ended  September 30, 1996 from $1.52 million for the same period in 1995.
The increase is primarily the result of increased borrowings for working capital
purposes resulting from decreased cash collections  coupled with higher interest
rates.


Income Taxes

     Income  taxes are  provided  in  accordance  with  Statement  of  Financial
Accounting Standards No. 109 "Accounting for Income Taxes." The effective income
tax rate for the nine months ended September 30, 1995 was lower than the federal
statutory rate due primarily to less than full benefit from operating losses due
to limited carryback opportunities and non-recognition of loss carryforwards due
to uncertainty regarding realization.


Variability of Quarterly Results

     In the past,  the  Company's  net revenues and results of  operations  have
fluctuated  from  quarter to  quarter,  and the  Company  anticipates  that such
fluctuations  will  continue in the  future.  Variations  in payor mix,  and the
frequency, timing and size of recent and future acquisitions, if any, contribute
to the quarterly variability of net revenues and operating results.  Inherent in
the  clinical  laboratory  industry  are  challenges  in billing and  collecting
accounts receivable  balances.  Consequently,  interim results of operations are
from  time  to  time  subject  to  fluctuations  resulting  from  the  Company's
recognition of certain identified uncollectible accounts.

     Additionally, the Company may experience further  fluctuations in quarterly
net  revenues  and  results  of  operations,  should  charges  relating  to  the
write-down  of intangible  assets and loss  accruals for capitated  contracts be
recognized. 

     Costs of continuing  litigation  and  management  participation  in ongoing
litigation and  investigations are significant and have had, and may continue to
have, a material  adverse  effect on the quarterly  variability of the Company's
operations.  The Company's  operations also experience  seasonal trends that the
Company  believes  affect  all  clinical  laboratory  companies.   In  addition,
regulatory changes,  reimbursement policies of governmental agencies,  insurance
companies  and other  third-party  payors,  and  actions  by the  Company or its
competitors,  may cause fluctuations in, and adversely affect, the Company's net
revenues  and  results of  operations.  Managed  care  contracts  are  generally
executed for periods of at least one year.  The execution of new, or the loss of
existing,  managed care contracts could also result in significant  fluctuations
in the Company's operations.







                                       18
<PAGE>


Liquidity and Capital Resources

     The Company's  primary source of short-term  financing for working  capital
purposes  has  been  operating  cash  flow  and  the   liquidation  of  accounts
receivable.   The  Company,   however,   is  currently   negotiating   financing
arrangements  with an outside  lender for  additional  funds which would help to
alleviate short-time cash constraints.

     Net cash  used in  operating  activities  totaled  $1,087,000  for the nine
months ended September 30, 1996.

     As of  September  30,  1996,  the  Company  had  $26,000  in cash  and cash
equivalents,  $1.96  million  in  restricted  cash and $8.30  million of current
borrowings  under  the  loan  agreement.  Management  believes  that  cash to be
generated from  operations,  together with existing cash  balances,  will not be
sufficient  to satisfy  the  Company's  cash  requirements  for the  foreseeable
future.  The  Company's  cash position may be further  adversely  impacted by an
unfavorable   outcome  of  any  of  the  existing   litigation   and/or  billing
investigations.  The Company  will  require  additional  financing  from outside
sources during 1996 to remain viable.

     Capital  expenditures  during the nine  months  ended  September  30,  1996
totaled  $547,000.  Of the total, the Company paid an aggregate of approximately
$348,000  with  respect to payments  made on customer  lists  acquired  prior to
January 1, 1996. In addition,  the Company purchased  approximately  $199,000 of
computer and laboratory equipment.

     The Company is  currently  involved in a number of lawsuits  including  two
derivative  suits,  one class  action  suit,  litigation  involving  its  former
Chairman,  President,  and Chief Executive Officer (the "Former  Executive") and
other   matters.   Certain  of  the  Company's   billing   practices  are  under
investigation  by  the  U.S.  Department  of  Health  and  Human  Services,  the
Department of Defense and the Department of Justice. These investigations relate
to practices of laboratories in the billing of groups of tests (i.e., panels and
profiles)  and  billing  tests  that have been  added to  recognized  panels and
profiles,  billing for tests deemed not to be medically  necessary,  billing for
tests not performed, double billing and other matters. As of September 30, 1996,
the Company was in discussion with the government  agencies regarding a proposed
settlement  agreement.  While an actual  agreement has not been  finalized,  the
Company has accrued to date $4.25 million of estimated potential  liability.  In
connection with these  investigations  and the Company's  review of its Medicare
reimbursements, the Company identified certain Medicare overpayments aggregating
approximately  $960,000 with respect to matters that were not the subject of the
original investigation. The Company paid Medicare $350,000 on December 18, 1995,
and is repaying the remaining balance of the overpayment in monthly installments
of $50,000  commencing  January  2, 1996.  Costs of  continuing  litigation  and
management   participation  in  ongoing   litigation  and   investigations   are
significant and have had a material adverse effect on the Company's  operations,
both  financially and with respect to diversion of  management's  attention from
operations of the Company.  An  unfavorable  outcome in any of these lawsuits or
investigations  would have a material adverse effect on the Company's results of


                                       19
<PAGE>
operations and cash flow. The ultimate outcome of these  litigation  matters and
investigations is uncertain.

     In October  1992,  the Company  and the Former  Executive  entered  into an
agreement  (the  "Settlement  Agreement")  for the purpose of resolving  certain
disputes between them. The Settlement Agreement is further described in Part II.
Other  Information  - Item 1. Legal  Proceedings.  The Company  paid cash in the
amount of $9.0 million for the  repurchase of all of the Company's  common stock
held by the Former  Executive.  Additionally,  the Company  issued a  three-year
secured  promissory note (the "Promissory Note") in the principal amount of $4.4
million which  required  installment  payments on April 15, 1993 and October 28,
1993,  1994 and 1995, of which $1.41 million and $1.47 million in principal were
paid during 1993 and 1994, respectively.

     On August 11, 1994,  the Superior  Court of the State of California for the
County of Santa Clara entered an order in relation to the Brown action (see Part
II. Other  Information  - Item 1. Legal  Proceedings)  directing the Company to,
within 10 days, (i) deposit with a bank escrow, to be held in trust, the balance
of  approximately  $3.17 million  (including  $1.47 million in principal paid in
1994 as described above) owing to the Former Executive under the Promissory Note
and (ii) indemnify the Former Executive for legal fees and expenses  incurred in
the amount of approximately $364,000, and to continue to indemnify him for legal
fees and expenses,  as he contends is required by and subject to the  provisions
of the Settlement  Agreement.  The decision was appealed. To perfect the appeal,
the Company  deposited  with the Superior  Court the sum of $546,000 as security
for the payment of the legal fees portion of the order.  In connection  with and
using the proceeds from a bank line of credit,  the Company paid the October 28,
1994  installment  under the Promissory  Note and deposited in an account with a
bank the  remaining  principal and interest  balance of $1,585,000  provided for
thereunder as restricted  cash available to satisfy  future payment  obligations
and may be  required  to be paid under the  Promissory  Note.  Since the Company
believes the Former  Executive is indebted to the Company in an amount in excess
of the amount of the final payment on the Promissory  Note, and the Company,  as
well as the plaintiffs in the Mills and Brown actions, are seeking rescission of
the  Settlement  Agreement  (see  Part II.  Other  Information  - Item 1.  Legal
Proceedings),  the Company has not made the final payment  under the  Promissory
Note. On September 26, 1995, the appellate  court entered an order reversing the
lower court's  decision and sustaining the Company's  position.  On December 26,
1995,  the sum  deposited as security for the appeal of $546,000 was returned to
the  Company.  The court has also held that the  deposit  made by the Company of
$1,585,000 with the bank satisfies the earlier  injunction insofar as it relates
to the Promissory Note payment.

     In April 1995, the jury in a wrongful  termination suit brought by a former
employee (see Part II. Other Information - Item 1. Legal  Proceedings)  returned
awards  against the  Company  and in favor of such former  employee in an amount
aggregating $300,000. Subsequently, the judge consolidated certain of the awards
and entered judgment for $253,000.  Both parties have appealed.  Unless modified
or set aside on appeal,  the judgement  will have to be satisfied  from existing
cash resources,  if available.  Approximately $300,000 has been accrued for this
matter at September 30, 1996.

     On July 27,  1995,  the Company  entered  into an  amendment of its Line of
Credit  agreement  in which  the bank  agreed to issue  letters  of credit in an

                                       20
<PAGE>
aggregate amount not to exceed (i) the lesser of the total Line of Credit or the
qualifying  borrowing base minus (ii) any amounts  outstanding under the Line of
Credit,  provided that the amount of outstanding letters of credit should not in
any case exceed $2.0 million.  The Line of Credit  agreement  contained  certain
financial covenants including a minimum quick ratio, a maximum debt to net worth
ratio, a minimum tangible net worth and  profitability on a monthly basis. As of
September 30, 1995,  the Company was in default of the  quarterly  profitability
covenant as well as certain other ratio covenants  under the Line of Credit.  In
addition,  the failure by the Company to make the final  payment on a Promissory
Note (see Part II. Other  Information - Item 1. Legal  Proceedings) is a default
under the Line of Credit.  The  Company  obtained a waiver  from the bank of all
defaults.  In conjunction  with obtaining such waiver,  on December 8, 1995, the
covenants  were amended to require a minimum quick ratio,  minimum  tangible net
worth,  maximum loss for the year ended  December 31, 1995, and a maximum senior
liabilities to earnings before interest expense, income taxes,  depreciation and
amortization (EBITDA) ratio. As of December 31, 1995, the Company was in default
of all  financial  covenants  under  the Line of  Credit  and  unsecured  senior
subordinated Debentures.  The Company obtained a waiver of such default from the
holders of the Debentures  effective  through  January 1, 1997 provided that the
Company's net worth remains greater than $9 million. The Company also obtained a
waiver of such default from the bank as of December 31, 1995.  See Notes 4 and 5
of Notes to Condensed Consolidated Financial Statements.

     Prior to September 20, 1996, the Company's outstanding borrowings under its
line of credit arrangement (the "Line of Credit") with a bank,  including unpaid
interest  and  costs  were  $8.2  million  (see  Note 4 of  Notes  to  Condensed
Consolidated  Financial  Statements)  which was  substantially  in excess of its
available  Line of Credit.  Additionally,  the Company was in default of all the
financial  covenants  under the Line of  Credit.  The Line of Credit  expired on
April 20, 1996 and on June 4, 1996,  the Company  and its bank  entered  into an
amendment to the Line of Credit Agreement (the "Amended Agreement").  Subject to
the  terms of the  Amended  Agreement  and in  accordance  with the terms of the
debenture  agreement  ("the  Debenture  Agreement")  (see  Note  5 of  Notes  to
Condensed  Consolidated  Financial  Statements),  the Company is prohibited from
making any further  payments of accrued  interest or principal on account of the
convertible  subordinated  debentures (the "Debentures").  Such nonpayment is an
event of default under the Debenture Agreement and resulted in the assessment of
interest on any unpaid  interest and reductions to the  conversion  price of the
Debentures by 1% per month until the overdue amounts have been paid in full. The
Amended Agreement further stated that the bank would forbear from exercising its
remedies   under  the  Line  of  Credit   agreement   until   August  15,  1996,
notwithstanding the Company's existing defaults. On August 14, 1996, the Company
entered into a forbearance  agreement  with the bank which included an extension
of the forbearance period to September 15, 1996.

     On  September  20, 1996,  the bank  assigned the entire $8.2 million of the
Company's  borrowings  to a private  lender  (the  "Lender")  under a  privately
negotiated  transaction.  The Lender  acquired from the bank any and all rights,
claims and causes of action under the Amended Agreement. On October 4, 1996, the
Lender advanced additional operating funds to the Company and the Company issued
a promissory note to the Lender in the amount of $575,000 payable on demand. The
Company and the Lender are in the process of negotiating amendments to the terms



                                       21
<PAGE>
of the  Amended  Agreement,  however,  under the terms of the  existing  Amended
Agreement,  the Lender may,  without notice to the Company,  exercise any of the
remedies  available to it under such  agreement.  There can be no assurance that
such negotiation will be concluded or, if concluded, will be on terms acceptable
to the Company.

     As of  September  30,  1996,  the  Company  was in default  of the  minimum
consolidated  net worth  criteria under the Debenture  Agreement.  Additionally,
compliance with the terms of the Amended Agreement with respect to nonpayment of
accrued interest or principal on account of the Debentures  constituted an event
of default  under the Debenture  Agreement.  The Company is attempting to obtain
waivers of default from the  Debenture  holders.  In the event that such waivers
are not received, the convertible  subordinated debt becomes due and payable and
adjustments  to the  conversion  price of the Debenture  become  effective.  The
Company has recognized the Debenture as a current  liability as of September 30,
1996.  Interest expense has been recorded and is included in accrued expenses at
September 30, 1996.

     The Company currently has no material commitments for capital expenditures.
The Company anticipates making expenditures to improve its financial and billing
systems and facilities in the foreseeable  future subject to cash  availability.
If  financing  for other than  working  capital and other  opportunities  become
available,  the Company also plans to continue increasing testing volume through
its acquisition program (see Acquisition Program).  The Company believes that in
addition to internal sales efforts,  acquisitions  will continue to be necessary
to achieve  growth in net revenues and achieve  operating  income in the future.
There can be no  assurance,  however,  that the Company  will be  successful  in
implementing  improvements  to its financial and billing systems and facilities,
or that, if implemented,  would have a positive impact on the Company's  results
of  operations.  There can also be no assurance that the Company will effect any
future  acquisitions,  or if effected,  such acquisitions  would have a positive
impact on the Company's results of operations.
     
     The Management's Discussion and Analysis of Financial Condition and Results
of Operations  section above and other sections of this Quarterly Report on Form
10-Q may contain  certain  forward-looking  statements  that  involve  risks and
uncertainties.    Potential   risks   and   uncertainties   relating   to   such
forward-looking   statements  and  the  Company  in  general  include,   without
limitation,  that the Lender will demand payment of all  outstanding  borrowings
and interest  related  thereto the  Company's  inability  to generate  cash from
operations or to secure additional  financing from outside sources sufficient to
satisfy the Company's cash  requirements  in the foreseeable  future,  continued
competitive pressures for clients and acquisition targets, continued decrease in
reimbursement  rates and increased  promulgation of government  regulation which
negatively impact the Company's results of operations. Furthermore, there can be
no assurance  that the Company will be successful in decreasing  costs,  or that
there will be an increase  in the number of  accessions  performed,  or that the
Company will return to profitability.  These risks and other risks are discussed
in more detail in the Company's Securities and Exchange Act filings.





                                       22
<PAGE>


                           PART II. OTHER INFORMATION


Item 1.        Legal Proceedings

Settlement Agreement with Former Executive

     On October 28, 1992, the Company entered into an agreement (the "Settlement
Agreement") with its former Chairman, President and Chief Executive Officer (the
"Former  Executive") for the purpose of resolving  certain  disputes between the
Former  Executive and the Company.  The  Settlement  Agreement  provided for the
Former  Executive's  resignation  from the Company's  Board of Directors and the
Company's purchase of all of the Former  Executive's  1,176,440 shares of common
stock of the Company. The Settlement Agreement also provided that for a ten-year
period,  the Former  Executive  will refrain from  competing with the Company in
certain areas or from taking certain actions, such as the purchase of any voting
securities of the Company, to influence the Company's management. The Settlement
Agreement also contains mutual general releases among the Former Executive,  the
Company and certain of the Company's officers and directors. The purchase of the
Former  Executive's  shares  and the  effectiveness  of the  other  terms of the
Agreement were  conditioned upon the closing price of the Company's common stock
(as quoted on the Nasdaq  National  Market System)  reaching at least $7-5/8 per
share, which occurred on November 2, 1992. The transaction closed on November 3,
1992.  Of the total  consideration,  the Company  allocated  $10,315,908  to the
repurchase  of common stock based upon an  evaluation  by an  independent  third
party.  A  total  of  $2,984,000   was  initially   allocated  to  the  covenant
not-to-compete.  During the fourth  quarter of 1993,  the Company  wrote off the
unamortized   balance  of  the  intangible  asset  relating  to  the  Settlement
Agreement.

     Pursuant to the Settlement Agreement, the Company paid the Former Executive
cash in the amount of $9,000,000  and issued the three-year  secured  Promissory
Note in the principal  amount of $4,400,000  bearing interest at a rate of 3.85%
per year. The Promissory  Note requires  installment  payments on April 15, 1993
and on October 28,  1993,  1994 and 1995.  On August 11,  1994,  the Company was
directed by a court order to deposit  with a bank  escrow,  to be held in trust,
the outstanding  balance under the Promissory  Note. See discussion of the Brown
action below for additional  information with respect to the final payment under
the Promissory Note.

     In consideration of the non-competition  agreement, the Company also agreed
to make certain  additional  payments to the Former  Executive (the  "Contingent
Payments")  computed by a formula  based upon the trading price of the Company's
common stock on certain future dates, or on the sale of all or substantially all
of the Company's assets or a merger, consolidation or other transaction in which
more  than  50%  of  the  Company's  voting  stock  is  transferred,   upon  the
consideration per share paid in such transaction.  The maximum amount the Former
Executive could have received pursuant to the Contingent  Payments provision was
$4,700,000.  Under the Settlement  Agreement,  the Company's  obligation to make
Contingent  Payments  expired on October 28, 1995. No  Contingent  Payments were



                                       23
<PAGE>
made and the  Company  believes  none  were  payable,  however,  the  Contingent
Payments are part of the Former Executive's  cross-complaint in the Brown action
(see below).

     The Settlement  Agreement is the subject of the derivative  suits discussed
below  and of  the  cross-complaints  filed  therein.  The  plaintiffs  in  such
derivative suits are seeking rescission of the Settlement  Agreement as does the
Company  as an  alternative  remedy in its cross  complaint  against  the Former
Executive for damages in the Brown action. In addition,  the Former Executive is
seeking payment of the amount of the Contingent  Payments in his cross complaint
filed in the Brown action.

Wrongful Termination Suit

     On August 27, 1992, a former employee of the Company filed suit against the
Company in the Superior Court of Santa Clara County, California, alleging breach
of contract, wrongful constructive termination in violation of public policy and
defamation.  The case was tried and, in April  1995,  the jury  returned  awards
aggregating  $300,000  against the Company and in favor of the former  employee.
Subsequently,  the judge consolidated certain of the awards and entered judgment
for $253,000.  The plaintiff and the Company have appealed the judgement.  As of
December 31, 1995, the Company  perfected its appeal  through a $379,000  surety
bond (150% of the amount of the  $253,000  judgement  as  required  by the court
rules).  On February 21, 1996,  the Company  deposited in an account with a bank
$379,000  provided  for  thereunder  as  restricted  cash.  The Company  accrued
approximately $300,000 at June 30, 1996 in connection with this matter.

Derivative Suits

     On September 14, 1992,  four  shareholders  filed a lawsuit in the Superior
Court of the County of San Mateo,  California,  seeking to pursue various claims
on a derivative basis (the "Mills action"). The suit has been transferred to the
Superior Court of Santa Clara County, California. It is now in its Third Amended
Complaint, and two of the original plaintiffs have withdrawn. The defendants are
the Company and certain current and former  directors of the Company,  including
the Former  Executive.  The Third Amended  Complaint alleges various breaches of
fiduciary  duty by the  Company's  directors  and seeks a  declaration  that the
Settlement Agreement is invalid, a constructive trust for commissions paid under
an  agreement  between  the  Company  and  Harmet   Associates,   an  injunction
prohibiting the Company in any securities offering from coupling the offering to
the survival, as directors,  of members of its Board of Directors (the "Board"),
the reformation of the Board, an investigation  by independent  Board members of
the Company's quality assurance  procedures,  compensatory and exemplary damages
in an unspecified amount, an order requiring all damages to be placed in a trust
fund for the  benefit of the  Company's  shareholders  so long as any  defendant
remains  an  officer  or  director  of  the  Company,  and  compensation  to the
plaintiffs and attorneys fees in unspecified  amounts. The Company believes that
the Third  Amended  Complaint  is without  merit and is  defending  the lawsuit.
Answers have been filed by all defendants.






                                       24
<PAGE>
     In May 1994, a cross-complaint  was filed in the Mills action by the Former
Executive  which  named  certain  current  and former  directors,  officers  and
employees as  cross-defendants.  The  cross-complaint  seeks  indemnity  for the
claims made against the Former Executive in the Third Amended Complaint referred
to above, and for legal fees and expenses  allegedly  incurred in defending such
claims. The defendants believe such claims to be without merit and are defending
the cross-complaint. An answer has been filed on behalf of the defendants.

     On July 1, 1993,  a demand was made on the Board to pursue the  allegations
contained in a derivative  lawsuit  filed in the Superior  Court of the State of
California  for the County of Santa Clara against the Company and certain of its
current  and  former  directors  including  the  Former  Executive  (the  "Brown
action").  On July 12,  1993,  the  Board  appointed  a special  committee  (the
"Special   Committee")   comprised  of  outside  directors  to  investigate  the
allegations  and to evaluate  whether the Company should pursue the lawsuit.  On
September 30, 1993, the Special Committee determined that the allegations in the
Complaint were unfounded,  that the claims alleged thereon lack merit,  and that
it is not in the best  interest of the Company  for the  litigation  to proceed,
either in the name of the  plaintiffs  derivatively  on behalf of the Company or
through the substitution of the Company as plaintiff. On that basis, the Special
Committee  determined  that the Company  should take  appropriate  steps to seek
dismissal of the action.  The Company and the  individual  defendants  moved for
summary  judgment  dismissing the action.  The motion was denied.  The Company's
attempt  for writ  review by an  appellate  court of the order  denying  summary
judgment was also denied.

     The Brown action is now in its Second Amended Complaint. The defendants are
the Company, certain current and former directors of the Company,  including the
Former Executive,  the Company's independent accountants and a principal of such
accounting  firm.  The Second  Amended  Complaint  alleges  certain  breaches of
fiduciary duty by the Company's  directors,  negligence,  conspiracy,  breach of
contract and negligent  misrepresentation and seeks an order that the Settlement
Agreement be  rescinded  and the Former  Executive to return all money  received
under the  Settlement  Agreement to the Company,  compensatory  damages  against
certain  defendants  in the  amount  of  $35,000,000,  exemplary  damages  in an
unspecified  amount against the same defendants,  an order requiring all damages
be placed in trust for the benefit of the Company's  shareholders so long as any
defendant remains an officer or director of the Company,  a declaration that the
individual  defendants  did not  act in good  faith  and  are  not  entitled  to
indemnification,   an  injunction  prohibiting  the  Company  from  indemnifying
individual  defendants and  compensation to the plaintiffs and attorneys fees in
unspecified  amounts.  The Company believes that the Second Amended Complaint is
without  merit and is  defending  the  lawsuit.  Answers  have been filed by all
defendants.

     On  October  29,  1993,  the  Former   Executive  filed  an  answer  and  a
cross-complaint in the Brown action naming as  cross-defendants  the Company and
certain of its  present  and  former  officers,  directors  and  employees.  The
cross-complaint  has  subsequently  been  amended  and has added  the  Company's
independent  accountants,  another  director and another former  employee of the
Company as additional  cross-defendants.  As amended, the cross-complaint  seeks
indemnification  for  expenses  allegedly  incurred by the Former  Executive  in



                                       25
<PAGE>

connection with various legal  proceedings and for such future damages as may be
incurred by the Former Executive,  compensatory and other damages for defamation
allegedly  committed by the Company and one of its  officers,  compensatory  and
other  damages and  injunctive  relief for  various  unfair  business  practices
alleged  to have  been  committed  by the  defendants,  damages  for  breach  of
contract,  breach  of the  implied  covenant  of good  faith  and fair  dealing,
conspiracy and intentional  interference with contract, the gravamen of which is
that the  cross-defendants  deprived the Former Executive of his potential stock
appreciation  rights  (i.e.  the  Contingent   Payments)  under  the  Settlement
Agreement  by allegedly  operating  the Company in such a way as to decrease the
value of the Company's  common stock and damages for violation of and conspiracy
to violate the Racketeer Influenced and Corrupt  Organization Act ("RICO").  All
damage claims are for  unspecified  amounts to be determined by the proof or the
Court.  RICO damages are  requested to be trebled.  The Company is defending the
cross-complaint. 

     On August 11, 1994,  the Superior  Court of the State of California for the
County of Santa Clara entered an order in relation to the Brown action directing
the Company to,  within 10 days,  (i) deposit with a bank escrow,  to be held in
trust,  the  balance of  approximately  $3.17  million (to be paid to the Former
Executive in two  installments  of $1,585,000 each on October 28, 1994 and 1995)
under the Promissory Note and (ii) indemnify the Former Executive for legal fees
and expenses allegedly incurred in the amount of approximately  $364,000, and to
continue  to  indemnify  him for legal  fees and  expenses,  as he  contends  is
required  by and  subject to the  provisions  of the  Settlement  Agreement.  In
connection  with and using  the  proceeds  from a bank  line of  credit  and the
private placement of convertible subordinated  debentures,  the Company paid the
October 28, 1994  installment  under the  Promissory  Note and  deposited  in an
account with a bank the remaining  principal and interest  balance of $1,585,000
provided for  thereunder as restricted  cash available to satisfy future payment
obligations as may be required to be paid under the Promissory  Note.  Since the
Company believes the Former Executive is indebted to the Company in an amount in
excess of the  amount of the  final  payment  on the  Promissory  Note,  and the
Company,  as well as the plaintiffs in the Mills and Brown actions,  are seeking
rescission  of the  Settlement  Agreement,  in lieu of  making  the  final  note
payment, the Company continues to hold the balance in a separate account pending
the outcome of the  litigation.  The Company  appealed the  indemnification  for
legal fees and expense portion of the decision,  and, on September 26, 1995, the
appellate  court  entered an order  reversing  the lower  court's  decision  and
sustaining  the  Company's  position.  On December 26,  1995,  pursuant to court
order,  the sum deposited as security for the appeal of $546,000 was returned to
the Company.

Company's Claim Against Former Officer and Others

     On October 6, 1993,  the Company filed in the United States  District Court
for the  Northern  District  of  California,  a  complaint  against  the  Former
Executive and certain other  defendants,  including certain of the plaintiffs in
the Mills and Brown  actions.  The Court granted  defendants'  motion to dismiss
various  portions of the  complaint,  and,  on May 25,  1994,  at the  Company's
request,  dismissed the action without prejudice.  On June 10, 1994, the Company



                                       26
<PAGE>
filed a similar suit as a cross-complaint in the Brown action against the Former
Executive  and certain of the  defendants in the Federal  action.  The Company's
cross-complaint  is in its third  amendment  as the  result  of the  defendants'
successful  demurrer  to  certain  causes  of  action  alleged  by the  Company,
including those based on violation of, and conspiracy to violate, RICO and civil
conspiracy.  The Company's most recently filed cross-complaint alleges breach of
contract,  promissory fraud, constructive fraud, defamation,  conspiracy, breach
of fiduciary duty, abuse of process,  interference  with contract,  interference
with prospective  economic  advantage,  and violation of California  Corporation
Code Section 15402.  It seeks  compensatory  and punitive  damages,  trebling of
certain  damages,  indemnification,  rescission  of  the  Settlement  Agreement,
rescission  of a  consulting  agreement  between the Company and another  former
employee and defendant and certain injunctive relief. The cross-defendants  have
answered the cross-complaint.

SEC Investigation

     Commencing in July 1993 the Company became involved in an  investigation by
the  Commission  relating  to certain  accounting,  public  reporting  and other
matters. As a result of this investigation,  in August 1994, the Company elected
to make  certain  revisions  in its  1992  and  1993  financial  statements.  On
September 26, 1994,  pursuant to settlement offers by the Company and two of its
officers,  in which neither it nor they admitted or denied any  wrongdoing,  the
Commission  issued an order (the "Order")  finding that the Company had violated
certain provisions of the Securities Act of 1933 and the Securities Exchange Act
of 1934 and certain rules  thereunder  and that the two  officers,  by virtue of
their positions in the Company and consequent responsibility for certain matters
underlying  the  investigation,  were  a  cause  of  certain  of  the  Company's
violations.  The Order  contained  no  finding  that the  Company  or any of its
officers or directors or employees,  including  the two  officers,  knowingly or
intentionally  committed any violations of laws,  and the Commission  imposed no
fines or penalties on the Company or any individuals. The settlement was entered
into without any admission or denial of  wrongdoing.  The Company  believes that
the  Order  resolves  the  Commission's  investigation;  however,  there  is  no
assurance  that the  Company  will not be subject to further  investigations  or
litigation related to this matter (see Class Action Suit below).

Class Action Suit

     On February 23, 1995,  two  shareholders  of the Company  owning an alleged
aggregate  of 3,161  shares of the  Company's  common  stock filed a suit in the
United States District Court for the Northern  District of California.  The suit
seeks to proceed as a class  action  suit and  purports to be based on the Order
issued by the Commission on September 26, 1994. The Company, certain current and
former officers and directors and certain of its investment  bankers,  attorneys
and  independent  accountants  were  named  defendants.  The  complaint  alleges
violations of Federal and state securities laws and seeks monetary damages in an
unspecified  amount and  equitable  relief  based on alleged  misrepresentations
contained in a registration statement and a prospectus filed with the Commission
and alleged fraudulent acts and practices of the defendants. A motion to dismiss
the complaint was filed by the defendants. Motions to dismiss the complaint have
been granted with  respect to certain  claims,  granted with leave to amend with



                                       27
<PAGE>
respect to other claims and denied with respect to the scienter based securities
laws claims against the Company and two of its officers.  Plaintiffs  have filed
an amended  complaint  against  the  Company,  four of its  former  and  current
officers  and its  independent  accountants.  A motion to  dismiss  the  amended
complaint with respect to the  independent  accountant  has been granted,  and a
motion to dismiss  with  respect to other  defendants  was  denied.  The Company
believes the amended  complaint is without  merit and is defending the law suit.
In response to  cross-motions  to certify and decertify  the class  action,  the
court orally  stated  recently  that it would certify the suit as a class action
suit.  No  written  opinion  has been  received  from  the  court  ordering  the
certification.


Investigations of Billing Practices; Qui Tam Suit

     On May 6, 1994, the Company was subpoenaed to furnish certain  documents to
the  Department  of Health  and  Human  Services  ("HHS")  with  respect  to the
Company's Medicare and Medicaid billing practices. On July 18, 1994, the Company
was  subpoenaed to furnish  certain  documents to the Department of Defense with
respect to the  Company's  Civilian  Health  and  Medical  Program of  Uniformed
Services  ("CHAMPUS")  billing  practices.  The Company  believes  these matters
relate to the  investigations  of such practices being conducted with respect to
other laboratories.  On August 28, 1995, the Company was notified that a Qui Tam
action had been filed by two former  employees  under the False  Claims Act. The
Company believes the Qui Tam action and billing  investigations are related. The
investigations  relate to billing  certain panels and profiles,  adding tests to
recognized  panels and  profiles,  billing for tests  deemed not to be medically
necessary,  improper coding, billing for tests not performed, double billing and
other alleged improper practices. During the fourth quarter of 1995, as a result
of correspondence  and discussions with government  agencies relating to certain
issues  under  investigation,  the  Company  recorded a charge of  approximately
$2,000,000.  The Company has produced the documents subpoenaed by the government
agencies  and both the  Company and the  government  agencies  have  discussed a
proposed  settlement.  While the actual  agreement has not been  finalized,  the
Company  recorded a charge during the third quarter of 1996 of $2,000,000  based
on preliminary estimates. Such amounts, when aggregated with previously recorded
accruals, bring the total estimated accrual to $4,250,000. However, based on the
ultimate outcome of the proposed settlement agreement, additional charges may be
recorded in the  future.  Additionally,  subsequent  to the  finalization  of an
agreement, noncompliance with any terms of such an agreement could result in the
acceleration of any unpaid amounts or imposition of additional  payments,  fines
and penalties.

     As a  consequence  of the  Company's  review of the  reimbursements  it has
received from Medicare  with respect to chemistry  panels and certain  questions
raised during the  investigation,  the Company determined that Medicare overpaid
the Company  approximately  $960,000  with  respect to matters that were not the
subject of the  original  investigations.  This amount was  charged  against net
revenues for the three  months ended  September  30,  1995.  The Company  repaid
$350,000 of this amount  during 1995 and is repaying  the  remaining  balance in
monthly installments of $50,000 commencing January 2, 1996.




                                       28
<PAGE>

Other Suits

     Members of the Company's current management are defendants in certain legal
actions, including the actions described above, that have been brought by former
employees  and  shareholders  of the Company.  These  actions are believed to be
without  merit  and  are  being   defended   with  the   Company's   assistance.
Additionally,  the  Company is  involved  in various  other  lawsuits  and legal
matters in the ordinary course of business. It is the opinion of management that
the ultimate  resolution  of these  lawsuits  and legal  matters will not have a
material  adverse  effect on the Company's  consolidated  financial  position or
results of operations.











































                                       29
<PAGE>

Item 3.        Defaults Upon Senior Securities

     Prior to September 20, 1996, the Company's outstanding borrowings under its
line of credit arrangement (the "Line of Credit") with a bank,  including unpaid
interest  and  costs  were  $8.2  million  (see  Note 4 of  Notes  to  Condensed
Consolidated  Financial  Statements)  which was  substantially  in excess of its
available  Line of Credit.  Additionally,  the Company was in default of all the
financial  covenants  under the Line of  Credit.  The Line of Credit  expired on
April 20, 1996 and on June 4, 1996,  the Company  and its bank  entered  into an
amendment to the Line of Credit Agreement (the "Amended Agreement").  Subject to
the  terms of the  Amended  Agreement  and in  accordance  with the terms of the
debenture  agreement  ("the  Debenture  Agreement")  (see  Note  5 of  Notes  to
Condensed  Consolidated  Financial  Statements),  the Company is prohibited from
making any further  payments of accrued  interest or principal on account of the
convertible  subordinated  debentures (the "Debentures").  Such nonpayment is an
event of default under the Debenture Agreement and resulted in the assessment of
interest on any unpaid  interest and reductions to the  conversion  price of the
Debentures by 1% per month until the overdue amounts have been paid in full. The
Amended Agreement further stated that the bank would forbear from exercising its
remedies   under  the  Line  of  Credit   agreement   until   August  15,  1996,
notwithstanding the Company's existing defaults. On August 14, 1996, the Company
entered into a forbearance  agreement  with the bank which included an extension
of the forbearance period to September 15, 1996.

     On  September  20, 1996,  the bank  assigned the entire $8.2 million of the
Company's  borrowings  to a private  lender  (the  "Lender")  under a  privately
negotiated  transaction.  The Lender  acquired from the bank any and all rights,
claims and causes of action under the Amended Agreement. On October 4, 1996, the
Lender advanced additional operating funds to the Company and the Company issued
a promissory note to the Lender in the amount of $575,000 payable on demand. The
Company and the Lender are in the process of negotiating amendments to the terms
of the  Amended  Agreement,  however,  under the terms of the  existing  Amended
Agreement,  the Lender may,  without notice to the Company,  exercise any of the
remedies  available to it under such  agreement.  There can be no assurance that
such negotiation will be concluded or, if concluded, will be on terms acceptable
to the Company.

     As of  September  30,  1996,  the  Company  was in default  of the  minimum
consolidated  net worth  criteria under the Debenture  Agreement.  Additionally,
compliance with the terms of the Amended Agreement with respect to nonpayment of
accrued interest or principal on account of the Debentures  constituted an event
of default  under the Debenture  Agreement.  The Company is attempting to obtain
waivers of default from the  Debenture  holders.  In the event that such waivers
are not received, the convertible  subordinated debt becomes due and payable and
adjustments  to the  conversion  price of the Debenture  become  effective.  The
Company has recognized the Debenture as a current  liability as of September 30,
1996.  Interest expense has been recorded and is included in accrued expenses at
September 30, 1996.






                                       30
<PAGE>


Item 5.        Other Information

     On October 28, 1996,  the Company  announced the  resignation of William E.
Neeley,  M.D.  from the  position of President  of Meris  Laboratories,  Inc. In
addition,  effective  November 1, 1996,  Dr. Neeley also resigned as a member of
the Board of  Directors.  Henry E. Bose,  most  recently the  Company's  General
Counsel,  has been appointed as the acting President and Chief Executive Officer
pending the hiring of a permanent replacement.












































                                      31
<PAGE>

                              
Item 6.        Exhibits and Reports on Form 8-K

     (a)  Exhibits


     Exhibit   10.1 Consulting  Agreement,  dated as of August 9, 1996,  entered
               into between the Registrant and Stephen P. Monticelli

     Exhibit   10.2 Consulting  Agreement,  dated as of August 9, 1996,  entered
               into between the Registrant and Henry W. Poett III

     Exhibit   10.3 Consulting  Agreement,  dated as of October 1, 1996, entered
               into between the Registrant and Henry E. Bose

     Exhibit   10.4  Letter  dated  October  1,  1996  to  confirm  the  further
               understandings  with respect to the Consulting  Agreement between
               the Registrant and Henry E. Bose dated October 1, 1996

     Exhibit   10.5 Term Promissory Note, dated as of September 6, 1996, entered
               into between the Registrant and Madeleine L.L.C.

     Exhibit   11 Computation of earnings per common shares

     Exhibit   27 Financial Data Schedule
     

     (b)  Reports on Form 8-K

          None.
            


















                                       32
<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.


                                      MERIS LABORATORIES, INC.


                          By:          /s/ Thurman Jordan
                                      --------------------------------------
                                      Thurman Jordan
                                      Senior Vice President - Finance
                                      (Duly authorized Officer and Principal
                                      Financial and Accounting Officer)

Date: November 14, 1996




































                                       33
<PAGE>

                                  EXHIBIT INDEX



Exhibit 
Number              Document
-------             --------

10.1              Consulting Agreement, dated as of August 9, 1996, entered into
                  between the Registrant and Stephen P. Monticelli

10.2              Consulting Agreement, dated as of August 9, 1996, entered into
                  between the Registrant and Henry W. Poett III

10.3              Consulting  Agreement,  dated as of October  1, 1996,  entered
                  into between the Registrant and Henry E. Bose

10.4              Letter   dated   October  1,  1996  to  confirm   the  further
                  understandings  with  respect  to  the  Consulting   Agreement
                  between the Registrant and Henry E. Bose dated October 1, 1996

10.5              Term Promissory Note,  dated as of September 6, 1996,  entered
                  into between the Registrant and Madeleine L.L.C.

11                Computation of earnings per common shares

27                Financial Data Schedule





















                                       34