<PAGE>



                     U.S. Securities and Exchange Commission
                             Washington, D.C. 20549

                                   FORM 10-KSB

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

     For the fiscal year ended JUNE 30, 2001 Commission File Number 0-21537
                               -------------                        -------

                            PACIFIC BIOMETRICS, INC.
-------------------------------------------------------------------------------
         (Exact name of small business issuer specified in its charter)

<TABLE>
<S>                                                                             <C>
                                 Delaware                                                    93-1211114
-----------------------------------------------------------------------------------------------------------------------------------
(State or other jurisdiction of incorporation or organization)                  (IRS Employer Identification Number)

               23120 Alicia Parkway #200, Mission Viejo, CA 92692
-----------------------------------------------------------------------------------------------------------------------------------
                                               (Address of principal executive offices)

                                                      949-455-9724
-----------------------------------------------------------------------------------------------------------------------------------
                                               (Issuer's telephone number)
</TABLE>
        Securities registered pursuant to Section 12(b) of the Act: None

           Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value per share Redeemable Common Stock Purchase Warrants



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

Indicate by check mark if the disclosures of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [  ]

The issuer's revenues for the year ended June 30, 2001 were $1,877,613.

As of August 31, 2001 there were outstanding 3,810,171 shares of common stock,
par value $0.01 per share. The aggregate market value of the voting stock of the
registrant held by non-affiliates of the registrant on August 31, 2001 based on
the average bid and asked price on such date was $90,617.

                       DOCUMENTS INCORPORATED BY REFERENCE

None.

         Traditional Small Business Disclosure Format: Yes ( ) No ( X )



<PAGE>


                            PACIFIC BIOMETRICS, INC.

                              INDEX TO FORM 10-KSB


<TABLE>
<CAPTION>
PART 1                                                                                     PAGE
                                                                                           -----
<S>                                                                                       <C>
ITEM 1  - BUSINESS ..................................................................       3

ITEM 2  - PROPERTIES ................................................................      13

ITEM 3  - LEGAL PROCEEDINGS .........................................................      13

ITEM 4 -  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .......................      13

PART II

ITEM 5 - MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED
         STOCKHOLDER MATTERS ........................................................      14

ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS
         OF FINANCIAL CONDITION AND PLAN OF OPERATION ...............................      15

ITEM 7  - FINANCIAL STATEMENTS ......................................................      21

ITEM 8  - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
          ACCOUNTING AND FINANCIAL DISCLOSURES ......................................      21


PART III

ITEM 9 -  DIRECTORS AND OFFICERS OF THE REGISTRANT .................................      22

ITEM 10 - EXECUTIVE COMPENSATION ...................................................      23

ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
          AND MANAGEMENT ...........................................................      24

ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ...........................      25

ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K .........................................      25
</TABLE>


                                       2

<PAGE>




PART I

ITEM 1  - BUSINESS

GENERAL

Pacific Biometrics, Inc. ("PBI" or the "Company") was incorporated in Delaware
in May 1996. PBI-Delaware was formed in connection with the acquisition of
BioQuant, Inc. ("BioQuant"), a Michigan corporation, and Pacific Biometrics,
Inc. ("PBI-WA"), a Washington corporation. On June 28, 1996, the Company
completed the mergers whereby BioQuant and PBI-WA became wholly owned
subsidiaries of the Company in separate stock-for-stock exchange transactions.
The Company had 18 employees as of June 30, 2001. The Company's principal
executive offices are located at 23120 Alicia Parkway #200, Mission Viejo, CA
92692.

PBI is a development stage company that provides specialty reference laboratory
services to the pharmaceutical and diagnostics industries. The Company had
previously been engaged in the development and commercialization of non-invasive
technologies for use in diagnostics to improve the detection and management of
chronic diseases, which commercialization efforts have been terminated due to
the Company's inability to obtain FDA approval for its OsteoPatch(TM) product
and lack of necessary funding. The Company has developed two patented platform
technologies that permit the use of sweat and saliva as diagnostic fluids.

PBI's intellectual property position in both sweat and saliva collection
technology is based on sixteen issued U.S. patents and one pending U.S. patent
with respect to the Company's SalivaSac(R) technology. The Company has invested
approximately $4,202,000 in research and development and approximately $819,000
for the acquisition of technology rights in 1999, 1998 and 1997. The Company has
ceased all product development activities due to a lack of funds. In addition,
approximately $6,374,000 of expense was recorded in 1996 for the value of
purchased in-process research and development related to a prior merger. In May
1998, the Company received a letter from the FDA in response to its 510(k)
application for the OsteoPatch(TM) device notifying the Company that the agency
did not find the device to be substantially equivalent to the predicate device,
a urine test marketed by Metra Biosystems. Despite numerous discussions and a
meeting with the FDA in July 1998, the Company was unable to reverse the
agency's decision or negotiate requirements for additional data that were within
the Company's financial ability to perform. Due to lack of funds, the Company
ceased development activities on the OsteoPatch(TM) device in August 1998.

In December 1998, the Company failed to make a payment of $1.6 million to
Sudormed, Inc. ("Sudormed"), the licensor of the patch technology relating to
the SweatPatch(TM) and OsteoPatch(TM), resulting in defaults under both the
license agreement dated December 30, 1997 (the "License Agreement") with
Sudormed (relating to the patch technology) and the supply agreement dated
August 1993, as amended (the "Supply Agreement") with Sudormed (relating to
production of patches). Sudormed terminated the License Agreement in May 1999
for failure to make required payments. The License Agreement permits the Company
to retain full license rights as long as the Company has an inventory of
patches. As of June 30, 2001, the Company had approximately 80,000 patches in
inventory, which are no longer saleable due to expirations, but are useable for
research purposes only. All investments and related assets in SweatPatch(TM)
technology, including the OsteoPatch(TM), were expensed during 1999.

The Company executed an Agreement of Purchase and Sale of Assets dated April 18,
2000 and a First Amendment to Agreement of Purchase and Sale of Assets dated
June 22, 2000 (together, the "Purchase Agreement") with Saigene Corporation
("Saigene"), a privately held corporation located in Redmond, Washington. As
previously reported, the Company executed a Management Agreement with Saigene on
September 15, 1999 and amended that agreement on April 15, 2000, April 30, 2000,
and August 7, 2000 (collectively, the "Management Agreement"). The Management
Agreement gives Saigene operational control of the Company's laboratory. The
Purchase Agreement, which is subject to stockholder approval, will transfer the
business and all assets of the Company's Seattle laboratory operation to Saigene
for a total consideration of $4,000,000. Saigene failed to satisfy certain
conditions relating to payments as required and defaulted on the Purchase
Agreement. Saigene requested a further extension to January 20, 2001 to complete
the Purchase Agreement and the Company and Saigene signed a Second Amendment to
Agreement of Purchase and Sale of Assets, dated August 4, 2000 (the "Second
Amendment").

                                       3
<PAGE>

In exchange for this extension, Saigene agreed to the following additional
terms. Saigene paid the Company $50,000 on May 22, 2000 and $75,000 on July 19,
2000 as part of the purchase price. Saigene also paid $20,000 on each of August
28th, September 20th, October 20th, November 20th and December 20, 2000.
One-half of each $20,000 payment will be credited toward the purchase price and
one-half of each payment will be consideration paid for the additional time
extension. Payments toward the purchase price will be credited against the
escrow payment required at the time of closing. All payments made according to
the Second Amendment will be forfeited by Saigene if they fail to make any of
the required payments, including the closing payments. Saigene and the Company
have further agreed that Saigene may extend the January 20, 2001 Closing Date on
a month-by-month basis by increasing the monthly payments to $30,000 beginning
January 20, 2001. One-half of such payment would be credited to the purchase
price and one-half would be consideration for the additional time extension. The
Company has the right to terminate the Purchase Agreement at the end of any
extension period by giving 20 days prior written notice.

Saigene failed to complete the Purchase Agreement on January 20, 2001 but has
elected to extend the Closing Date on a month-by-month basis having made all
required payments due through December 20, 2000 and all payments due from
January 20, 2001 through August 20, 2001.

There can be no assurance that Saigene will be able to complete the Purchase
Agreement as amended or consummate the transactions contemplated therein.
Failure to complete this transaction would likely return operational control of
the laboratory to the Company. While the laboratory would have less debt as a
result of the Second Amendment, the Company will not be financially capable of
maintaining the laboratory operation and there can be no assurance that another
buyer could be found in a timely manner. This could force the Company to seek
protection from creditors under the bankruptcy laws.

Even upon completion of the transaction with Saigene, the Company will still
have significant debts and claims that need to be settled. These include amounts
owed to various consultants, vendors and suppliers of the Company not related to
the Seattle laboratory operation of approximately $600,000; deferred
compensation to current and former employees of approximately $800,000; accrued
dividends to preferred stockholders of approximately $660,000; and a potential
liability, disputed by the Company, of approximately $2,000,000 related to the
OsteoPatch(TM) technology. The Company will attempt to settle these debts with
cash, stock, and technology assets. There can be no assurance that the Company
will be successful in these negotiations and may have to seek protection from
creditors under the bankruptcy laws. If the Company is successful in settling
the remaining debts, then the Company plans to pursue a merger with another
company as a means of providing some value to common stockholders. There can be
no assurance that the Company will be successful in finding and negotiating a
successful merger or that any such merger would create value for the
stockholders.

SWEATPATCH(TM) - SWEAT COLLECTION DEVICE

This patented transdermal collection device provides a non-invasive biological
sample that was designed to replace blood and urine in various medical
diagnostic applications. The design of the SweatPatch(TM) allows the aqueous
component of sweat to evaporate from the patch, leaving behind the analytes that
are collected and concentrated on the absorbent pad contained within the patch.
The design permits the sample on the pad to be mailed directly to a central
laboratory for analysis. The SweatPatch (TM) can be worn anywhere from 30
minutes up to seven days with no discomfort or irritation to the patient
permitting a time integrated sample to be collected. The Minnesota Mining and
Manufacturing Company ("3M") manufactures the patch for PBI pursuant to the
Supply Agreement with Sudormed, the licensor of the patch technology. The
License Agreement and the Supply Agreement between the Company and Sudormed were
terminated by Sudormed in May 1999 due to the failure of the Company to make
required payments. The development of the SweatPatch(TM) and OsteoPatch(TM) was
suspended in August 1998 after the FDA denied the Company's 510(k) application
and efforts to get the FDA to reverse its decision were unsuccessful.
Additionally, the Company was not successful in negotiating specific FDA
requirements for additional clinical data that, in the opinion of the Company,
could be obtained with the financial resources available at that time.

SALIVASAC(R) - SALIVA COLLECTION & PROCESSING DEVICE

                                       4


<PAGE>


This proprietary device, developed by the Company, collects a non-invasive
saliva sample that the Company had hoped would be able to replace blood and
urine testing in various applications. The SalivaSac(R), which contains a small
quantity of a substance that acts as an osmotic driver, is placed in the mouth
and rapidly fills with an ultrafiltrate of saliva that is filtered as it passes
through the semi-permeable outer membrane. The resulting fluid is clear, easy to
use, and does not contain interfering substances. The Company believes
SalivaSac(R) design has the potential to lend itself to point-of-care diagnostic
applications. The SalivaSac(R), as a sample collection device, can be combined
with currently available testing technologies to permit new non-invasive
diagnostic test applications. However, almost all development of the
SalivaSac(R) has been suspended as of December 1998 due to a lack of funding.

PRODUCTS

OsteoPatch(TM): The OsteoPatch(TM) is designed to enhance the physician's
ability to identify patients at risk of bone loss, a factor in the detection of
osteoporosis, and to monitor treatment effectiveness. The OsteoPatch(TM) system
combines the patented SweatPatch(TM) device with licensed assay technology for
the detection of biochemical bone resorption markers released in sweat. The
Company has exclusive rights, relating to bone resorption in human sweat, to use
patented antibodies for the detection of these markers owned by Metra
Biosystems, Inc. ("Metra"), a developer and marketer of bone loss urine tests.
Metra was acquired by Quidel Corporation in September, 1999. The Company is
dependent on 3M for the supply of patches and on Metra for supply of antibodies
used in the OsteoPatch(TM) system. However, in May 1999, the License Agreement
and the Supply Agreement relating to continued development and production of the
OsteoPatch(TM) were terminated by Sudormed. The Company has the right to
continue to sell and use its remaining inventory of OsteoPatch(TM) devices. The
Company has, however, recorded a 100% valuation allowance against this inventory
as of June 30, 1999. The OsteoPatch(TM) was launched in Italy in January 1999 on
a limited basis by the Company's Italian licensee, Segix Italia, S.p.A. (Segix).
Due to the Company's financial difficulties and loss of the Sudormed License,
Segix did not expand distribution of the product beyond its limited introduction
and has since discontinued the program.

Saliva Glucose Applications: The Company had been awarded two SBIR Phase I
grants to research this technology for non-invasive glucose monitoring. As a
result of this research the Company had used its SalivaSac(R) technology to
develop a screening product to detect diabetes in the general population and a
monitoring product to produce detailed quantitative measurements of glucose
levels to enable diabetics to monitor glucose levels throughout the day. While
previous attempts by others to correlate saliva glucose with blood glucose have
been unsuccessful, the Company has had encouraging preliminary results using the
SalivaSac(R) device, as it appears to exclude substances that interfere with
accurate glucose measurements. However, without additional funding the Company
will not be able to successfully develop the Saliva Sac for such use. On August
15, 2000 the Company was issued United States Patent No. 6,102,872 for Glucose
Detector and Method as a result of the SalivaSac(R) research conducted earlier.

In September, 1999 the Company received a SBIR Phase I grant to research the use
of the SalivaSac(R) technology for the collection and measurement of
homocysteine, a newly discovered marker with potential application for use as a
risk factor in heart disease. The Company was not able to make any useful
discoveries with this Phase I grant and has no plans to file for a Phase II
grant for the homocysteine application.

MARKET POTENTIAL FOR PRODUCTS UNDER DEVELOPMENT

Osteoporosis Market: Osteoporosis is one of the fastest growing, largest, and
debilitating diseases affecting the aging population today. New ways of
preventing, diagnosing and managing the disease are being developed. Medical
intervention usually occurs only after symptoms such as pain or fractures appear
and when treatment is generally too late to prevent bone loss. The Company
understands at least twenty-five new therapeutic products are under development
and in 1996 the total U.S. market for diagnostics and therapeutics for
osteoporosis was $1.7 billion and is expected to grow to $4.6 billion by 2003.
Thus, the Company believes there is a need for diagnostic tools and assessments
that will identify those at risk, allow for early treatment and enhance the
physician's ability to monitor the effectiveness of such treatment. Today,
according to the National Osteoporosis Foundation ("NOF"), twenty eight million
Americans are at risk of osteoporosis and more than 100 million people worldwide
are affected or at risk. In the U.S. alone, the NOF estimates approximately $14
billion is spent annually on osteoporosis related fractures.

                                       5
<PAGE>

Diabetes Market: An estimated 16 million Americans and more than 100 million
people worldwide suffer from diabetes. However, the Centers for Disease Control
(the "CDC") estimates that in the U.S. alone, only half of all diabetics have
actually been diagnosed. The American Diabetes Association (the "ADA") has
issued guidelines to screen everyone over the age of 45 every three years. In
the U.S., approximately 4.5 million people perform a blood glucose test at least
once a day. In 1996, the total cost of diagnosing and treating diabetes in the
U.S. was estimated to be $92 billion. In 1996, the U.S. market for home blood
glucose monitoring had revenues of nearly $1 billion and is expected to grow to
$1.7 billion by 2001.

SERVICES PROVIDED BY PBI'S LABORATORY

The Company's reference laboratory has established itself as a technical leader
due to its strong expertise in cardiovascular disease (lipids). The Company's
affiliated foundation is one of only eleven laboratories designated worldwide
(five in the U.S.) by the CDC as a cholesterol reference method network
laboratory. The laboratory services include development of laboratory reference
methods, development of clinical trial protocols, and contract research and
development.

The Company's specialty reference laboratory has developed an expertise in the
emerging field of osteoporosis laboratory assessments through its work with
diagnostic manufacturers of assays for bone markers such as Ostex International,
Inc. and Metra, in addition to pharmaceutical manufacturers of drugs that
prevent bone loss such as Merck & Co., Inc. and The Procter & Gamble Company.
This work has helped to establish the Company as a leader in the understanding
of biochemical markers for bone formation and bone resorption.

The Company's laboratory business and assets are under contract to be sold to
Saigene, subject to stockholder approval and other conditions of closing. See
"Significant Recent Developments and Subsequent Events" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations".

SIGNIFICANT RECENT DEVELOPMENTS AND SUBSEQUENT EVENTS

In December 1997, the Company executed the License Agreement with Sudormed,
which provided the Company an exclusive worldwide license to all medical
diagnostic applications of Sudormed's skin patch technology. This License
Agreement replaced the Company's previous license agreement with Sudormed for
the skin patch technology for the application of measuring bone loss markers in
sweat, which is the basis for the Company's OsteoPatch(TM) system. In addition,
the License Agreement allowed for the development of all other potential
applications of such technology, except for those relating to alcohol and drugs
of abuse.

Pursuant to the License Agreement, the Company was obligated to pay Sudormed
approximately $3 million over a fifteen-month period plus an ongoing royalty
payment based on the amount of sales of products developed under this license.
Such payments included a lump-sum payment of $1.6 million due in December 1998.
The Company failed to make the required license payments and Sudormed terminated
the License Agreement and the Supply Agreement in May, 1999. The Company still
retains license rights as long as the Company has inventory of patches. As of
June 30, 2001, the Company had approximately 80,000 patches in inventory, which
are no longer saleable due to expirations, but are useable for research purposes
only. Once existing inventory is depleted, the Company will not be able to sell
additional OsteoPatch(TM) products or fulfill obligations with Segix.

On February 20, 1998, the Company consummated the sale of 925,000 shares of
Series A Convertible Preferred Stock (the "Preferred Stock") with an
institutional investor for an aggregate purchase price of $1,850,000. In
addition, the Company granted such institutional investor an option (the
"Option") to purchase an additional 625,000 shares of Preferred Stock until May
20, 1998 for an exercise price of $1,250,000. The Option was exercised in full
during May 1998. The Preferred Stock is convertible into shares of the Company's
Common Stock at the option of the holder at any time on a one-for-one basis,
subject to adjustment for stock splits, dividends and similar events. The
Preferred Stock provides for a cumulative cash dividend payable quarterly in
arrears at an annual rate of 8%. The Company has the right to force conversion
of the Preferred Stock in the event the price per share of the Common Stock is
$8.00 or more for twenty consecutive trading days. The Company has agreed to use
commercially reasonable efforts to effect the registration of the Common Stock
into which the Preferred Stock is convertible. To date, no such efforts have
been


                                       6

<PAGE>


undertaken. The Company is not current on dividend payments and approximately
$662,000 in dividends have accrued as of June 30, 2001.

In April of 1999 the Company and its subsidiaries entered into an Accounts
Receivable Factoring Agreement (the "Factoring Agreement") with Silicon Valley
Bank (the "Bank"). The Company has been factoring the majority of the accounts
receivable from laboratory operations to provide the Company with working
capital to meet laboratory operations obligations and to maintain minimal
corporate operations. Under the terms of the Factoring Agreement, the Bank will
advance 80% of accepted receivables and charge the Company an administrative fee
of 0.75% and an annualized rate of 21% on outstanding balances. The amount
outstanding as of June 30, 2001 was $51,587.

In July 1998, the Company signed a License, Supply and Distribution Agreement
(the "Distribution Agreement") with Segix for the Company's OsteoPatch(TM)
diagnostic system for the Italian market. The Distribution Agreement contains
provisions requiring minimum purchases and investment in marketing, foreign
currency adjustment mechanisms, unit price adjustment mechanisms, and
exclusivity for the territory of Italy, Vatican City and San Marino. The
agreement had an initial term of ten years. Execution of the Distribution
Agreement was intended to give the Company access to the Italian market through
Segix's 70 person direct sales force. Segix launched the product on a limited
basis at the beginning of calendar year 1999 but has since discontinued the
program due to the uncertainty caused by the Company's default and loss of the
License Agreement and the Supply Agreement.

The Company owns rights to a sample preparation device marketed under the name
SPINPRO(R), which simplifies and improves the methods used for performing the
testing of HDL cholesterol. In June 1997, the Company suspended production of
SPINPRO(R) units due to insufficient demand. The Company is involved in two
arbitration proceedings with former subcontractors related to the manufacturer
of SPINPRO(R). As of the date of this report, the Company does not believe that
the proceedings will have any material adverse impact on the Company. During the
fourth quarter of fiscal 1998, the Company expensed the remaining net book value
of $126,323 related to SPINPRO(R) assets.

On March 29, 1999, the Company announced by press release that it had received
notification that the Nasdaq Listings Qualifications Panel had delisted the
Company's securities from the Nasdaq Stock Market effective as of the close of
business on March 29, 1999. This included the common stock, symbol PBMI, and the
publicly traded warrants, symbol PBMIW (which warrants have since expired by
their terms). This delisting decision has had an adverse impact on the liquidity
of the Company's securities, which trade on the OTC Bulletin Board or the
over-the-counter market. This has made it more difficult to trade in the
Company's securities or liquidate an investor's holdings. Also such delisting
has made it more difficult for the Company to raise additional capital.

As previously reported, in May 1999, the landlord of the Company's office and
laboratory space in Lake Forest, California was proceeding against the Company
to cancel the lease. The landlord obtained a judgment against the Company from
Orange County Superior Court for approximately $150,000 related to the default
on the lease. In addition, liabilities continue to accrue at about $13,000 per
month until the space is leased. The total liability to the Company is estimated
to be approximately $350,000. This obligation has been assumed by Saigene as
part of the proposed sale of laboratory assets to Saigene.

As previously disclosed, the Company has continued to negotiate forbearance
agreements with Transamerica Business Credit related to payments due on capital
leases. In exchange for the most recent Forbearance Agreement the Company has
granted Transamerica additional warrants and a lien position on assets of the
Company. This Forbearance Agreement expired on September 30, 1999 and was
extended again through December 31, 1999 in exchange for 150,508 additional
warrants. Although the Forbearance Agreement has expired, Transamerica has not
taken action to collect the debt, which approximates $460,000. Most of this debt
will be assumed by Saigene upon sale of the laboratory.

The Minnesota Mining and Manufacturing Company (3M), as a party in possession of
secured property, has not informed the Company of its plans for the Sudormed
assets. This includes the SkinPatch(TM) technology rights, which are part of the
Company's OsteoPatch(TM) product. The Company had sought to reestablish certain
rights to this technology in order to create additional value for the Company's
other intellectual property related to the OsteoPatch(TM). Without an agreement
with 3M, the Company's OsteoPatch(TM) assets may not have any value. The Company
expensed all of these assets in 1999. In May 2000, 3M notified the Company that,
in its capacity as a secured party in possession of the






                                       7


<PAGE>

Sudormed assets, it demands payment in full of the $1.6 million plus accrued
interest and fees due under the License Agreement between the Company and
Sudormed. 3M is seeking to settle this claim and has threatened to seek a
judgment in a court of law and has objected to the laboratory sale transaction
that is proceeding with Saigene. The Company disputes 3M's claim and intends to
defend itself in this matter. If 3M should be successful in blocking the
proposed sale of the laboratory, or commences a legal action against the
Company, the Company may have no alternative than to seek protection from
creditors under the bankruptcy laws. In that event the Company would consider
suing 3M for damages to shareholders and creditors as a result of this action.

In August 1999, the Company announced the signing of a Letter of Intent to sell
its Seattle laboratory business and assets to Saigene. In September 1999, the
Company signed the Management Agreement with Saigene giving Saigene operational
control over the laboratory. In May 2000, the Company announced the signing of
the Purchase Agreement with Saigene to sell to Saigene all of the business and
assets of the Company's Seattle laboratory for a total consideration of
$4,000,000. Stockholder approval will be required to complete this transaction.
The purchase price is comprised of the following: 1) $200,000 already advanced
to support the operation of the laboratory under the Management Agreement; 2)
The assumption of approximately $1,200,000 in debt; 3) $700,000 in cash; and, 4)
A promissory note in connection with the redemption of $1,900,000 of Series A
Convertible Preferred Stock of the Company, which Series A Preferred Stock will
be returned to the Company. These amounts are subject to adjustment upon audit
of funds advanced and the May 31, 2000 balance sheet of the laboratory
operation. The cash portion of the purchase is payable as follows: 1) $50,000
which was paid upon signing; 2) $350,000 paid on June 15, 2000; and, 3) $300,000
placed into escrow on June 15, 2000 to be paid to the Company upon stockholder
approval. The assumption of debt in the amount of $1,200,000 includes: $350,000
to settle the debt with the landlord of the Company's Lake Forest, California
office and laboratory facility; $400,000 of equipment lease financing
obligations with Transamerica; $140,000 of additional equipment leases; and
accrued expenses and accounts payable of the laboratory.

On June 26, 2000, the Company announced that Saigene failed to make the cash
payment of approximately $650,000 due on June 15, 2000 under the Purchase
Agreement, and that Saigene requested an extension of time in order to comply.
Accordingly, the Purchase Agreement was amended on June 22, 2000 to extend the
closing date of the Purchase Agreement from June 15, 2000 to August 15, 2000 and
Saigene was required to pay $150,000 of the purchase price on or before July 15,
2000. The balance of cash and escrow payments and all other consideration due
originally on June 15 was to be due on August 15, 2000. In exchange for this
extension, Saigene had agreed (i) to waive all financial claims against the
Company for funds advanced under the Management Agreement and forfeit all monies
paid under the Purchase Agreement and (ii) to be responsible for all liabilities
previously assumed by Saigene or agreed to be assumed by Saigene including the
Company's debt to the Lake Forest, California landlord in the event that Saigene
fails to make cash payments due on July 15 or August 15, 2000.

Saigene failed to satisfy certain conditions relating to payments as required
and defaulted on the Purchase Agreement and the Amendment. Saigene requested a
further extension to January 20, 2001 to complete the Purchase Agreement and the
Company and Saigene signed the Second Amendment on August 4, 2000.

In exchange for this extension, Saigene agreed to the following additional
terms. Saigene paid the Company $50,000 on May 22, 2000 and $75,000 on July 19,
2000 as part of the purchase price. Saigene paid $20,000 on each of August 28th,
September 20th, October 20th, November 20th and December 20, 2000. One-half of
such payments will be credited toward the purchase price and one-half will be
consideration paid for the additional time extension. Payments toward the
purchase price will be credited against the escrow payment required at the time
of closing. All payments made according to the Second Amendment will be
forfeited by Saigene if they fail to make any of the required payments,
including the closing payments. Saigene and the Company have further agreed that
Saigene may extend the January 20, 2001 Closing Date on a month-by-month basis
by increasing the monthly payments to $30,000 beginning January 20, 2001.
One-half of such payments would be credited to the purchase price and one-half
would be consideration for the additional time extension. The Company has the
right to terminate the Purchase Agreement at the end of any extension period by
giving 20 days prior written notice.

Saigene failed to complete the Purchase Agreement on January 20, 2001 but has
elected to extend the Closing Date on a month-by-month basis having made all
required payments due through December 20, 2000 and all payments due from
January 20, 2001 through August 20, 2001.

                                       8
<PAGE>

There can be no assurance that Saigene will be able to complete the Purchase
Agreement as amended or consummate the transactions contemplated therein.
Failure to complete this transaction would return operational control of the
laboratory to the Company. While the laboratory would have less debt as a result
of the Amendment, there can be no assurance that the Company will be financially
capable of maintaining the laboratory operation and no assurance that another
buyer could be found in a timely manner. This could force the Company to seek
protection from creditors under the bankruptcy laws. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

On May 10, 2001 a Final Judgment of Permanent Injunction was issued by the
United States District Court for the District of Columbia ordering the Company
to (a) file with the SEC, on or before June 29, 2001,: (1) the Company's Annual
Report on Form 10-KSB for its fiscal year ended June 30, 2000; (2) the Company's
Quarterly Reports on Form 10-QSB for its quarters ended March 31, September 30,
and December 31, 2000; and (3) such other periodic reports which may become due
prior to the entry of the Final Judgment, and (b) file timely and in proper form
with the SEC accurate and complete information and reports of the Company as are
required to be filed under the securities laws. All such reports were filed on
June 29, 2001. Accordingly, the Company believes it is currently in compliance
with such Final Judgment.

RISK FACTORS

An investment in the securities of the Company is highly speculative and subject
to a high degree of risk. Prospective investors should carefully consider the
following factors affecting the business of the Company.

HISTORY OF LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY. The Company has incurred
significant operating losses since inception. The consolidated net loss for the
fiscal year ended June 30, 2001 was approximately $172,000. The Company's
accumulated deficit at June 30, 2001 was approximately $23,500,000 including a
one-time charge of approximately $6,374,000. The one-time charge is related to
purchased research and development, in connection with the Company's prior
mergers in 1996. The net loss and accumulated deficit will continue to increase.
The Company has not had an extensive operating history and revenues to date have
been limited, and upon sale of the laboratory, are expected to be insignificant.
Potential investors should be aware of the problems, delays, expenses and
difficulties encountered by an enterprise in the Company's stage of development,
many of which may be beyond the Company's control. These include, but are not
limited to, unanticipated problems relating to the competitive and regulatory
environment in which the Company operates and marketing problems and additional
costs and expenses that may exceed current estimates. Potential investors should
be aware of the difficulties normally encountered by new enterprises and the
high rate of failure associated with such enterprises. The likelihood of success
must be considered in light of the problems, expenses, difficulties,
complications, delays and competition encountered in connection with the
development of a business in the biotechnology industry.

The Company has, in fact, encountered significant regulatory problems with the
OsteoPatch(TM) product and has not had access to capital required to restore the
technology licenses and to continue development. It is very unlikely that the
Company will have access to capital for this purpose. The Company has signed an
agreement to sell the business and assets of its Seattle laboratory, the major
source of revenue. Due to these factors, it is likely that the Company will
never achieve significant revenue or profitable operations and may find it
necessary to seek protection from creditors under the bankruptcy laws.

RISK OF BANKRUPTCY. Upon completion of the transaction with Saigene (See
"Significant Recent Developments and Subsequent Events" above), the Company will
still have various debts and claims that need to be settled. These include
amounts owed to various consultants, vendors and suppliers of the Company not
related to the Seattle laboratory operation of approximately $600,000; deferred
compensation to current and former employees of approximately $800,000; accrued
dividends to preferred stockholders of approximately $660,000; and a potential
liability, disputed by the Company, of approximately $2,000,000 related to the
OsteoPatch(TM) technology. The Company will attempt to settle these debts with
cash, stock, and technology assets if possible. There can be no assurance that
the Company will be successful in these negotiations and may have to seek
protection from creditors under the bankruptcy laws. As a consequence, it is
unlikely that investors will receive any return on their investment in the
Company.

EARLY STAGE OF DEVELOPMENT AND TECHNOLOGICAL UNCERTAINTIES. The Company is at an
early stage of development. Except for revenues from its laboratory (which is
under contract to be sold), all of the Company's potential products still



                                       9


<PAGE>


require development and have generated only insignificant amounts of revenue,
and no significant additional product revenues are anticipated. A significant
portion of the Company's resources have been dedicated to the Company's research
and development programs and the Company lacks funds to continue development. It
is highly unlikely that the Company will be able to develop a commercial product
from these projects.

The potential medical diagnostic products and other potential applications of
the Company's technology will require significant additional research and
development and pre-clinical testing and will require extensive clinical testing
prior to submission of any regulatory application for commercial use. The
Company does not have funds to perform this work and is unlikely to have access
to such funds. Furthermore, the Company's potential products are subject to the
risks of failure inherent in the development of medical diagnostic products
based on new technologies. These risks include the possibilities that the
Company's novel approach to diagnosis will not be successful; that any or all of
the Company's potential products will not be found to be safe and effective or
otherwise fail to receive necessary regulatory clearances; that the products, if
safe and effective, will be difficult to manufacture on a large scale or
uneconomical to market; that proprietary rights of third parties will preclude
the Company from marketing such products; or that third parties will market
superior or equivalent products. It is extremely unlikely that the Company can
resume research and development activities or develop commercially viable
products.

FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company will
require substantial additional funds in order to continue the research and
development programs and pre-clinical testing of its potential diagnostic
products and to conduct clinical trials and marketing of such products that may
be developed. The Company's capital requirements depend on numerous factors,
including the progress of its research and development programs, the progress of
pre-clinical and clinical testing, the time and costs involved in obtaining
regulatory approvals, the cost of filing, prosecuting, defending and enforcing
any patent claims and other intellectual property rights, competing
technological and market developments, changes in the Company's existing license
and supply relationships, the ability of the Company to establish collaborative
arrangements, the development of commercialization activities and arrangements,
and the purchase of additional capital equipment. Other than the Company's
laboratory revenues (the laboratory is under contract to be sold), the Company
has no current source of revenues or capital. The Company believes that its
current condition makes it nearly impossible to raise capital from sources other
than the sale of assets. Accordingly, after the sale of the laboratory, the
Company will have limited assets with which to raise funds or satisfy its
obligations.

DEPENDENCE ON LICENSES. The Company has licensed technologies with respect to
the development of the OsteoPatch(TM), other SweatPatch(TM) related products and
SalivaSac(R) applications. The Company had entered into arrangements with
Sudormed with respect to the OsteoPatch(TM) and other SweatPatch(TM) related
development projects, and ActiMed, with respect to development of SalivaSac(R)
applications.

Both the License Agreement with Sudormed and the license agreement with ActiMed
have been terminated by the licensors as a result of the Company's inability to
make payments for technology licenses and development work. Accordingly, it is
unlikely that the Company will be able to develop products that rely on such
licensed technology.

UNCERTAINTY OF PROTECTION OF PATENTS AND INTELLECTUAL PROPERTY RIGHTS; RISK OF
PATENT INFRINGEMENT LIABILITY. The Company does not have the resources to
protect existing patents, licenses, intellectual property rights, trade secrets,
and to prevent others from infringing on the intellectual property rights of the
Company. In addition, the Company has exclusive licenses from third parties
under various U.S. patents and pending U.S. patent applications to the
technology covered in whole or in part by the claims therein. Since a patent may
be invalid or circumvented by alternative technologies, there can be no
assurance as to the breadth of protection that any such patents may afford the
Company. In the event the Company is held liable for patent infringement,
insurance may not cover any or all of the infringement damages and as such, any
infringement liability would adversely affect the business, financial condition
and results of operations of the Company.

GOVERNMENT REGULATION AND PRODUCT APPROVAL. The FDA and comparable agencies in
state and local jurisdictions and in foreign countries impose substantial
requirements upon the testing, manufacturing and marketing of therapeutic and
diagnostic products, through lengthy and detailed laboratory and clinical
testing procedures, sampling activities and other costly and time consuming
procedures. Satisfaction of these requirements may take several years or more
and varies substantially based upon the type, complexity and novelty of the
diagnostic product. In addition, the Company's laboratory business is subject to
federal regulation under the Clinical Laboratory Improvement Amendments of 1988

                                       10
<PAGE>

("CLIA") and regulations promulgated thereunder and the FDA's Good Laboratory
Practices for Non-clinical Laboratory Studies regulations. Failure to comply
with applicable regulations could result in loss of certification under CLIA and
disqualification resulting in the exclusion of studies performed in the
laboratory from consideration in support of FDA submissions, as well as civil
and criminal sanctions.

In May 1998, the Company announced that it received a letter from the FDA in
response to its 510(k) application. Following several conversations, submission
of additional analysis of the data, and a meeting with FDA officials, the
Company was unable to convince the FDA that its 510(k) application for the
OsteoPatch(TM) should be cleared. Furthermore, the Company was unable to
successfully negotiate requirements for approval that could be achieved with
available financial resources. Accordingly, the Company ceased development of
the product in August, 1998 and searched for additional funding or buyers for
the technology. The Company has not been successful in either raising capital to
continue development or in finding a buyer for the technology. Accordingly, the
Company will not be able to develop the OsteoPatch(TM) or other products using
the SweatPatch(TM) technology.

In addition to the OsteoPatch(TM), two products were developed through the
feasibility stage utilizing the SalivaSac(R) technology with regard to glucose
screening and glucose monitoring for possible applications as diabetes related
products. While the Company believes that the results attained to date in such
studies relating to SalivaSac(R) support further research and development of
these potential products, the Company does not have sufficient resources to
engage in such activity.

RISKS INHERENT IN INTERNATIONAL TRANSACTIONS. The Company currently has only one
foreign distribution arrangement with respect to distribution of the
OsteoPatch(TM) in Italy through Segix. Such agreement contains provisions
requiring minimum purchases and investment in marketing, foreign currency
adjustment mechanisms, unit price adjustment mechanisms, and exclusivity for the
territory of Italy, Vatican City and San Marino. The agreement has an initial
term of ten years. Further, international sales and operations may be limited or
disrupted by the imposition of government controls, export license requirements,
economic and political instability, price controls, trade restrictions, and
changes in tariffs or difficulties with foreign distributors. Segix launched the
product on a limited basis in January, 1999 and subsequently ceased its efforts
due to the Company's financial situation and the termination of the License
Agreement and the Supply Agreement by Sudormed in May, 1999. Foreign regulatory
agencies often establish product standards different from those in the U.S. and
any inability to obtain or maintain foreign regulatory approvals on a timely
basis could have a material adverse effect on the Company's arrangement with
Segix or others in the future. Additionally, the Company's business, financial
condition and results of operations may be materially and adversely affected by
fluctuations in currency exchange rates as well as increases in duty rates and
difficulties in obtaining required licenses and permits. There can be no
assurance that the Company will be able to successfully commercialize its
products in any foreign market. In addition, the laws of some countries do not
protect the Company's proprietary rights to the same extent as do the laws of
the U.S.

Distribution of the Company's products outside the U.S. is subject to extensive
foreign government regulation. These regulations, including the requirements for
approvals or clearance to market, the time required for regulatory review and
the sanctions imposed for violations, vary from country to country. There can be
no assurance that the Company will obtain regulatory approvals in such countries
or that it will not be required to incur significant costs in obtaining or
maintaining its foreign regulatory approvals. In addition, the export by the
Company of certain of its products, which have not yet been cleared for domestic
commercial distribution, may be subject to FDA export restrictions. Failure to
obtain necessary regulatory approvals, the restriction, suspension or revocation
of existing approvals or any other failure to comply with regulatory
requirements would have a material adverse effect on the Company's ability to
distribute products outside the United States.

MANUFACTURING LIMITATIONS. The Company depends upon third parties for the
manufacture of its products. The Company is unable to order more product from
either 3M or Metra (Metra Biosystems was acquired by Quidel Corporation.) and
cannot seek alternate sources to manufacture due to contractual provisions in
existing agreements and lack of sufficient financial resources. Accordingly,
once existing inventory is depleted, the Company will not be able to sell
additional OsteoPatch(TM) products.

COMPETITION AND TECHNOLOGICAL CHANGE. There are many companies, both public and
private, including well-known pharmaceutical companies, chemical companies and
specialized biotechnology companies, engaged in developing



                                       11



<PAGE>




medical diagnostic products for certain of the applications being pursued by the
Company. Many of these companies have substantially greater capital, research
and development, manufacturing, marketing and human resources and experience
than the Company and represent substantial long-term competition for the
Company. Such companies may develop products more quickly or products that are
more effective and less costly than any that may be developed by the Company.
The industry in which the Company proposes to compete is characterized by
extensive research efforts and rapid technological progress. New developments
are expected to continue and there can be no assurance that discoveries by
others will not render the Company's products or potential products
noncompetitive. Competition may increase further as a result of advances that
may be made in the commercial applicability of technologies and greater
availability of capital for investment in these fields. Currently, the Company
is unable to compete effectively due to its financial condition.

RELIANCE ON DISTRIBUTORS, SUPPLIERS AND MANUFACTURERS. The Company is, and
expects that it will continue to be, highly dependent upon certain distributors,
suppliers and manufacturers and the Company's ability to operate competitively
will depend, at least in part, on its ability to assure continuous and reliable
sources of distribution and supply. The Company is currently dependent on
Sudormed for the supply and manufacture of the Company's skin patch related
products, including the OsteoPatch(TM). Sudormed subcontracts its supply and
manufacturing obligations to 3M. However such suppliers are unwilling to
continue to produce products or components for the Company. Accordingly, once
existing inventory is depleted, the Company will not be able to sell additional
OsteoPatch(TM) products.

DEPENDENCE ON MAJOR CUSTOMERS. Revenues received from laboratory operations are
generally pursuant to short-term contracts. The Company has no long-term
contracts or agreements with its customers. Each contract is negotiated
separately with the pharmaceutical manufacturer or research organization and is
usually limited to a specific project with limited duration. The cancellation of
any contracts with existing customers or the failure to replace such contracts
upon expiration or termination could have a material adverse effect on the
Company's laboratory operations. Sales to the Company's five largest customers
represented approximately 49 percent and 41 percent of total sales in fiscal
2001 and fiscal 2000, respectively. The laboratory is under contract to be sold
to Saigene, subject to stockholder approval and other requirements.



                                       12
<PAGE>


ITEM 2  - PROPERTIES

The Company's executive offices were located at 25651 Atlantic Ocean Drive,
Suite A-1, Lake Forest, California and its laboratory facilities are located in
Seattle, Washington. The Company vacated the Lake Forest facility in July 1999
after defaulting on the lease. The landlord of this facility has obtained a
judgment against the Company in the amount of $150,000 plus monthly accruals
equal to $13,000. See "Legal Proceedings". The Company also leases approximately
15,000 square feet of office and laboratory space in Seattle, Washington
pursuant to a ten-year lease at an average annual rental of $238,000, which
expires on September 30, 2007. With respect to the Seattle property, a security
deposit of $100,000 has been placed in an interest bearing account in the
Company's name, with interest earned accruing to the Company. This amount has
been classified as restricted cash on the accompanying consolidated balance
sheet and has a current balance of $69,000 as modified by mutual agreement with
the landlord.

In order to replace its executive office facility in Lake Forest, the Company
entered into a month-to-month lease of an office in a shared executive office
facility at 23120 Alicia Parkway, Suite 200 in Mission Viejo, California at a
monthly rental of approximately $900.


ITEM 3  - LEGAL PROCEEDINGS

On May 10, 2001 a Final Judgment of Permanent Injunction was issued by the
United States District Court for the District of Columbia ordering the Company
to (a) file with the SEC, on or before June 29, 2001: (1) the Company's Annual
Report on Form 10-KSB for its fiscal year ended June 30, 2000; (2) the Company's
Quarterly Reports on Form 10-QSB for its quarters ended March 31, September 30,
and December 31, 2000; and (3) such other periodic reports which may become due
prior to the entry of the Final Judgment, and (b) file timely and in proper form
with the SEC accurate and complete information and reports of the Company as are
required to be filed under the securities laws. All such reports were filed on
June 29, 2001. Accordingly, the Company believes it is currently in compliance
with such Final Judgment.

On September 24, 1997 the Company received from the former manufacturer of
SPINPRO(R) a demand for arbitration in connection with alleged breaches of the
contract relating to the manufacture of SPINPRO(R). The former manufacturer is
seeking damages of approximately $515,000. The Company does not believe that the
claims have any merit and believes that the ultimate outcome of this proceeding
will not have a material impact on the Company. The Company is vigorously
contesting such claims and has filed counterclaims against the former
manufacturer. The Company has also filed for arbitration against a former vendor
relating to SPINPRO(R), seeking damages for alleged breach of contract with
respect to the manufacture of molds for SPINPRO(R) parts.

As previously reported, the landlord of the Company's previous office and
laboratory space in Lake Forest, California was proceeding against the Company
to cancel the lease. The landlord has obtained a judgment against the Company
from Orange County Superior Court for approximately $150,000 related to the
default on the lease. In addition, liabilities continue to accrue at about
$13,000 per month until the space is leased. The total liability to the Company
is estimated to be approximately $350,000. The Company has been advised by
Saigene Corporation ("Saigene"), the proposed purchaser of the Company's
laboratory, that Saigene has purchased from the landlord of the Lake Forest
property, for the sum of $350,000, the rights to all claims and judgments
rendered against the Company related to its default on the Lake Forest lease,
subject to the sale of the Company's laboratory assets to Saigene. However, it
is unclear whether or not Saigene may re-assign such rights to the landlord if
the sale of the laboratory assets to Saigene is not completed. In any event,
Saigene, under the terms of the First Amendment to the Purchase Agreement, has
agreed that Saigene will be responsible for satisfaction of such judgment and,
therefore, the Company believes it would be entitled to seek recovery from
Saigene for any costs or liabilities as a result of Saigene's failure to satisfy
such claim.


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

No matters were submitted to a vote of security holders during the fourth
quarter ended June 30, 2001.

                                       13

<PAGE>

PART II

ITEM 5 - MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED
          STOCKHOLDER MATTERS

The Common Stock of the Company began trading in October 1996 (subsequent to the
initial public offering) on the Nasdaq Stock Market under the symbol "PBMI". In
March 1999 the Company's securities were delisted from the Nasdaq Stock Market
as the Company failed to meet the maintenance requirements for tangible net
assets and minimum stock price. The stock currently trades on the OTC electronic
Bulletin Board or in the over-the-counter market.

                                                           COMMON STOCK
                                                           ------------
                                                     High              Low
                                                     ----              ---
First Quarter ended 9/30/99                            .312            .125
Second Quarter ended 12/31/99                          .187            .050
Third Quarter ended 3/31/00                           1.000            .050
Fourth Quarter ended 6/30/00                           .437            .130

First Quarter ended 9/30/00                            .140            .050
Second Quarter ended 12/31/00                          .100            .010
Third Quarter ended 3/31/01                            .080            .020
Fourth Quarter ended 6/30/01                           .020            .020

On June 30, 2001, the per share closing sales price of the Common Stock was $.02
as reported in the OTC market/OTCBB. As of August 31, 2001 the closing sales
price of the Common Stock was $.30. As of August 31, 2001, the Company had
approximately 133 holders of record with respect to the Common Stock.

At this time the Company does not pay a dividend on the common stock and does
not plan to in the immediate future. The Company has accrued dividends on the
Preferred Stock of approximately $660,000 as of June 30, 2001.




                                       14

<PAGE>


ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS
         OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes in this Form 10-KSB.

OVERVIEW

Pacific Biometrics, Inc. ("PBI" or the "Company") was incorporated in Delaware
in May 1996 in connection with the acquisition of BioQuant, Inc. ("BioQuant"), a
Michigan corporation, and Pacific Biometrics, Inc. ("PBI-WA"), a Washington
corporation. On June 28, 1996, the Company completed the mergers whereby
BioQuant and PBI-WA became wholly owned subsidiaries of the Company in separate
stock-for-stock exchange transactions.

PBI is a development stage company that provides specialty reference laboratory
services to the pharmaceutical and diagnostics industries. The Company's
specialty reference laboratory is under contract to be sold to Saigene
Corporation for a total consideration of $4,000,000. PBI and Saigene have also
entered into the Management Agreement in which Saigene provides day-to-day
management of the laboratory. The Company had previously been engaged in the
development and commercialization of non-invasive diagnostics to improve the
detection and management of chronic diseases, which commercialization efforts
have been terminated due to the Company's inability to obtain FDA approval for
its OsteoPatch(TM) product and lack of necessary funding. The Company has
developed two patented technologies that permit the use of sweat and saliva as
diagnostic fluids.

Expenses consist, and are expected to continue to consist, primarily of
operating expenses necessary for the laboratory operations. In addition, the
Company maintains a small corporate office in Mission Viejo, California.

As of June 30, 2001, the Company had an accumulated deficit since inception of
$23,502,356, which included a one-time charge of $6,373,884 for the value of
purchased research and development expenses relating to the Company's merger
with BioQuant and a one-time charge of $428,368 relating to a prior merger
involving PBI-WA in 1995.

As previously reported, the Company executed the Purchase Agreement with
Saigene. The Purchase Agreement, which is subject to stockholder approval, will
transfer the business and all assets of the Company's Seattle laboratory
operation to Saigene for a total consideration of $4,000,000. Saigene failed to
satisfy certain conditions relating to payments as required and defaulted on the
Purchase Agreement. Saigene requested a further extension to January 20, 2001 to
complete the Purchase Agreement and the Company and Saigene signed the Second
Amendment on August 4, 2000.

In exchange for this extension, Saigene agreed to the following additional
terms. Saigene paid the Company $50,000 on May 22, 2000 and $75,000 on July 19,
2000 to be credited as part of the purchase price. Saigene paid $20,000 on each
of August 28th, September 20th, October 20th, November 20th and December 20,
2000. One-half of each $20,000 payment will be credited toward the purchase
price and one-half of each payment will be consideration paid for the additional
time extension. Payments toward the purchase price will be credited against the
escrow payment required at the time of closing. All payments made according to
the Second Amendment will be forfeited by Saigene if they fail to make any of
the required payments, including the closing payments. Saigene and the Company
have further agreed that Saigene may extend the January 20, 2001 Closing Date on
a month-by-month basis by increasing the monthly payments to $30,000 beginning
January 20, 2001. One-half of each such payment would be credited to the
purchase price and one-half would be consideration for the additional time
extension. The Company has the right to terminate the Purchase Agreement at the
end of any extension period by giving 20 days' prior written notice.

Saigene failed to complete the Purchase Agreement on January 20, 2001 but has
elected to extend the Closing Date on a month-by-month basis having made all
required payments due through December 20, 2000 and all payments due from
January 20, 2001 through August 20, 2001.

There can be no assurance that Saigene will be able to complete the Purchase
Agreement as amended or consummate the transactions contemplated therein.
Failure to complete this transaction would likely return operational control of
the laboratory to the Company. While the laboratory would have less debt as a
result of the Second Amendment, the Company will not be financially capable of
maintaining the laboratory operation and there can be no assurance that




                                       15


<PAGE>

another buyer could be found in a timely manner. This could force the Company to
seek protection from creditors under the bankruptcy laws.

Even upon completion of the transaction with Saigene, the Company will still
have significant debts and claims that need to be settled. These include amounts
owed to various consultants, vendors and suppliers of the Company not related to
the Seattle laboratory operation of approximately $600,000; deferred
compensation to current and former employees of approximately $800,000; accrued
dividends to preferred stockholders of approximately $660,000; and a potential
liability, disputed by the Company, of approximately $2,000,000 related to the
OsteoPatch(TM) technology. The Company will attempt to settle these debts with
cash, stock, and technology assets. There can be no assurance that the Company
will be successful in these negotiations and may have to seek protection from
creditors under the bankruptcy laws. If the Company is successful in settling
the remaining debts, then the Company plans to pursue a merger with another
company as a means of providing some value to common stockholders. There can be
no assurance that the Company will be successful in finding and negotiating a
successful merger or that any such merger would create value for the
stockholders.

On May 10, 2001 a Final Judgment of Permanent Injunction was issued by the
United States District Court for the District of Columbia ordering the Company
to (a) file with the SEC, on or before June 29, 2001,: (1) the Company's Annual
Report on Form 10-KSB for its fiscal year ended June 30, 2000; (2) the Company's
Quarterly Reports on Form 10-QSB for its quarters ended March 31, September 30,
and December 31, 2000; and (3) such other periodic reports which may become due
prior to the entry of the Final Judgment, and (b) file timely and in proper form
with the SEC accurate and complete information and reports of the Company as are
required to be filed under the securities laws. All such reports were filed on
June 29, 2001. Accordingly, the Company believes it is currently in compliance
with such Final Judgment.

RESULTS OF OPERATIONS

The following tables compare the years ending June 30, 2001 and June 30, 2000 as
shown in the attached financial statements and the prior comparative year ending
June 30, 1999 and shows the year to year variances on a dollar and percentage
basis for informative purposes. All dollar amounts are rounded to the nearest
thousand.

<TABLE>
<CAPTION>
Laboratory revenues:
-----------------------------------------------------------------------------------------------
   6/30/01       6/30/00      6/30/99      01 vs. 00    00 vs. 99    01 vs. 00     00 vs. 99
-----------------------------------------------------------------------------------------------
<S>             <C>          <C>          <C>          <C>          <C>            <C>
    $1876         $1,371       $1,405        $505         ($34)         37 %          -2%
-----------------------------------------------------------------------------------------------
</TABLE>

Laboratory revenues increased in 2001 due to increases in size and number of
clinical trials for which the laboratory performed testing and consulting work.
Laboratory revenues decreased in 2000 due to decreases in these same variables.
As previously disclosed, the Company has entered into an agreement to sell the
laboratory. Accordingly, assuming that the laboratory is sold in fiscal 2002,
laboratory revenues will no longer contribute to the revenues of the Company
subsequent to such sale.

Product revenues:

Product revenues are no longer presented as they have not contributed materially
to revenues in the prior two fiscal years and are not expected to contribute
materially in the future.

<TABLE>
<CAPTION>
Laboratory expenses and cost of goods sold:
-----------------------------------------------------------------------------------------------
   6/30/01       6/30/00      6/30/99      01 vs. 00    00 vs. 99    01 vs. 00     00 vs. 99
-----------------------------------------------------------------------------------------------
<S>             <C>           <C>         <C>           <C>          <C>          <C>
     $962          $951        $1,233         $11         ($282)         1%          -23%
-----------------------------------------------------------------------------------------------
</TABLE>

Laboratory expenses and cost of goods sold expenditures in 2001 were comparable
to 2000. In 2000, the decrease in expenses and cost of goods sold reflected
significant cost-cutting measures implemented as a result of the Company's
severe financial problems.

                                       16
<PAGE>

<TABLE>
<CAPTION>
Diagnostic research and product development:
-----------------------------------------------------------------------------------------------
   6/30/01       6/30/00      6/30/99      01 vs. 00    00 vs. 99    01 vs. 00     00 vs. 99
-----------------------------------------------------------------------------------------------
<S>             <C>           <C>         <C>           <C>          <C>          <C>
     $19           $64          $790         ($45)        ($726)        -70%         -92%
-----------------------------------------------------------------------------------------------
</TABLE>

Costs decreased in 2001 and 2000 as PBI curtailed research and development
programs due to its severe financial problems.

<TABLE>
<CAPTION>
Selling, general and administrative:
-----------------------------------------------------------------------------------------------
    6/30/01       6/30/00      6/30/99     01 vs. 00     00 vs. 99    01 vs. 00    00 vs. 99
-----------------------------------------------------------------------------------------------
<S>             <C>           <C>         <C>           <C>          <C>          <C>
    $1,187         $1,201       $2,340       ($14)       ($1,139)        -1%          -49%
-----------------------------------------------------------------------------------------------
</TABLE>

Selling, general and administrative expenditures in 2001 were comparable to
2000. The decrease in selling, general and administrative costs in 2000
reflected significant cost-cutting measures implemented as a result of the
Company's severe financial problems.

<TABLE>
<CAPTION>
Other income and (expense):
-----------------------------------------------------------------------------------------------
   6/30/01       6/30/00      6/30/99      01 vs. 00    00 vs. 99    01 vs. 00     00 vs. 99
<S>             <C>           <C>         <C>           <C>          <C>          <C>
-----------------------------------------------------------------------------------------------
     $118         ($72)       ($2,397)       $190         $2,325        264%         -98%
-----------------------------------------------------------------------------------------------
</TABLE>

The increase in net other income in 2000 is primarily due to fees paid by
Saigene in consideration of extending the deadline for purchase of the
laboratory. The higher other expense in 1999 is primarily due to the other
expense related to the write-down of OsteoPatch(TM) assets.

<TABLE>
<CAPTION>
Net loss:
-----------------------------------------------------------------------------------------------
   6/30/01       6/30/00      6/30/99      01 vs. 00    00 vs. 99    01 vs. 00     00 vs. 99
-----------------------------------------------------------------------------------------------
<S>             <C>           <C>         <C>           <C>          <C>          <C>
    ($172)        ($915)      ($6,069)       $743         $5,154        81%          -85%
-----------------------------------------------------------------------------------------------
</TABLE>

The net loss decrease in 2001 is due to increased revenues and a stable level of
expenditures. The net loss decreased in 2000 due to curtailed expenses in all
areas and significant write-downs taken in 1999.



LIQUIDITY AND CAPITAL RESOURCES

FINANCING
---------

On February 20, 1998, the Company consummated the sale of 925,000 shares of
Series A Convertible Preferred Stock (the "Preferred Stock") with an
institutional investor for an aggregate purchase price of $1,850,000. In
addition, the Company granted such institutional investor an option (the
"Option") to purchase an additional 625,000 shares of Preferred Stock until May
20, 1998 for an exercise price of $1,250,000. The Option was exercised in full
during May 1998. The Preferred Stock is convertible into shares of the Company's
Common Stock at the option of the holder at any time on a one-for-one basis,
subject to adjustment for stock splits, dividends and similar events. The
Preferred Stock provides for a cumulative cash dividend payable quarterly in
arrears at an annual rate of 8%. The Company has the right to force conversion
of the Preferred Stock in the event the price per share of the Common Stock is
$8.00 or more for twenty consecutive trading days. The Company has agreed to use
commercially reasonable efforts to effect the registration of the Common Stock
into which the Preferred Stock is convertible. To date, no such efforts have
been undertaken. The Company is not current on dividend payments and, as of June
30, 2001, the Company has accrued dividends on the Preferred Stock of
approximately $660,000. Terry Giles, a former and current director of the
Company, has purchased 925,000 shares of the Preferred stock from the original
institutional investors.

The Registration Statement pertaining to the initial public offering ("IPO") of
the Company was declared effective by the Securities and Exchange Commission on
October 29, 1996. Gross proceeds from the public offering were $8,075,000. The
Company has used the net proceeds from the offering (approximately $6.3 million)
for product development activities relating to the OsteoPatch(TM), for funding
the growth of its central reference laboratory operations, working capital, and
also used approximately $1.2 million to repay debt.

In April 1997, the Company entered into a capital equipment leasing facility
with Transamerica Business Credit Corporation to provide credit for equipment
purchases up to $1,500,000. The Company issued 51,429 warrants to


                                       17

<PAGE>



Transamerica as part of this agreement. The Company received gross proceeds of
$376,808 under the agreement during fiscal 1997 and received gross proceeds of
$329,154 during fiscal 1998. The Company is required to raise additional capital
in order to draw additional funding from this arrangement.

The Company has continued to negotiate forbearance agreements with Transamerica
Business Credit related to payments due on capital leases. In exchange for the
first forbearance agreement the 51,429 warrants were repriced to $0.50 per share
in December 1998. No discount was recorded for the value of the warrants because
the amount was not material.

In exchange for the most recent Forbearance Agreement, dated August 1999, the
Company had repriced warrants previously issued to Transamerica, granted
Transamerica additional warrants and a lien position on assets of the Company.
This Forbearance Agreement expired on September 30, 1999 and was extended again
through December 31, 1999 in exchange for 150,508 additional warrants. Although
the Forbearance Agreement has expired, Transamerica has not taken action to
collect the debt, which approximates $460,000. Most of this debt will be assumed
by Saigene upon sale of the laboratory.

In April of 1999, the Company and its subsidiaries entered into an Accounts
Receivable Factoring Agreement (the "Factoring Agreement") with Silicon Valley
Bank (the "Bank"). The Company issued 93,024 warrants to the Bank as part of the
Factoring Agreement. The Company has been factoring the majority of the accounts
receivable from laboratory operations to provide the Company with working
capital to meet laboratory operations obligations and to maintain minimal
corporate operations. Under the terms of the Factoring Agreement, the Bank will
advance 80% of accepted receivables and charge the Company an administrative fee
of .75% and an annualized rate of 21% on outstanding balances. The amount
outstanding as of June 30, 2001 was $51,587.

The Company extended until June 30, 1999, the 1,700,000 warrants issued in
conjunction with the Company's initial public offering of its securities in
October 1996. These warrants expired by their terms on June 30, 1999.

The Company has entered into deferred compensation agreement with four of its
senior executives. The agreements provide that a specified portion of their
salaries be deferred until they elect to receive the deferred amount. Deferred
compensation expense in connection with these agreements was $88,000 and 198,533
for the years ended June 30, 2001 and 2000, respectively, and $558,363 for the
period from inception to June 30, 2001. In 1997, the liability for deferred
compensation of $64,413 was converted to a promissory note bearing annual
interest at 7% and is payable on demand. In 1999, the liability for deferred
compensation of $198,583 was converted to a promissory note bearing annual
interest at 7% and is payable on demand. This obligation is included with notes
payable to related parties on the accompanying consolidated balance sheet. The
Company has not made any interest payments since September 1998. Additional
deferred compensation of $295,368 to various employees was due as of June 30,
2001 and is not part of the above-mentioned notes payable.

The Company had entered into a contract for management and consulting services
with a company owned by certain of the Company's stockholders. The Company
incurred $109,000 and $186,000 for management and consulting services provided
during the years ended June 30, 1995 and 1996, respectively. The liability for
management consulting services under the contract of $187,000 as of June 30,
1996 was converted in 1997 to a promissory note bearing annual interest at 7%
and is payable on demand. This obligation is included with notes payable to
related parties on the accompanying consolidated balance sheet. The management
contract was terminated effective June 28, 1996.


                                       18
<PAGE>


PRODUCTS AND SERVICES
---------------------

In May 1998, the Company received a letter from the FDA in response to its
510(k) application for the OsteoPatch(TM) device notifying the Company that the
agency did not find the device to be substantially equivalent to the predicate
device, a urine test marketed by Metra Biosystems. Despite numerous discussions
and a meeting with the FDA in July 1998, the Company was unable to reverse the
agency's decision or negotiate requirements for additional data that were within
the Company's financial ability to perform. Due to lack of funds, the Company
ceased development activities on the OsteoPatch(TM) device in August 1998.

In December 1998, the Company failed to make a payment of $1.6 million to
Sudormed, the licensor of the patch technology relating to the SweatPatch(TM)
and OsteoPatch(TM), resulting in a default under the License Agreement and the
Supply Agreement with Sudormed. Sudormed terminated the License Agreement in
May, 1999 for failure to make required payments. The License Agreement permits
the Company to retain full license rights as long as the Company has inventory
of patches. As of June 30, 2001, the Company had approximately 80,000 patches in
inventory, which are no longer saleable due to expirations, but are useable for
research purposes only. All investments in SweatPatch(TM) technology, including
the OsteoPatch(TM) and inventory, were expensed in March 1999.

In May 2000, the Company announced the signing of the Purchase Agreement with
Saigene. This Purchase Agreement, which is subject to stockholder approval, will
transfer the business and assets of the Company's Seattle laboratory operation
to Saigene for a total consideration of $4,000,000, including cash, cash
advances, notes to Preferred Stockholders, and assumption of debt. In August
2000, the Company announced a further extension to the closing date from August
15, 2000 to January 20, 2001. The closing date has been further extended on a
month-by-month basis by Saigene through June 20, 2001. Saigene is able to extend
the closing date by making monthly payments of $30,000, in which half of such
payments may be credited to the purchase price upon consummation of the sale
transaction. The Company can terminate the Purchase Agreement at the end of any
extension period by providing 20 days written notice.

The SalivaSac(R), developed by the Company, collects a non-invasive saliva
sample that the Company had hoped would be able to replace blood and urine
testing in various applications. The Company had been awarded two SBIR Phase I
grants to research this technology for non-invasive glucose monitoring. As a
result of this research the Company had used its SalivaSac(R) technology to
research the development of a screening product to detect diabetes in the
general population and a monitoring product to produce detailed quantitative
measurements of glucose levels to enable diabetics to monitor glucose levels
throughout the day. While previous attempts by others to correlate saliva
glucose with blood glucose have been unsuccessful, the Company has had
encouraging preliminary results using the SalivaSac(R) device, as it appears to
exclude substances that interfere with accurate glucose measurements. However,
almost all development of the SalivaSac(R) has been suspended as of December
1998 due to a lack of funding and without additional funding the Company will
not be able to successfully develop the SalivaSac(R) for such use. On August 15,
2000 the Company was issued United States Patent No. 6,102,872 for Glucose
Detector and Method as a result of the SalivaSac(R) research conducted earlier.
In September, 1999 the Company received a SBIR Phase I grant to research the use
of the SalivaSac(R) technology for the collection and measurement of
homocysteine, a newly discovered marker with potential application for use as a
risk factor in heart disease. The Company was not able to make any useful
discoveries with this Phase I grant and has no plans to file for a Phase II
grant for the homocysteine application.

FUTURE OPERATING RESULTS
------------------------

As previously reported, the Company executed the Purchase Agreement with
Saigene. The Purchase Agreement, which is subject to stockholder approval, will
transfer the business and all assets of the Company's Seattle laboratory
operation to Saigene for a total consideration of $4,000,000. Saigene failed to
satisfy certain conditions relating to payments as required and defaulted on the
Purchase Agreement. Saigene requested a further extension to January 20, 2001 to
complete the Purchase Agreement.

In exchange for this extension, Saigene agreed to the following additional
terms. Saigene paid the Company $50,000 on May 22, 2000 and $75,000 on July 19,
2000 to be credited as part of the purchase price. Saigene paid $20,000 on each
of August 28th, September 20th, October 20th, November 20th and December 20,
2000. One-half of each $20,000 payment will be credited toward the purchase
price and one-half of each payment will be consideration paid for the additional
time extension. Payments toward the purchase price will be credited against the
escrow payment required at








                                       19

<PAGE>


the time of closing. All payments made according to the Second Amendment will be
forfeited by Saigene if they fail to make any of the required payments,
including the closing payments. Saigene and the Company have further agreed that
Saigene may extend the January 20, 2001 Closing Date on a month-by-month basis
by increasing the monthly payments to $30,000 beginning January 20, 2001.
One-half of each such payment would be credited to the purchase price and
one-half would be consideration for the additional time extension. The Company
has the right to terminate the Purchase Agreement at the end of any extension
period by giving 20 days' prior written notice.

Saigene failed to complete the Purchase Agreement on January 20, 2001 but has
elected to extend the Closing Date on a month-by-month basis having made all
required payments due through December 20, 2000 and all payments due from
January 20, 2001 through August 20, 2001.

There can be no assurance that Saigene will be able to complete the Purchase
Agreement as amended or consummate the transactions contemplated therein.
Failure to complete this transaction would likely return operational control of
the laboratory to the Company. While the laboratory would have less debt as a
result of the Second Amendment, the Company will not be financially capable of
maintaining the laboratory operation and there can be no assurance that another
buyer could be found in a timely manner. This could force the Company to seek
protection from creditors under the bankruptcy laws.

Even upon completion of the transaction with Saigene, the Company will still
have significant debts and claims that need to be settled. These include amounts
owed to various consultants, vendors and suppliers of the Company not related to
the Seattle laboratory operation of approximately $600,000; deferred
compensation to current and former employees of approximately $800,000; accrued
dividends to preferred stockholders of approximately $660,000; and a potential
liability, disputed by the Company, of approximately $2,000,000 related to the
OsteoPatch(TM) technology. The Company will attempt to settle these debts with
cash, stock, and technology assets. There can be no assurance that the Company
will be successful in these negotiations and may have to seek protection from
creditors under the bankruptcy laws. If the Company is successful in settling
the remaining debts, then the Company plans to pursue a merger with another
company as a means of providing some value to common stockholders. There can be
no assurance that the Company will be successful in finding and negotiating a
successful merger or that any such merger would create value for the
stockholders.

The landlord of the Company's previous office and laboratory space in Lake
Forest, California cancelled the lease. The landlord also obtained a judgment
against the Company from Orange County Superior Court for approximately $150,000
related to the default on the lease. In addition, liabilities continued to
accrue at about $13,000 per month until the space is leased. The total liability
to the Company is estimated to be approximately $350,000. The Company has been
advised by Saigene that Saigene has purchased from the landlord of the Lake
Forest property, for the sum of $350,000, the rights to all claims and judgments
rendered against the Company related to its default on the Lake Forest lease,
subject to the sale of the Company's laboratory assets to Saigene. However, it
is unclear whether or not Saigene may re-assign such rights to the landlord if
the sale of the laboratory assets to Saigene is not completed. In any event,
Saigene, under the terms of the First Amendment, has agreed that Saigene will be
responsible for satisfaction of such judgment and, therefore, the Company
believes it would be entitled to seek recovery from Saigene for any costs or
liabilities as a result of Saigene's failure to satisfy such claim. While the
laboratory would have less debt as a result of the Purchase Agreement, the
Company will not be financially capable of maintaining the laboratory operations
and there can be no assurance that another buyer could be found in a timely
manner. This could force the Company to seek protection from creditors under the
bankruptcy laws.

The Minnesota Mining and Manufacturing Company (3M), as a party in possession of
secured property, has not informed the Company of its plans for the Sudormed
assets. This includes the SkinPatch(TM) technology rights, which are part of the
Company's OsteoPatch(TM) product. The Company had sought to reestablish certain
rights to this technology in order to create additional value for the Company's
other intellectual property related to the OsteoPatch(TM). Without an agreement
with 3M, the Company's OsteoPatch(TM) assets may not have any value. The Company
expensed all of these assets in March 1999. In May 2000, 3M notified the Company
that, in its capacity as a secured party in possession of the Sudormed assets,
it demands payment in full of the $1.6 million plus accrued interest and fees
due under the License Agreement between the Company and Sudormed. The Company
and 3M are seeking to settle this claim. 3M has objected to the laboratory sale
transaction that is proceeding with Saigene. Although the Company disputes 3M's
claim, 3M may seek to enforce its rights through legal process. The Company is
not certain of the impact of 3M's demand on




                                       20
<PAGE>

the proposed transaction with Saigene or what legal rights may be asserted by 3M
to protect its claim. If 3M should be successful in blocking the proposed sale
of the laboratory, or commences a legal action against the Company, the Company
may have no alternative than to seek protection from creditors under the
bankruptcy laws.

ITEM 7  - FINANCIAL STATEMENTS

The required financial statements appear at the end of this report, and are
incorporated herein by reference. See index to consolidated financial statements
at page F-1.


ITEM 8  - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
          ACCOUNTING AND FINANCIAL DISCLOSURES

Not applicable.


                                       21
<PAGE>

PART III

ITEM 9 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
         COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

DIRECTORS AND OFFICERS AS OF JUNE 30, 2001
------------------------------------------

<TABLE>
<CAPTION>
                                                PRESENT PRINCIPAL OCCUPATION AND
NAME, BUSINESS                                    PRINCIPAL OCCUPATION DURING LAST                    DIRECTOR
ADDRESS AND AGE                                     FIVE YEARS; OTHER ACTIVITIES                        SINCE
------------------------------------ ------------------------------------------------------------ ------------------
<S>                                  <C>                                                          <C>
Paul G. Kanan                        Paul G. Kanan has served since July 1996 as the  President,        1996
Age 55                               Chief Executive Officer and a director of the Company,  and
                                     served  from 1993 to 1996 as the  President  and a director
                                     of  BioQuant.  Mr. Kanan is also an officer and director of
                                     CEO  Advisors,  a  health  care  consulting  firm  that  he
                                     co-founded in 1992. From 1991 to 1992,  Mr. Kanan  operated
                                     his own health  care  consulting  firm,  and during part of
                                     such period  served as acting CEO and CEO of SPS,  Inc.,  a
                                     healthcare  service  firm.  From 1988 to 1991, he served as
                                     President and CEO of Oncotech,  Inc., a medical  diagnostic
                                     company in Irvine,  California  involved in the development
                                     and marketing of  oncological  testing.  From 1976 to 1988,
                                     Mr.  Kanan was employed by Baxter  Healthcare  Corporation,
                                     most  recently as  President of its  Chemotherapy  Services
                                     Division.   He   received   his  B.S.E.   degree  from  the
                                     University  of Michigan  and an M.B.A.  degree from Harvard
                                     University Graduate School of Business.

Terry M. Giles                       Terry M. Giles has been a  director  of the  Company  since     1996-98 and
Age 53                               March 24, 2000 and was a director of the Company  from July     since 2000
                                     1996 through  September  1998. He was previously a director
                                     of PBI-WA from 1995 to 1996.  In 1975,  Mr.  Giles  founded
                                     the law  firm  of  Giles  and  Burkhalter,  Orange  County,
                                     California,  of  which  he  was  a  member.  Mr. Giles  has
                                     served on the board of  Computerland  since 1987,  and is a
                                     member of the Board of  Regents of  Pepperdine  University.
                                     He received his B.A. from the California  State  University
                                     of  Fullerton  and  his  J.D.  from  Pepperdine  University
                                     School of Law.
</TABLE>


As of June 30, 2001, the directors of the Company consisted of Paul Kanan and
Terry Giles, who was formerly a director of the Company through September 10,
1998 and was reappointed as a director on March 24, 2000.

During the fiscal year ended June 30, 2001, the Company's Board of Directors
held 1 meeting, which was attended by 100% of the then current directors in
person or by telephone.

All directors hold office until the next annual meeting of stockholders and the
election and qualification of their successors. Directors receive compensation
for serving on the Board of Directors as described below. During fiscal 2001,
the Company's audit and compensation committees, were comprised of Messrs. Kanan
and Giles. Officers are elected annually by the Board of Directors and serve at
the discretion of the Board.

There is no family relationship among any of the directors or executive officers
of the Company.

COMPENSATION OF DIRECTORS
-------------------------

                                       22
<PAGE>

The Company's policy is not to pay compensation to directors who are also
employees of the Company for their services as directors. The Company's
compensation policy for non-employee directors is to grant such persons for each
meeting attended in person (up to a maximum of six meetings per year) that
number of stock options, based on the fair market value on the date of grant,
equal to $1,000. The Company will also reimburse reasonable out-of-pocket
expenses of directors for attendance at meetings. No such options were granted
during the years ended June 30, 2000 or 2001.

FILING REQUIREMENTS
-------------------

The Company believes that all filing requirements under Section 16(a) of the
Securities Exchange Act of 1934 applicable to its officers, directors and
greater than 10% beneficial owners were complied with during the fiscal year
ended June 30, 2001, except that Terry Giles, a director of the Company, failed
to timely file the required report upon his election to the board of directors.
Mr. Giles intends to file such report as soon as practicable.

ITEM 10 - EXECUTIVE COMPENSATION

EXECUTIVE COMPENSATION
----------------------

The following table summarizes all compensation paid by the Company with respect
to each of the fiscal years presented for services in all capacities of the
Company's Chairman, the Company's Chief Executive Officer and the Company's
other highly compensated officers (the "Named Executive Officers"). No other
executive officer of the Company earned in excess of $100,000 in any of such
fiscal periods.

                           Summary Compensation Table
                           --------------------------
<TABLE>
<CAPTION>
                                Annual Compensation                           Long-Term Compensation
                                -------------------                           ----------------------
                                                     Other                                                    All
                                                    Annual         Awards                                    Other
                                                    Compen-      Restricted                     LTIP        Compen
  Name and Principal             Salary     Bonus    sation     Stock Awards   Options/        Payouts     -sation
      Position           Year      ($)       ($)     ($)(1)         ($)         SARs (#)        ($)           ($)
      --------           ----      ---       ---     ------         ---         -------         ---           ---
<S>                     <C>      <C>        <C>     <C>         <C>            <C>             <C>           <C>
    Paul G. Kanan        2001    48,000      -       88,000          -             -             -            -
   President, Chief      2000    87,133      -      112,867          -             -             -            -
Executive Officer and    1999    91,667      -         -             -             -             -            -
       Director
</TABLE>
(1)      Deferred compensation, all of which is still payable to the above
         employee as of the date of this report.

OPTION GRANTS DURING FISCAL 2001
--------------------------------

None.


                                       23

<PAGE>


The following table reflects options exercised during the fiscal year and the
year-end values for in-the-money options for each of the named executive
officers:

         AGGREGRATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END
                                OPTION/SAR VALUES
<TABLE>
<CAPTION>
--------------------------- ------------- ----------- ----------------------------- ----------------------------
           Name                Shares       Value         Number of Securities         Value of Unexercised
                            Acquired On    Realized      Underlying Unexercised     In-The-Money Options as of
                            Exercise (#)     ($)      Options as of June 30, 2001        June 30, 2001 ($)
                                                       Exercisable/Unexercisable    Exercisable / Unexercisable
--------------------------- ------------- ----------- ----------------------------- ----------------------------
<S>                         <C>           <C>         <C>                           <C>
Paul G. Kanan                    0            0               313,683 / 0                      0 / 0
--------------------------- ------------- ----------- ----------------------------- ----------------------------
</TABLE>

EMPLOYMENT CONTRACTS
--------------------

None.

ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
          MANAGEMENT

The following table sets forth certain information as of August 31, 2001 with
respect to the number of shares of Common Stock beneficially owned by (i) those
persons known to the Company to be the owners of more than five percent of the
Common Stock, (ii) each director of the Company (one of whom is the Chief
Executive Officer of the Company) and (iii) all directors and executive officers
of the Company as a group. Unless otherwise indicated, each of the listed
persons has sole voting and investment power with respect to the shares
beneficially owned by such stockholder.

<TABLE>
<CAPTION>
NAME AND ADDRESS(1)                    AMOUNT AND NATURE             PERCENT OF
                                         OF BENEFICIAL              COMMON STOCK
                                       OWNERSHIP (2) (3)             OUTSTANDING
<S>                                   <C>                  <C>
Terry M. Giles (4)                         1,346,942                    28.4%

Paul G. Kanan (5)                            372,674                     9.0%

Enterprise Development Fund (6)              303,911                     8.0%
425 North Main Street
Ann Arbor, MI 48104-1133

All directors and officers as a            1,719,616                    34.0%
group (2 persons)(7)
</TABLE>
--------------

(1)   The address of each of these persons is c/o the Company, 23120 Alicia
      Parkway, Suite 200, Mission Viejo, California 92692.
(2)   Unless otherwise noted, all persons named in the table have sole voting
      and dispositive power with respect to all Common Stock beneficially owned
      by them.
(3)   Includes currently exercisable options, warrants to purchase shares of
      Common Stock, and Preferred Stock convertible to Common Stock.


                                       24
<PAGE>

(4)   Includes 416,942 shares of Common Stock, and 930,000 shares of Preferred
      Stock convertible to Common Stock. Mr. Giles' resigned from the Board of
      Directors effective on September 10, 1998 and rejoined the Board of
      Directors effective March 24, 2000.
(5)   Includes 58,991 shares of Common Stock held by the Kanan Living Trust
      Dated May 15, 1990, of which Mr. Kanan is a co-trustee with his wife, and
      313,683 shares of Common Stock subject to currently exercisable warrants
      and options.
(6)   Includes 303,910 shares of Common Stock all held by Enterprise Development
      Fund I, L.P. ("EDF"), of which Enterprise Management, Inc. ("EMI") acts as
      general partner and in which Ms. Mary Campbell, a former director of the
      Company, is an officer and one of three directors. Ms. Campbell disclaims
      beneficial ownership as to all of said shares, except for approximately
      21,000 shares (or approximately 7 percent of such shares) which represents
      her one-third interest in EMI which, in turn, holds an approximately 21
      percent interest in EDF.
(7)   Includes 779,843 shares of Common Stock, 313,683 shares of Common Stock
      subject to currently exercisable options and warrants, and 930,000 shares
      of Preferred Stock convertible to Common Stock. In the event such options
      and warrants are fully exercised and the Preferred Stock is converted to
      Common Stock, management will hold an aggregate of 1,719,616 shares or
      34.0 percent based on a total of 5,053,854 shares outstanding subsequent
      to such exercise.


ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------

Paul Kanan is a principal of CEO Advisors, a company that provided management
services to BioQuant beginning in 1993. This arrangement has been terminated
effective upon the consummation of the Mergers on June 28, 1996. During fiscal
1995 and fiscal 1996, BioQuant paid CEO Advisors an aggregate of $109,000 and
$186,000, respectively, for all services rendered. Amounts outstanding at June
30, 1996 under this arrangement aggregated $187,000, for which two promissory
notes were issued in the principal amount of $93,500 and bear interest at 7
percent per annum. The promissory notes were issued to each of Paul Kanan and
Ellen Rudnick, a former director of the Company, along with options to purchase
27,100 shares of Common Stock at an exercise price of $3.45 as an inducement to
accept the notes in lieu of cash. The notes are payable on demand.

In March of 1999 the Company converted $199,000 in deferred salary to three of
its senior executives into additional debt due under the same terms as the above
debt accruing interest at 7%. The Company has not made any interest payments
since September of 1998. The Company has entered into a deferred compensation
arrangement with certain of its senior executives, including Paul Kanan. At June
30, 2001, the Company's aggregate deferred compensation obligation was
approximately $810,000, including $515,000 included in notes payable to related
parties and $295,000 in deferred compensation on the accompanying balance sheet.
Compensation expense in connection with these agreements was $88,000 and
$120,000 for the years ended June 30, 2001 and 2000, respectively

The Company believes that the transactions between the Company and its officers
and directors described above are on terms no less favorable to the Company then
could have been obtained from unaffiliated parties under similar circumstances.


ITEM 13 - EXHIBITS, LIST AND REPORTS ON FORM 8-K

(a) Exhibits are listed on the Index to Exhibits at the end of this report. The
exhibits required by Item 601 of Regulation S-B are listed on such Index in
response to this Item and are incorporated herein by reference.

(b) No Form 8-K reports were filed during the last quarter of the fiscal year
covered by this Report.


                                       25

<PAGE>


         SIGNATURES

         In accordance with section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

DATED:    October 1, 2001              Pacific Biometrics, Inc.

                                       By /s/
                                          -------------------------------
                                       Paul G. Kanan, President and Chief
                                       Executive Officer


In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and dates
indicated.


<TABLE>
<CAPTION>
<S>                                         <C>                                         <C>
/s/                                         President, Chief Executive                  DATED: October 1, 2001
---------------------                       Officer and Director (principal
Paul G. Kanan                               executive officer and principal
                                            financial officer)




/s/                                         Director                                    DATED: October 1, 2001
-------------------
Terry Giles
</TABLE>

                                       26
<PAGE>


                           Index of Exhibits
                           -----------------
<TABLE>
<S>          <C>
1.1    --    Revised Form of Underwriting Agreement.*
3.1    --    Certificate of Incorporation of the Registrant.*
3.2    --    Amended and Restated By-Laws of the Registrant.*
4.1    --    Specimen Stock Certificate.*
4.2    --    Specimen Warrant Certificate.*
4.3    --    Form of Warrant Agreement.*
4.4    --    Revised Form of Underwriter's Purchase Warrant.*
10.1   --    License Agreement, dated December 31, 1992, by and between Sudor Partners and CEO Advisors, Inc.*
10.2   --    Amendment No. 1 To License Agreement, dated August 6, 1993 by and between Sudor Partners and CEO Advisors, Inc.*
10.3   --    Supply Agreement, dated August 6, 1993, by and between Sudormed, Inc. and CEO Advisors, Inc.*
10.4   --    Assignment of License and Supply Agreements--Consent, dated September 7, 1993, October 7, 1993 and October 11, 1993, by
               and between CEO Advisors, Inc. and BioQuant, Inc.*
10.5   --    License Agreement, dated February 15, 1995, by and between Metra and BioQuant.*, **
10.6   --    Development Agreement, dated October 4, 1995, by and between BioQuant and Assay Designs.*
10.7   --    Agreement, dated October 26, 1995, by and between PBI-WA and Sigma Diagnostics.*
10.8   --    Manufacturing Agreement, dated March 1, 1996, by and between Merchant House Scientific and Irvine Scientific.*
10.9   --    Agreement and Plan of Merger, dated May 15, 1996, by and among BioQuant, Inc., Pacific Biometrics, Inc. and
               BioQuant-Acquisition, Inc.*
10.10  --    Agreement and Plan of Merger, dated May 15, 1996, by and among Pacific Biometrics, Inc.  (Washington), Pacific
               Biometrics, Inc. (Delaware), and PBI-Acquisition, Inc.*
10.11  --    Office Lease, dated January 15, 1990, by and between Bruce M. and Ann Stever Blume and Pacific Biometrics, Inc.*
10.12  --    Amendment No. 1 to Lease Agreement, dated June 15, 1992, by and between Blume 1100 Limited Partnership and Pacific
               Biometrics, Inc.*
10.13  --    Office Lease, dated August 13, 1992, by and between Blume 1100 Limited Partnership and Drake Mortgage.*
10.14  --    Assignment of Lease, dated November 30, 1993, by and between Pacific Biometrics, Inc. and Columbia First Service, Inc.*
10.15  --    Standard Form Lease, dated May 23, 1993, by and between Merchant House Scientific and Harris Trust and Savings Bank.*
10.16  --    First Amendment to Lease, dated July 11, 1996, by and between Bank of New York, as directed Trustee for Unisys Master
               Trust and Registrant.*
10.17  --    Stock Incentive Plan.*
10.18  --    Employment Agreement, dated October 14, 1996, by and between Registrant and Ellen A. Rudnick.*
10.19  --    Employment Agreement, dated October 14, 1996 by and between Registrant and Paul G. Kanan.*
10.20  --    Employment Agreement, dated October 23, 1996 by and between Registrant and G. Russell Warnick.*
10.21  --    Employment Agreement, dated October 22, 1996 by and between Registrant and Elizabeth Teng Leary, Ph.D.*
10.22  --    Clinical Laboratory Agreement, dated March 8, 1995, by and between Warner-Lambert Company and Registrant.*
10.23  --    Clinical Laboratory Agreement, dated March 7, 1996 by and between Parke-Davis Pharmaceutical Research and Registrant.*
10.24 --     Clinical Laboratory Agreement, dated March 7, 1996, by and between Parke-Davis Pharmaceutical Research and Registrant.*
10.25 --     Office Lease, dated April 23, 1997, by and between Tom Kane and Elsa Kane and Pacific Biometrics, Inc.***
10.26 --     Technical Development and License Agreement, dated December 8, 1997, by and between ActiMed
                Laboratories, Inc., a Delaware corporation, and the Company. ****
10.27 --     Amended and Restated License Agreement, dated December 30, 1997, by and among Sudormed, Inc., a
                California corporation, William R. Miller, Donald W. Schoendorfer and the Company. ****
10.28 --     Amended and Restated License Agreement, dated December 30, 1997, by and between  Sudormed, Inc.

                                       27
<PAGE>
                and the Company.****
10.29  --    Lease dated January 5, 1998 between the Company and  Makena Commercentre II, LLC with respect to the Company's
                office at 25651 Atlantic Ocean Drive, A1-A, Lake Forest, California, 92630.*****
10.30  --    Agreement of Purchase and Sale of Assets, dated as of April 18, 2000, by and among the Registrant, Pacific Biometrics,
               Inc.  (Washington) and Saigene Corporation. ******
10.31  --    First Amendment to the Purchase Agreement, dated as of June 22, 2000, by and among the Registrant, Pacific Biometrics,
               Inc.  (Washington) and Saigene Corporation. *******
10.32  --    Second Amendment to the Purchase Agreement, dated as of August 4, 2000, by and among the Registrant, Pacific
               Biometrics, Inc.  (Washington) and Saigene Corporation.
10.33  --    Management Agreement, dated as of September 15, 1999, by and among the Registrant, Pacific Biometrics, Inc.
               (Washington) and Saigene Corporation.
21.1   --    Subsidiaries.*

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

*             Incorporated by reference to Exhibits of Registrant's Registration Statement on Form SB-2, Registration
              No. 333-11551
**            Portions of this document have been deleted pursuant to a request for confidential treatment.
***           Incorporated by reference to Exhibits of Registrant's Annual Report on Form 10-KSB for the fiscal year
              ended June 30, 1997
****          Incorporated by reference to Exhibits of Registrant's Quarterly Report on Form 10QSB for the quarter
              ended December 31, 1997.
*****         Incorporated by reference to Exhibits of Registrant's Quarterly Report on Form 10QSB for the quarter ended
              March 31, 1998.
******        Incorporated by reference to Exhibits of Registrant's Current Report on Form 8-K dated May 15, 2000.
*******       Incorporated by reference to Exhibits of Registrant's Current Report on Form 8-K dated June 27, 2000.
</TABLE>

                                       28
<PAGE>


                            PACIFIC BIOMETRICS, INC.
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



<TABLE>
<CAPTION>
                                                                                  PAGE
                                                                                  ----
<S>                                                                              <C>

Report of Independent Certified Public Accountants.............................. F - 2

Consolidated Balance Sheet as of June 30, 2001.................................. F - 3

Consolidated Statements of Operations for the years ended June 30, 2001 and
 2000, and for the period from inception (December 1992) to June 30, 2001....... F - 4

Consolidated Statements of Cash Flows for the years ended June 30, 2001 and
 2000, and for the period from inception (December 1992) to June 30, 2001....... F - 5

Consolidated Statements of Stockholders' Equity (Deficit) for the period from
 inception (December 1992) to June 30, 2001..................................... F - 6

Notes to Consolidated Financial Statements...................................... F - 9
</TABLE>








                                      F-1




<PAGE>


REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS


The Board of Directors
Pacific Biometrics, Inc.
Lake Forest, California

We have audited the accompanying consolidated balance sheet of Pacific
Biometrics, Inc. (a company in the development stage) as of June 30, 2001 and
the related consolidated statements of operations and cash flows for the years
ended June 30, 2001 and 2000, and for the period from inception (December 1992)
to June 30, 2001, and the consolidated statement of stockholders' equity
(deficit) for the period from inception (December 1992) to June 30, 2001. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financing statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Pacific
Biometrics, Inc. as of June 30, 2001, and the consolidated results of its
operations and its cash flows for the years ended June 30, 2001 and 2000, and
for the period from inception (December 1992) to June 30, 2001, in conformity
with accounting principals generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 3 to the
financial statements, the Company has experienced recurring losses from
operations and cash flow shortages, and has reported deficiencies in working
capital and stockholders' equity. Additionally, the Company has significant
amounts of debt that are past due as of June 30, 2001. These matters raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plan, in regard to these matters are also described in Note 3. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

/s/ Grant Thornton LLP

Irvine, California
August 31, 2001



                                      F-2


<PAGE>
                            PACIFIC BIOMETRICS, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
                           CONSOLIDATED BALANCE SHEET
                                  JUNE 30,2001

<TABLE>
<CAPTION>
                                     ASSETS
<S>                                                                      <C>
Current assets:
    Cash and cash equivalents                                             $      100,547
    Accounts receivable, net of allowance for doubtful
          accounts of $32,824                                                    299,485
    Prepaid expenses and other                                                    17,489
                                                                          --------------
          Total current assets                                                   417,521

Property and equipment, net                                                      121,656
Other assets:
    Restricted cash                                                               69,143
                                                                          --------------
          Total assets                                                    $      608,320
                                                                          ==============
                      LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
    Notes payable to bank                                                 $       51,587
    Notes payable to related parties                                             514,936
    Notes payable other                                                           19,367
    Accounts payable                                                             481,389
    Accrued liabilities                                                          803,979
    Dividends payable                                                            661,828
    Deferred compensation                                                        295,368
    Advances from customers                                                      307,290
    Technology licenses payable                                                2,244,040
    Capital lease obligations-current portion                                    440,108
                                                                          --------------
          Total current liabilities                                            5,819,892

Capital lease obligations - long term portion                                     51,592
                                                                          --------------
          Total liabilities                                                    5,871,484
                                                                          --------------
Stockholders' deficit:
    Preferred stock, $0.01 par value, 5,000,000 shares
          authorized, 1,550,000 shares issued and outstanding                     15,500
    Common stock, $0.01 par value, 30,000,000 shares
          authorized, 3,810,171 shares issued and outstanding                     38,102
    Additional paid-in capital Preferred Stock                                 5,000,966
    Additional paid-in capital Common Stock                                   13,184,624
    Deficit accumulated during the development stage                         (23,502,356)
                                                                          --------------
          Total stockholders' deficit                                         (5,263,164)
                                                                          --------------
          Total liabilities and stockholders' deficit                     $      608,320
                                                                          ==============
</TABLE>

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



                                      F-3
<PAGE>

                            PACIFIC BIOMETRICS, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
               CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS
         ENDED JUNE 30, 2001 AND 2000 AND FOR THE PERIOD FROM INCEPTION
                        (DECEMBER 1992) TO JUNE 30, 2001

<TABLE>
<CAPTION>
                                                                                                       For the Period
                                                                   Year Ended June 30                  from Inception
                                                          ------------------------------------       (December 1992) to
                                                             2001                     2000             June 30,2001
                                                          -----------              -----------          ------------
<S>                                                       <C>                      <C>                 <C>
Revenues                                                  $ 1,877,390              $ 1,374,214          $ 12,278,454
                                                          -----------              -----------          ------------
Operating expenses:
    Laboratory expense and cost of goods sold                 961,833                  951,780             8,820,078
    Research and product development                           19,002                   64,360             5,719,908
    Selling, general and administrative                     1,186,992                1,200,509            10,870,396
    Purchased in-process research and development                   0                        0             6,373,884
    Amortization of intangible assets                               0                        0             1,616,565
                                                          -----------              -----------          ------------

          Total operating expenses                          2,167,827                2,216,649            33,400,830
                                                          -----------              -----------          ------------

Operating loss                                               (290,437)                (842,435)          (21,122,377)
                                                          -----------              -----------          ------------
Other income (expense):
    Interest expense                                          (79,835)                (138,020)             (834,188)
    Interest income                                             6,174                    2,072               325,528
    Write-off of intangible assets                                  0                        0            (2,078,100)
    Grant and other income                                    191,890                   63,717               206,780
                                                          -----------              -----------          ------------
                                                              118,229                  (72,231)           (2,379,979)
                                                          -----------              -----------          ------------

Net loss                                                  $  (172,208)             $  (914,666)         $(23,502,356)
                                                          ===========              ===========          ============

Preferred stock dividend accrued                             (248,000)                (248,000)
                                                          -----------              -----------

Net loss applicable to common stockholders                $  (420,208)             $(1,162,666)
                                                          ===========              ===========

Basic and diluted loss per share                          $     (0.11)             $     (0.31)
                                                          ===========              ===========

Number of shares used in per-share calculation              3,810,171                3,810,171
                                                          ===========              ===========
</TABLE>


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


                                      F-4

<PAGE>

                            PACIFIC BIOMETRICS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
          For the Years Ended June 30, 2001 and 2000 and For the Period
                 from Inception (December 1992) to June 30, 2001

<TABLE>
<CAPTION>
                                                                                                                  For the Period
                                                                               Year Ended June 30                 from Inception
                                                                         ------------------------------         (December 1992) to
                                                                             2001               2000               June 30, 2001
                                                                             ----               ----               -------------
<S>                                                                      <C>               <C>                  <C>
Cash flows from operating activities:
      Net loss                                                           $ (172,208)        $ (914,666)           $ (23,502,356)
                                                                         ----------         ----------            -------------
  Adjustments to reconcile net loss to net cash provided by
           (used in) operating activities:
      Depreciation & Amortization                                           130,674            210,530                1,014,849
      Loss on disposal of property & equipment                                                  48,051                   48,051
      Amortization and write-off of technology licenses                                                               3,221,297
      Common stock and warrants issued for services and financings                              38,000                  934,087
      Services provided for subscription receivable                                                                      55,556
      Amortization of goodwill                                                                                          428,368
      Purchased in process research and product development                                                           6,373,884
      Interest expense for intangible asset                                                                             223,713
      Write off of Spin-Pro Asset                                                                                       226,323
      Changes in assets and liabilities:
        Accounts receivable                                                (125,356)           108,359                 (142,263)
        Other receivables                                                     4,627             (4,627)                  37,751
        Inventory                                                                                                        26,508
        Prepaid expenses and other                                           (6,011)            30,745                   (3,042)
        Accounts payable and accrued liabilities                            (36,981)           392,208                1,254,646
        Deferred compensation                                                88,000            119,534                  242,530
        Advances from clients                                               148,641             90,213                   95,192
                                                                         ----------         ----------            -------------
           Sub-total                                                        203,594          1,033,013               14,037,450
                                                                         ----------         ----------            -------------
           Net cash provided by (used in) operating activities               31,386            118,347               (9,464,906)
                                                                         ----------         ----------            -------------
Cash flows from investing activities:
      Cash acquired in connection with mergers                                                                          221,698
      Advances to BioQuant prior to acquisition, net                                                                   (145,000)
      Capital expenditures                                                   (1,425)           (11,200)                (313,581)
      Orgainzation costs                                                                                                 (5,000)
      Deposits and other                                                                                                 (4,702)
      Purchase of short-term investments                                                                               (973,110)
      Proceeds from short-term investments                                                                              973,110
                                                                         ----------         ----------            -------------
           Net cash used in  investing activities                            (1,425)           (11,200)                (246,585)
                                                                         ----------         ----------            -------------
Cash flows from financing activities:
        Common stock sold for cash or services                                                                        9,548,905
        Purchases of technology license                                                                              (1,027,823)
        Borrowings from related parties                                                                                 859,963
        Preferred stock sold for cash                                                                                 3,100,000
        Cost of equity                                                                                               (1,811,325)
        Preferred stock dividend paid                                                                                  (152,266)
        Common stock exercise proceeds                                                                                   28,253
        Proceeds with related parties                                                                                   141,469
        Net proceeds (repayment) of bank borrowings                          17,692            (21,631)                (250,555)
        Proceeds of Second Bridge Loan                                                                                1,000,000
        Repayment of Second Bridge Loan                                                                              (1,000,000)
        Transfer (to) from restricted cash                                   (1,847)             8,157                  (69,143)
        Payments on capital lease obligations                               (39,191)           (36,118)                (555,440)
                                                                         ----------         ----------            -------------
            Net cash (used in) provided by financing activities             (23,346)           (49,592)               9,812,038
                                                                         ----------         ----------            -------------
      Net change in cash and cash equivalents                                 6,615             57,555                  100,547
      Cash and cash equivalents, beginning of period                         93,932             36,377                        0
                                                                         ----------         ----------            -------------
      Cash and cash equivalents, end of period                           $  100,547         $   93,932            $     100,547
                                                                         ==========         ==========            =============
</TABLE>


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

                                      F-5



<PAGE>
                            PACIFIC BIOMETRICS, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
          CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR
           THE PERIOD FROM INCEPTION (DECEMBER 1992) TO JUNE 30, 2001

<TABLE>
<CAPTION>
                                                                                                              Deficit
                                                                                   Preferred     Common     Accumulated
                                    Common Stock                  Preferred Stock  Additional  Additional   during the
                                 ------------------- Subscription ---------------   Paid-in      Paid-in    Development
                                 Shares     Amount    Receivable   Shares  Amount   Capital      Capital        Stage       Total
                                 -------  ---------   ----------   ------  ------   -------    ----------   ------------ -----------
<S>                              <C>      <C>       <C>           <C>     <C>      <C>        <C>           <C>          <C>
Common stock issued for
  cash at inception
  (December 1992)                511,862     $5,119   ($245,000)                                 $494,881                  $255,000
Cash received in
  satisfaction of
  subscription receivable                               161,000                                                             161,000
Net loss                                                                                                      (199,455)    (199,455)
                                 -------  ---------   ----------   ------  ------   -------    -----------  -----------  -----------
  Balance, June 30, 1993         511,862      5,119     (84,000)       0       0         0        494,881     (199,455)     216,545

Common stock issued in
  connection with purchase
  of technology license
  and services                    62,561        569     (55,556)                                   54,987                         0
Cash received in satisfaction
  of subscription receivable                             84,000                                                              84,000
Cash received in satisfaction
  of subscription receivable                             38,578                                                              38,578
Stockholder loans converted
  to equity                                                                                       310,000                   310,000
Common stock issued for cash       4,739         47                                                49,953                    50,000
Net loss                                                                                                      (732,874)    (732,874)
                                 -------  ---------   ----------   ------  ------   -------    -----------  -----------  -----------
  Balance, June 30, 1994         579,162      5,735     (16,978)       0       0         0        909,821     (932,329)     (33,751)

Services provided in
  satisfaction of subscription
  receivable                                             16,978                                                              16,978
Stockholder loans converted to
  equity                                                                                          324,963                   324,963
Common stock issued for
  services and loan guarantees    47,867        479                                                80,021                    80,500
Common stock issued in
  connection with acquisition
  of Pacific Biometrics, Inc.
  (a Washington corporation)     189,061      1,891                                               143,109                   145,000
Common stock issued for cash      42,181        422                                               553,478                   553,900
Conversion from $0.01 par
  value to no par value
  common stock                            2,011,392                                            (2,011,392)                        0
Net loss                                                                                                    (1,664,190)  (1,664,190)
                                 -------  ---------   ----------   ------  ------   -------    -----------  -----------  -----------
Balance, June 30, 1995           858,271  2,019,919           0        0       0         0              0   (2,596,519)    (576,600)


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

</TABLE>





                                       F-6

<PAGE>

                            PACIFIC BIOMETRICS, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
          CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR
           THE PERIOD FROM INCEPTION (DECEMBER 1992) TO JUNE 30, 2001

<TABLE>
<CAPTION>


                                      Common Stock                     Preferred Stock
                                  -------------------   Subscription   ---------------
                                   Shares     Amount     Receivable    Shares    Amount
                                  --------  ----------  ------------   ------    ------
<S>                              <C>        <C>         <C>           <C>        <C>
Balance, June 30, 1995             858,271   2,019,919        0             0         0
Common stock issued for cash        45,500     360,000
Common stock issued for
  services                         135,080     466,026
Issuance of $0.01 par value
  common stock in exchange
  for no par value common
  stock in acquisitions of
  BioQuant and Pacific
  Biometrics, Inc. (PBI-WA)                 (2,835,556)
Common stock issued in
  connection with
  acquisition of BioQuant          700,364       7,003
Net loss
                                 ---------  ----------  ------------   ------    ------
Balance, June 30, 1996           1,739,215      17,392        0             0         0

Common stock issued for
  services                          64,000         640
Stockholder loans converted
  to common stock                  142,274       1,423
Common stock issued for cash         2,900          29
Initial Public Offering (IPO)    1,700,000      17,000
Underwriter commissions and
  IPO costs
Common stock issued upon
  exerciseof stock options          57,133         571        0
Net loss
                                 ---------  ----------  ------------   ------    ------
Balance, June 30,1997            3,705,522      37,055        0             0         0

Preferred stock issued for
  cash                                                              1,550,000    15,500
Cost of preferred stock issue
Common stock issued upon
  exercise of stock options          4,149          42        0
Net loss
Preferred stock dividends paid
Deemed preferred stock
  dividends
                                 ---------  ----------  ------------   ------    ------
Balance, June 30, 1998           3,709,671     $37,097       $0     1,550,000   $15,500

Common stock issued for
  services                         100,500       1,005
Warrants issued related to
  financing agreements
Net loss
Preferred stock dividends
  paid or accrued
                                 ---------  ----------  ------------   ------    ------
Balance, June 30, 1999           3,810,171     $38,102       $0     1,550,000   $15,500
</TABLE>




<TABLE>
<CAPTION>
                                                                Deficit
                                  Preferred     Common        Accumulated
                                  Additional   Additional      during the
                                   Paid-in      Paid-in       Development
                                   Capital      Capital           Stage          Total
                                   -------    -----------     ------------    -----------
<S>                                <C>         <C>           <C>              <C>
Balance, June 30, 1995                   0              0      (2,596,519)      (576,600)
Common stock issued for cash                                                     360,000
Common stock issued for
  services                                                                       466,026
Issuance of $0.01 par value
  common stock in exchange
  for no par value common
  stock in acquisitions of
  BioQuant and Pacific
  Biometrics, Inc. (PBI-WA)                     2,835,556                              0
Common stock issued in
  connection with
  acquisition of BioQuant                       5,919,997                      5,927,000
Net loss                                                       (7,560,863)    (7,560,863)
                                ----------    -----------    -------------   ------------
Balance, June 30, 1996                   0      8,755,553     (10,157,382)    (1,384,437)

Common stock issued for
  services                                        220,160                        220,800
Stockholder loans converted
  to common stock                                 489,422                        490,845
Common stock issued for cash                        9,976                         10,005
Initial Public Offering (IPO)                   8,058,000                      8,075,000
Underwriter commissions and
  IPO costs                                    (1,790,290)                    (1,790,290)
Common stock issued upon
  exerciseof stock options                         25,932               0         26,503
Net loss                                                       (1,577,229)    (1,577,229)
                                ----------    -----------    -------------   ------------
Balance, June 30,1997                    0     15,768,753     (11,734,611)     4,071,197
Preferred stock issued for
  cash                           3,084,500                                     3,100,000
Cost of preferred stock issue      (21,034)                                      (21,034)
Common stock issued upon
  exercise of stock options                         1,708                          1,750
Net loss                                                       (4,611,836)    (4,611,836)
Preferred stock dividends paid      53,648        (70,093)                       (16,445)
Deemed preferred stock
  dividends                      1,937,500     (1,937,500)                             0
                                ----------    -----------    -------------   ------------
Balance, June 30, 1998          $5,054,614    $13,762,868    ($16,346,447)    $2,523,632

Common stock issued for
  services                                         78,309                         79,314
Warrants issued related to
  financing agreements                             49,447                         49,447
Net loss                                                       (6,069,035)    (6,069,035)
Preferred stock dividends
  paid or accrued                  (53,648)      (248,000)                      (301,648)
                                ----------    -----------    -------------   ------------
Balance, June 30, 1999          $5,000,966    $13,642,624    ($22,415,482)   ($3,718,290)


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


                                       F-7

<PAGE>

                            PACIFIC BIOMETRICS, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
          CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR
           THE PERIOD FROM INCEPTION (DECEMBER 1992) TO JUNE 30, 2001

<TABLE>
<CAPTION>


                                                       Common Stock                      Preferred Stock
                                                 -----------------------  Subscription  ------------------
                                                   Shares       Amount     Receivable     Shares    Amount
                                                 ----------    ---------   ----------   ---------  --------
<S>                                             <C>           <C>         <C>           <C>        <C>
Balance, June 30, 1999                            3,810,171     $38,102        $0       1,550,000   $15,500
Warrants issued relating to financing agreement
Net loss
Preferred stock dividends paid or accrued
Balance, June 30, 2000                            3,810,171     $38,102        $0       1,550,000   $15,500
Net loss
Preferred stock dividends paid or accrued
Balance, June 30, 2001                            3,810,171     $38,102        $0       1,550,000   $15,500


<CAPTION>


                                                                                   Deficit
                                                     Preferred       Common      Accumulated
                                                     Additional    Additional    during the
                                                      Paid-in       Paid-in      Development
                                                      Capital       Capital         Stage           Total
                                                     ----------    ----------   --------------   -----------
<S>                                                 <C>           <C>           <C>             <C>
Balance, June 30, 1999                               $5,000,966    $13,642,624   ($22,415,482)   ($3,718,290)
Warrants issued relating to financing agreement                         38,000                        38,000
Net loss                                                                             (914,666)      (914,666)
Preferred stock dividends paid or accrued                             (248,000)                     (248,000)
Balance, June 30, 2000                               $5,000,966    $13,432,624   ($23,330,148)   ($4,842,956)
Net loss                                                                             (172,208)      (172,208)
Preferred stock dividends paid or accrued                             (248,000)                     (248,000)
Balance, June 30, 2001                               $5,000,966    $13,184,624   ($23,502,356)   ($5,263,164)


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


                                       F-8





<PAGE>


                            PACIFIC BIOMETRICS, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  ORGANIZATION AND BASIS OF PRESENTATION

Pacific Biometrics, Inc. ("PBI" or the "Company") is a development stage company
that provides specialty reference laboratory services to the pharmaceutical and
diagnostics industries. The Company had previously been engaged in the
development and commercialization of non-invasive diagnostics to improve the
detection and management of chronic diseases. The Company has developed two
patented platform technologies that permit the use of sweat and saliva as
diagnostic fluids.

The Company was incorporated in Delaware in May 1996. The Company conducts its
business through its wholly owned subsidiaries, Pacific Biometrics, Inc., a
Washington corporation ("PBI-WA") and BioQuant, Inc., a Michigan corporation
("BioQuant"). On June 28, 1996, the Company completed the mergers (the
"Mergers") whereby BioQuant and PBI-WA became wholly owned subsidiaries of the
Company in separate stock-for-stock exchange transactions.

Except for the revenues from laboratory services, nominal revenues have been
generated from the Company's products. Consequently, the Company is a
development stage enterprise.

All material intercompany balances and transactions have been eliminated in the
accompanying consolidated financial statements.

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash and Cash Equivalents

Cash and cash equivalents consist of highly liquid investments with an original
maturity of three months or less when purchased.

Inventory

Inventory consists of items used to calibrate test equipment or verify testing
methods related to lipids, inventory related to saliva collection devices and
OsteoPatch(TM) units. These items are recorded at the lower of estimated cost
(weighted-average) or market.

Restricted Cash

During 1997, in connection with the signing of a new facility lease in Seattle,
Washington, the Company was required to maintain $100,000 as a security deposit,
throughout the term of the lease. This amount has been reduced to $69,143 as
of June 30, 2001 and has been recorded as restricted cash on the accompanying
consolidated balance sheet.

Long - Lived Assets

Property and equipment are recorded at cost. Depreciation is provided using the
straight-line method over the useful lives of the related assets, which ranges
from three to five years. Leasehold improvements are amortized over the terms of
the respective leases. The cost and related accumulated depreciation of property
or equipment sold or otherwise disposed of are removed from the accounts and the
resulting gains or losses are included in the statement of operations.

All of the Company's long-lived assets are reviewed for impairment whenever
events or changes in circumstances indicate the carrying amount may not be
recovered. If the sum of the expected future cash flows is less than the
carrying amount of the asset, a loss is recognized. See also Note 15.

                                      F-9
<PAGE>




Technology Licenses

The Company had an exclusive worldwide license for the use of a transdermal
perspiration collection device for all medical diagnostic applications of
Sudormed's skin patch technology. This license allowed for the development of
all other potential applications of such technology, except for those relating
to alcohol and drugs of abuse. Pursuant to the license agreement, the Company
had agreed to pay Sudormed approximately $3 million over a fifteen-month period
plus an ongoing royalty payment based on the amount of sales of products
developed under this license. Such payments included a lump-sum payment of $1.6
million due in December 1998. The Company is in default on this obligation.

The Company has licensed exclusive rights, related to bone resorption in human
perspiration, to use patented anti-pyridinium crosslinks antibody technology
(this is an exclusive worldwide license excluding Japan). Licensing fees with
respect to this antibody technology have been fully amortized.

Customer Advances

The Company receives advances from certain customers to perform consulting,
laboratory services, and clinical studies. These advances are deferred and
recognized as revenue in the period the related services are performed.

Income Taxes

Deferred tax assets and liabilities are recorded for differences between the
financial statement and tax bases of the assets and liabilities that will result
in taxable or deductible amounts in the future based on enacted tax laws and
rates applicable to the periods in which the differences are expected to affect
taxable income. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount expected to be realized. Income tax expense is
recorded for the amount of income tax payable or refundable for the period
increased or decreased by the change in deferred tax assets and liabilities
during the period.

Financial Instruments

The carrying amounts of cash and cash equivalents approximate fair value due to
the short-term maturities of these instruments. The carrying value of the
Company's debt approximates their estimated fair values because the rates of
interest on the debt approximate current interest rates for similar obligations
with like maturities.

Stock-Based Compensation

 The Company accounts for stock-based employee compensation as prescribed by APB
Opinion No. 25, "Accounting for Stock Issued to Employees," and has adopted the
disclosure provisions of Statement of Financial Accounting Standards 123,
"Accounting for Stock-based Compensation" ("SFAS 123"). SFAS 123 requires pro
forma disclosures of net income and net income per share as if the fair value
based method of accounting for stock-based awards had been applied. Under the
fair value based method, compensation cost is recorded based on the value of the
award at the grant date and is recognized over the service period.

Revenue Recognition

The Company recognizes revenue in the period that the related services are
performed. Currently, the Company is in the development stage and derives
revenues from laboratory services only.

Basic and Diluted Net Loss per share

Basic net loss per share is based upon the weighted average number of common
shares outstanding. Diluted net loss per share is based on the assumption that
options, warrants, and convertible preferred stock are included in the
calculation of diluted earnings per share, except when their effect would be
anti-dilutive. Dilution is computed by applying the treasury stock method. Under
this method, options and warrants are assumed to be exercised at the beginning
of the period (or at



                                      F-10


<PAGE>


the time of issuance, if later), and as if funds obtained thereby were used to
purchase common stock at the average market price during the period.

Use of Estimates

The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Accordingly, actual results could differ from those estimates and assumptions.

Reclassifications

Certain reclassifications have been made to the consolidated statement of
operations for 2000 and for the period from inception to date in order to
conform to the 2001 presentation.

Risks and Uncertainties

Any product that the Company develops will likely require approvals from the
Food and Drug Administration (FDA) and international regulatory agencies prior
to commercialized sales. With respect to the Company's Osteopatch product, the
Company failed to recieve FDA approval and, as a result, has ceased product
development and has defaulted with respect to the Sudormed license agreement.

In April 2000, the Company entered into an agreement to sell the laboratory
business, the only source of revenue for the Company. Additionally, the
Company's securities have been delisted from the Nasdaq Stock Market.

The Company's financial position also created risks and uncertainties as
discussed below in Note 3.

3.  GOING CONCERN

The Company has experienced recurring losses from operations and cash flow
shortages, and has reported deficiencies in working capital and stockholders'
equity. Also the Company has significant amounts of debt past due. These matters
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
this Note 3. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.

Management has taken steps to revise its operating and financial requirements,
which it believes are sufficient to provide the company with the ability to
continue in existence for the near term. These steps include significant
reductions in expenses and staffing, suspension of research and development
projects, renegotiations of contractual commitments and a proposed sale of the
Company's laboratory.

Even if the Company is able to sell the laboratory operations, the Company will
still have various debts and claims that need to be settled. The Company will
attempt to settle these debts with cash, stock, and technology assets. There can
be no assurance that the Company will be successful in these negotiations and
may have to seek protection from creditors under the bankruptcy laws.

4.   CONCENTRATION OF CREDIT RISK

One customer individually accounted for approximately 16% of the Company's total
sales in fiscal 2001. Two customers individually accounted for approximately 20
percent of the Company's total sales in fiscal 2000. Sales to the Company's five
largest customers represented approximately 49 percent and 41 percent of total
sales in fiscal 2001 and fiscal 2000, respectively. The Company reviews a
customer's credit history before extending credit, and generally does not
require collateral from customers. The Company establishes allowances for
doubtful accounts when management believes the Company is exposed to credit
risk.


                                      F-11


<PAGE>

5.  PROPERTY AND EQUIPMENT

Property and equipment consists of the following at June 30, 2001:

<TABLE>
<CAPTION>
<S>                                                                                            <C>
Laboratory equipment.............................................................              $ 138,051
Computer equipment...............................................................                124,499
Office furniture and equipment...................................................                 63,539
Leasehold improvements...........................................................                 33,039
Equipment held under capital leases..............................................                602,014
                                                                                                --------
Gross property and equipment.....................................................                961,142
Less accumulated depreciation and amortization...................................               (839,486)
                                                                                                --------
Net property and equipment.......................................................               $121,656
                                                                                                --------
</TABLE>

6.  CAPITAL LEASES

The Company leases laboratory and other equipment under capital lease
arrangements. The obligations under capital leases have interest rates ranging
from 8% to 9% and mature at various dates through 2003. Annual future minimum
lease payments for years subsequent to June 30, 2001 are as follows:

<TABLE>
<CAPTION>
<S>                                                           <C>
                  2002                                           $     461,392
                  2003                                                 26,515
                  2004                                                 13,295
                  2005                                                  1,108
                                                              ----------------
                  Total minimum payments                              502,310
                  Less amount representing interest                   (10,610)
                                                              ----------------
                  Obligations under capital leases                    491,700
                  Less current portion                               (440,108)
                                                              ---------------
                  Long term portion                             $      51,592
                                                              ===============
</TABLE>



In April 1997, the Company entered into a capital equipment leasing facility
with Transamerica Business Credit Corporation to provide credit for equipment
purchases up to $1,500,000. The Company issued 51,429 warrants to Transamerica
as part of this agreement (Note 11). The Company received gross proceeds of
$376,808 under the agreement during fiscal 1997 and received gross proceeds of
$329,154 during fiscal 1998. The Company is required to raise additional capital
in order to draw additional funding from this arrangement.

In exchange for the first forbearance agreement the 51,429 warrants were
repriced to $0.50 per share in December 1998. A discount of $23,400 was recorded
for the value of the warrants issued.

The Company has continued to negotiate forbearance agreements with Transamerica
Business Credit related to payments due on capital leases. In exchange for the
most recent Forbearance Agreement the Company repriced warrants previously
issued to Transamerica, has granted Transamerica additional warrants and a lien
position on assets of the Company. This Forbearance Agreement expired on
September 30, 1999 and was extended again through December 31, 1999 in exchange
for 150,508 additional warrants. A discount of $38,000 was recorded for the
value of the warrants issued. Although the Forbearance Agreement has expired,
Transamerica has not taken action to collect the debt, which approximates
$460,000.

                                      F-12

<PAGE>


7.   FINANCING

Line of Credit

In March 1998, the Company and its subsidiaries entered into a Loan and Security
Agreement (the "Loan Agreement") relating to a $1 million term loan (the "Loan")
with Silicon Valley Bank (the "Bank"). The Company issued 15,094 warrants to the
Bank as part of this agreement. The Company must comply with certain minimum
financial standards and ratios, including a minimum stated net worth and a
liquidity coverage ratio, and other non-financial restrictions, including
restrictions on the Company's ability to declare dividends. The Company was not
in compliance with certain of such financial ratios at June 30, 1998. The
Company did not draw down any amounts under the Loan and the Loan Agreement was
terminated during fiscal 1999.

In April of 1999 the Company and its subsidiaries entered into a Accounts
Receivable Factoring Agreement (the "Factoring Agreement") with Silicon Valley
Bank (the "Bank"). The Company issued 93,024 warrants to the Bank as part of the
Factoring Agreement. The Company has been factoring the majority of the accounts
receivable from laboratory operations to provide the Company with working
capital to meet laboratory operations obligations and to maintain minimal
corporate operations.

Equity Financing

The Company extended the 1,700,000 warrants issued in conjunction with the
Company's initial public offering of its securities to June 30, 1999, from their
previous expiration date of January 31, 1998; the exercise price of $12.00
remained the same. Such warrants expired by their terms as of June 30, 1999.

On February 20, 1998, the Company consummated the sale of 925,000 shares of
Series A Convertible Preferred Stock (the "Preferred Stock") with an
institutional investor for an aggregate purchase price of $1,850,000. In
addition, the Company granted such institutional investor an option (the
"Option") to purchase an additional 625,000 shares of Preferred Stock until May
20, 1998 for an exercise price of $1,250,000. The Option was exercised in full
during May 1998. The Preferred Stock is convertible into shares of the Company's
Common Stock at the option of the holder at any time on a one-for-one basis,
subject to adjustment for stock splits, dividends and the like. The Preferred
Stock provides for a cumulative cash dividend payable quarterly in arrears at an
annual rate of 8%. The Company has the right to force conversion of the
Preferred Stock in the event the price per share of the Common Stock is $8.00 or
more for twenty consecutive trading days. The Company has agreed to use
commercially reasonable efforts to effect the registration of the Common Stock
into which the Preferred Stock is convertible. To date, no such efforts have
been untertaken. The Company is not current on dividend payments and, as of June
30, 2001 approximately $660,000 in dividends have accrued. See Note 12 for
calculation of beneficial conversion and imputed preferred stock dividend.

Technology License Payable

The Minnesota Mining and Manufacturing Company (3M), as a party in possession of
secured property, has not informed the Company of its plans for the Sudormed
assets. This includes the SkinPatch(TM) technology rights, which are part of the
Company's OsteoPatch(TM) product. The Company had sought to reestablish certain
rights to this technology in order to create additional value for the Company's
other intellectual property related to the OsteoPatch(TM). Without an agreement
with 3M, the Company's OsteoPatch(TM) assets may not have any value and the
Company expensed all of these assets in March 1999. In May 2000, 3M notified the
Company that, in its capacity as a secured party in possession of the Sudormed
assets, it demands payment in full of the $1.6 million plus accrued interest and
fees due and owing under the License Agreement between the Company and Sudormed.
The Company and 3M are seeking to settle this claim. 3M has objected to the
laboratory sale transaction that is proceeding with Saigene. Although, the
Company disputes 3M's claim, 3M may seek to enforce its rights through legal
process. The Company is not certain of the impact of 3M's demand on the proposed
transaction with Saigene or what legal rights may be asserted by 3M to protect
its claim. If 3M should be successful in blocking the proposed sale of the
laboratory, or commences a legal action against the Company, the Company may
have no alternative than to seek protection from creditors under the bankruptcy
laws. Current maturities of the technology license payable are $2,244,040 as
shown on the balance sheet.


                                      F-13
<PAGE>

In May 2000, 3M notified the Company that, in its capacity as a secured party in
possession of the Sudormed assets, it demands payment in full of all fees due
under the License Agreement between the Company and Sudormed. 3M is seeking to
settle this claim or seek a judgment in a court of law and has objected to the
laboratory sale transaction that is proceeding with Saigene. The Company
disputes 3M's claim and intends to defend itself in this matter. If 3M should be
successful in blocking the proposed sale of the laboratory, or commences a legal
action against the Company, the Company may have no alternative than to seek
protection from creditors under the bankruptcy laws.

8.   INCOME TAXES

No provision for federal and state income taxes has been recorded as the Company
has incurred net operating losses through June 30, 2001. At June 30, 2001, the
Company has net operating loss carryforwards available to offset future taxable
income for federal and state income tax purposes of approximately $17 million;
such carryforwards expire in various years through 2021. Deferred tax assets
include these net operating loss carryforwards as well as certain expenses that
are reported for book and tax purposes in different periods. The Company has
provided a valuation allowance to offset all deferred tax assets due to the
uncertainty of realization.

Under the Tax Reform Act of 1986, the amounts of and benefits from the Company's
net operating loss carry forwards are limited due to a cumulative ownership
change that occurred over a three year period. However, based upon preliminary
estimates, management believes that the effect of such limitation, will not have
a material adverse effect on its financial condition or results of operations.


9.  SUPPLEMENTARY INFORMATION ON NONCASH TRANSACTIONS

Equipment Purchased Under Capital Lease

<TABLE>
<CAPTION>
       Year                                                             Equipment Value
       ----                                                             ---------------
<S>                                                                     <C>
       1996                                                                $  28,006
       1997                                                                  477,428
       1998                                                                  370,888
       1999                                                                   14,998
       2000                                                                   50,000
                                                                           ---------

       From inception to June 30, 2001                                     $ 941,320
                                                                           =========
</TABLE>

Stockholder Loans Converted to Equity

During 1997, certain of the Company's stockholders converted their loans to the
Company for 142,274 shares of the Company's common stock, valued at $3.45 per
share. The amount converted was $490,845, including accrued interest of $30,845.
For the period from inception to June 30, 2001, a total of $1,125,808 in
stockholder loans have been converted to equity.

Common Stock Issued for Technology License, Services and Loan Guarantees

The Company has issued common stock for technology licenses, services and loan
guarantees as follows:

<TABLE>
<CAPTION>
        Year Issued                                                       Number of Shares         Estimated Fair Value
        -----------                                                       ----------------         --------------------
<S>                                                                       <C>                      <C>
             1994                                                              62,561                   $ 55,556
             1995                                                              47,867                     80,500
             1996                                                             135,080                    466,026
             1997                                                              64,000                    220,800
             1999                                                             100,500                     79,314
                                                                              -------                   --------
             For the period from inception to June 30, 2001                   410,008                  $ 902,196
                                                                              =======                  =========
</TABLE>


                                      F-14

<PAGE>

Common Stock Issued in Connection with Acquisitions

In 1996, the Company acquired BioQuant through an exchange of common stock as
described in Note 1. The Company issued 700,364 shares of common stock to the
stockholders of BioQuant in connection with this acquisition.

Acquisition of Technology License

During 1998, as described in Notes 2 and 7, the Company acquired worldwide
license rights from Sudormed in exchange for a non-interest bearing note payable
of approximately $2,829,000 which was recorded net of a discount of
approximately $222,000.

10.  STOCK OPTION PLANS

1996 Stock Incentive Plan

In July 1996, the Company adopted a Stock Incentive Plan (the "Plan") with
1,000,000 shares of common stock reserved for issuance under this Plan. In
November 1997, the shareholders approved that the number of shares reserved for
issuance would be increased to 2,000,000. Options granted under this plan may be
either incentive stock options within the meaning of Section 422(b) of the
Internal Revenue Code, or nonqualified options. The Company may also award stock
appreciation rights, restricted stock, performance shares, loans or tax offset
payments. The option price of each incentive stock option granted shall not be
less than the fair value of the underlying common stock, and will expire no
later than ten years following the date of grant. With respect to nonqualified
options, the exercise price and term will be determined at the discretion of the
Board. However, the exercise price will not be less than 85% of the fair value
of the underlying stock, and the term will not exceed a period of ten years. The
options generally vest over five years.

In connection with the BioQuant merger, all outstanding options to purchase
BioQuant shares became fully vested and were converted to 491,535 options to
purchase shares of the Company's common stock. The following is a summary of the
activity in the Plan for the period from inception:

                                      F-15

<PAGE>


<TABLE>
<CAPTION>
                                                                          SHARES UNDER OPTIONS
                                                                          --------------------
                                                                            Weighted Average
                                                     Exercise Price          Exercise Price
                                                       per Share                per Share                Shares
                                                       ---------                ---------                ------
<S>                                                  <C>                    <C>                        <C>
  Conversion of BioQuant options                     $0.13 - $0.63               $0.27                     491,535
  Granted                                                  -                        -                         -
  Exercised                                                -                        -                         -
  Terminated
                                                       ---------                ---------               ----------

Options outstanding at June 30, 1996                  $0.13 - $0.63              $0.27                     491,535

  Granted                                             $2.38 - $5.00              $3.69                     761,908
  Exercised                                           $0.13 - $0.63              $0.54                     (57,133)
    Terminated                                        $     4.75                 $4.75                      (5,000)
                                                       ---------                ---------               ---------

Options outstanding at June 30, 1997                  $0.13 - $5.00               $2.42                  1,191,310
                                                      =============               =====                  =========

  Granted                                             $2.66 - $3.50               $3.27                    313,900
  Exercised                                                $0.42                  $0.42                     (4,149)
    Terminated                                        $0.63 - $4.75               $2.80                    (13,607)
                                                       ---------                ---------                ---------

Options outstanding at June 30, 1998                  $0.13 - $5.00               $2.60                  1,487,454
                                                      =============               =====                  =========
     Granted                                          $1.63 - $0.25               $0.29                    252,599
     Exercised                                              $0.00                 $0.00                          0
     Terminated                                       $0.42 - $5.00               $2.73                   (111,109)
                                                       ---------                ---------                ---------

Options outstanding at June 30, 1999                  $0.13 - $5.00               $2.24                  1,628,944
                                                      =============               =====                  =========

     Granted                                                $0.00                 $0.00                         0
     Exercised                                              $0.00                 $0.00                         0
     Terminated                                       $0.25 - $5.00               $3.15                  (656,044)
                                                       ---------                ---------               ---------

Options outstanding at June 30, 2000                  $0.13 - $4.75               $1.62                   972,900
                                                      =============               =====                 =========

Granted                                                     $0.00                 $0.00                         0
     Exercised                                              $0.00                 $0.00                         0
     Terminated                                       $0.25 - $4.75               $1.25                  (17,853)
                                                       ---------                ---------               ---------

Options outstanding at June 30, 2001                  $0.13 - $4.75               $1.63                  955,047
                                                      =============               =====                  =======
</TABLE>

The weighted average contractual life remaining of options outstanding at June
30, 2001 is approximately 3 years. The following information applies to options
outstanding at June 30, 2001:

                                      F-16
<PAGE>


<TABLE>
<CAPTION>

                           Options Outstanding                                            Options Exercisable
                           -------------------                                            -------------------
                                    Weighted
                                     average             Weighted                                     Weighted
     Range of                       remaining            average                                       average
      exercise        Number       contractual           exercise                   Number            exercise
       Prices       outstanding    life (years)            price                  exercisable           price
  ---------------  ------------   -------------          ---------               ------------        -----------
<S>                <C>            <C>                   <C>                      <C>                 <C>

  $0.13-$0.13        309,606             2                 $0.13                     309,606             $0.13
  $0.25-$0.69        228,481             3                 $0.37                     228,481             $0.37
  $1.63-$3.50        400,960             1                 $3.38                     382,335             $3.39
  $3.69-$5.00         16,000             .5               $4.48                       16,000             $4.48
                    ----------                                                    -----------         -----------

                     955,047                                                         936,422             $1.59
                    ==========                                                    ==========          ===========
</TABLE>

Stock-Based Compensation

The Company has adopted the disclosure-only provisions of SFAS No. 123. No stock
options were granted in 2001 or 2000. Had compensation cost been determined
based on the fair value of stock options granted in a manner consistent with the
method promulgated by SFAS No. 123, the Company's net loss and loss per share
would have been increased to the pro forma amounts below:

<TABLE>
<CAPTION>
                                For the Years Ended June 30,
                                ---------------------------
                                  2001               2000
                                  ----               ----
<S>                            <C>                <C>
Net loss:
  As reported                  $(172,207)         $(914,666)
  Pro forma                    $(366,628)        $(1,403,051)
Loss per share:
  As reported                    $ (.11)            $ (.31)
  Pro forma                      $ (.16)            $ (.43)
</TABLE>

11.  STOCK PURCHASE WARRANTS

In connection with the BioQuant merger, outstanding warrants to purchase
BioQuant shares were converted to 74,083 warrants to purchase shares of the
Company's common stock at a price of $4.22.

In connection with Bridge Loans completed by the Company during June and July
1996, the Company issued 300,000 warrants. Each warrant entitled the holder to
purchase a share of the Company's common stock for $5.70 and were exercisable
until April 30, 1998, and have expired. No discount was recorded for the value
of the warrants because the amount was not material.

In October 1996, as a part of the IPO, 1,700,000 redeemable warrants were
issued. Each warrant entitled the holder to purchase one share of common stock
at an exercise price of $12.00. The warrants expired on June 30, 1999.

Also in conjunction with the IPO, the Company issued a warrant to the
underwriters to purchase 170,000 shares of common stock at an exercise price of
$5.70 per share, exercisable over a four-year period commencing October 30,
1997.

During 1997, the Company issued 51,429 warrants to an institutional lender in
conjunction with a capital equipment leasing facility (Note 6). Each warrant
entitles the holder to purchase one share of the Company's common stock at an
exercise price of $2.63. In December of 1998 the Company reduced the exercise
price to $0.50 as part of a debt


                                      F-17
<PAGE>

forbearance agreement. The Company's stock has not closed at an amount greater
than $.50 per share since the repricing date. The warrants expire on March 13,
2004. No discount was recorded for the value of the warrants because the amount
was not material.

In March 1998, Silicon Valley Bank was issued 15,094 warrants in conjunction
with a credit agreement (Note 6). Each warrant entitles the holder to purchase
one share of the Company's common stock at an exercise price of $3.31. The
warrants expire on March 13, 2004. No discount was recorded for the value of the
warrants because the amount was not material.

In February 1998, the Company issued 100,000 warrants to the principals of
Sudormed in conjunction with the technology license agreement (Note 2). Each
warrant entitles the holder to purchase one share of the Company's common stock
at an exercise price of $3.10. The warrants expire on February 10, 2003.

In January of 1999, the principals of the landlord of the Company's Lake Forest
facility advanced the Company $15,000 and received 45,000 warrants related to
the advance. A discount of $23,400 was recorded for the value of the warrants.

In March of 1999, Silicon Valley Bank was issued 93,024 warrants in conjunction
with a credit agreement (Note 6). Each warrant entitles the holder to purchase
one share of the Company's common stock at an exercise price of $0.27. The
warrants expire on March 13, 2004. A discount of $26,047 was recorded for the
value of the warrants.

In August 1999, the Company issued 150,508 warrants to an institutional lender
as part of a debt forbearance agreement. Each warrant entitles the holder to
purchase one share of the Company's common stock at an exercise price of $0.09.
Also in August of 1999 the Company reduced the exercise price to $0.09 on 40,000
of the 51,429 previously issued warrants as part of the debt forbearance
agreement. The warrants expire on March 13, 2004. No discount was recorded for
the value of the warrants because the amount was not material.

In February 2000 the Company reduced the exercise price from $.09 to $.0625 on
the 150,508 warrants and 40,000 of the 51,429 warrants referred to above.

The following is a summary of the activity for the period from inception:

<TABLE>
<CAPTION>
                                                                         WARRANTS UNDER OPTIONS
                                                                         ----------------------
                                                                            Weighted Average
                                                     Exercise Price          Exercise Price
                                                       per Share                per Share                Shares
                                                       ---------                ---------                ------
<S>                                                  <C>                    <C>                       <C>
  Conversion of BioQuant warrants                         $4.22                  $4.22                     74,083
  Granted                                                 $5.70                  $5.70                     50,000
  Exercised                                                 -                      -                          -
  Terminated                                                -                      -                          -
                                                       ---------                ---------               ---------
Warrants outstanding at June 30, 1996                      $4.81                 $4.81                    124,083

  Granted                                             $2.63 - $12.00            $10.56                  2,171,429
  Exercised                                                 -                      -                          -
  Terminated                                                -                      -                          -
                                                       ---------                ---------               ---------
Warrants outstanding at June 30, 1997                 $2.63 - $12.00            $10.25                  2,295,512

  Granted                                             $3.10 - $3.31              $3.13                    115,094
  Exercised                                                 -                      -                          -
  Terminated                                              $5.70                  $5.70                   (300,000)
                                                       ---------                ---------               ---------
Warrants outstanding at June 30, 1998                 $2.63 - $12.00             $10.51                 2,110,606
Granted                                               $0.34 - $0.27               $0.29                   138,024

                                      F-18


<PAGE>

Repriced - Old Price                                      $2.63                   $2.63                   (51,429)
Repriced - New Price                                      $0.50                   $0.50                    51,429
Exercised                                                   -                      -                         -
Terminated                                               $12.00                  $12.00                (1,700,000)
                                                       ---------                ---------               ---------
Warrants outstanding at June 30, 1999                 $0.27 - $5.70               $3.11                   548,630

Granted                                                   $0.09                   $0.09                   150,508
Repriced - Old Price                                      $0.50                   $0.50                   (40,000)
Repriced - New Price                                      $0.09                   $0.09                    40,000
Repriced - Old Price                                      $0.09                   $0.09                  (190,508)
Repriced - New Price                                    $0.0625                 $0.0625                   190,508
Exercised                                                   -                      -                         -
Terminated                                                  -                      -                         -
                                                       ---------                ---------               ---------
Warrants outstanding at June 30, 2000               $0.0625 - $5.70               $2.42                   699,138

Terminated                                            $4.22 - $5.70                5.25                  (244,083)
                                                       ---------                ---------               ---------
Warrants outstanding at June 30, 2001               $0.0625 - $3.31               $0.91                   455,055
                                                    ===============               =====                 ==========
</TABLE>

                                      F-19
<PAGE>


12. EARNINGS PER SHARE

As the Company had a net loss from continuing operations for the years ended
June 30, 2001 and 2000 and for the period from inception to June 30, 2001, the
basic and diluted net loss per share are the same.

Net loss applicable to common stockholders includes $248,000 in cumulative
dividends on the convertible preferred stock during both years ended June 30,
2001 and 2000, and $1,937,500 for the non-cash imputed dividend related to the
beneficial conversion feature on the convertible preferred stock and preferred
stock option in the inception to date period. The beneficial conversion feature
is computed as the difference between the quoted market price of a share of
common stock on date of issue and the conversion price times all shares of
preferred stock sold and under option. The imputed dividends are a non-cash
one-time charge based on the immediate conversion feature.

Basic and diluted loss per common share were calculated as follows:

<TABLE>
<CAPTION>
                                                                                            For the Period
                                                                                            from Inception
                                               2001                      2000              to June 30, 2001
                                           ------------           --------------           ----------------
<S>                                        <C>                    <C>                      <C>
         Net Loss                          $  (172,208)            $   (914,666)           $   (23,502,356)
         Preferred Stock cumulative
         dividend                             (248,000)                (248,000)                  (814,093)
         Imputed dividend on Preferred
           Stock issued                              -                        -                 (1,156,250)
         Imputed  dividend on
           Preferred Stock
           Option Granted                            -                        -                   (781,250)
                                           ------------           --------------           ----------------


         Net Loss available to common
           Shareholders                    $   (420,208)           $  (1,162,666)           $   (26,253,949)
                                           ============           ==============           ================

         Basic and diluted
          loss per share                   $       (.11)           $       (.31)
                                           ============           =============
         Number of shares used in
          per-share calculation               3,810,171               3,810,171
                                           ============           =============
</TABLE>

13.  COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company has entered into non-cancelable operating leases for office
facilities. Under these leases, the Company is responsible for its proportionate
share of real estate taxes, insurance and common area maintenance costs. Rent
expense was $245,709 and $226,744 for the years ended June 30, 2001 and 2000,
respectively, and $1,814,430 for the period from inception to June 30, 2001.

Future minimum lease payments are as follows:

<TABLE>
<CAPTION>
                           Year Ended June 30,
                           -------------------
<S>                        <C>                       <C>
                           2002                       $  255,617
                           2003                          259,312
                           2004                          261,674
                           2005                          234,483
                           2006                          226,252
                           Thereafter                    310,232
                                                         -------
                                                      $1,547,570
                                                      ==========
</TABLE>

                                      F-20
<PAGE>

Employment and Noncompetition Agreements

The Company has entered into employment and noncompetition agreements with four
executives. These agreements expired during fiscal 1999. In July, 1998 an
executive, who is covered by such agreements resigned. The Company incurred a
severance liability of approximately $102,000 of which $45,000 is unpaid as of
June 30, 2001.

Legal Proceedings

On May 10, 2001 a Final Judgment of Permanent Injunction was issued by the
United States District Court for the District of Columbia ordering the Company
to (a) file with the SEC, on or before June 29, 2001,: (1) the Company's Annual
Report on Form 10-KSB for its fiscal year ended June 30, 2000; (2) the Company's
Quarterly Reports on Form 10-QSB for its quarters ended March 31, September 30,
and December 31, 2000; and (3) such other periodic reports which may become due
prior to the entry of the Final Judgment, and (b) file timely and in proper form
with the SEC accurate and complete information and reports of the Company as are
required to be filed under the securities laws. All such reports were filed on
June 29, 2001. Accordingly, the Company believes it is currently in compliance
with such Final Judgment.

On September 24, 1997 the Company received from the former manufacturer of
SPINPRO(R) a demand for arbitration in connection with alleged breaches of the
contract relating to the manufacture of SPINPRO(R). The former manufacturer is
seeking damages of approximately $515,000. The Company does not believe that the
claims have any merit and believes that the ultimate outcome of this proceeding
will not have a material impact on the Company. The Company is vigorously
contesting such claims and has filed counterclaims against the former
manufacturer. The Company has also filed for arbitration against a former vendor
relating to SPINPRO(R), seeking damages for alleged breach of contract with
respect to the manufacture of molds for SPINPRO(R) parts. No amounts have been
accrued for this potential liability in the accompanying financial statements.

As previously reported, the landlord of the Company's previous office and
laboratory space in Lake Forest, California was proceeding against the Company
to cancel the lease. The landlord has obtained a judgment against the Company
from Orange County Superior Court for approximately $150,000 related to the
default on the lease. In addition, liabilities continue to accrue at about
$13,000 per month until the space is leased. The total liability to the Company
is estimated to be approximately $350,000, which has been accrued in the
accompanying financial statements at June 30, 2001. The Company has been advised
by Saigene Corporation ("Saigene"), the proposed purchaser of the Company's
laboratory, that Saigene has purchased from the landlord of the Lake Forest
property, for the sum of $350,000, the rights to all claims and judgments
rendered against the Company related to its default on the Lake Forest lease,
subject to the sale of the Company's laboratory assets to Saigene. However, it
is unclear whether or not Saigene may re-assign such rights to the landlord if
the sale of the laboratory assets to Saigene is not completed. In any event,
Saigene, under the terms of the First Amendment to the Purchase Agreement, has
agreed that Saigene will be responsible for satisfaction of such judgment and,
therefore, the Company believes it would be entitled to seek recovery from
Saigene for any costs or liabilities as a result of Saigene's failure to satisfy
such claim.

Pending Transaction

In August of 1999, the Company announced the signing of a Letter of Intent to
sell its Seattle laboratory business and assets to Saigene Corporation, a
privately held company located in Redmond, Washington. In September 1999, the
Company signed a Management Agreement with Saigene giving them operational
control over the laboratory. In May 2000, the Company announced the signing of a
Contract with Saigene Corporation to sell to Saigene all of the business and
assets of the Company's Seattle laboratory for a total consideration of
$4,000,000. Stockholder approval will be required to complete this transaction.
The purchase price is comprised of the following: 1) $200,000 already advanced
to support the operation of the laboratory under a Management Agreement with
Saigene dated September 15, 1999; 2) The assumption of approximately $1,200,000
in debt; 3) $700,000 in cash; and, 4) A promissory note in connection with the
redemption of $1,900,000 of Series A Convertible Preferred Stock. The Series A
Convertible Preferred Stock will be returned to the Company. These amounts are
subject to adjustment upon audit of funds advanced and the May 31, 2000 balance
sheet of the laboratory operation. The cash portion of the purchase is payable
as follows: 1) $50,000




                                      F-21


<PAGE>



which was paid upon signing; 2) $350,000 paid on June 15, 2000; and, 3) $300,000
placed into escrow on June 15, 2000 to be paid to the Company upon stockholder
approval. The assumption of debt in the amount of $1,200,000 includes: $350,000
to settle the debt with the landlord of the Company's Lake Forest, California
office and laboratory facility; $400,000 of equipment lease financing
obligations with Transamerica; $140,000 of additional equipment leases; and
accrued expenses and accounts payable of the laboratory.

On June 26, 2000, the Company announced that Saigene failed to make the cash
payment of approximately $650,000 due on June 15, 2000 under the Purchase
Agreement, and that Saigene requested an extension of time in order to comply.
Accordingly, the Purchase Agreement was amended on June 22, 2000 (the
"Amendment"). The Amendment extended the Closing Date of the Purchase Agreement
from June 15, 2000 to August 15, 2000 and required Saigene to pay $150,000 of
the purchase price on or before July 15, 2000. The balance of cash and escrow
payments and all other consideration due originally on June 15 were due on
August 15, 2000. In exchange for this extension, Saigene agreed (i) to waive all
financial claims against the Company for funds advanced under the Management
Agreement and forfeit all monies paid under the Purchase Agreement and (ii) to
be responsible for all liabilities previously assumed by Saigene or agreed to be
assumed by Saigene including the debt to the Company's Lake Forest, California
landlord in the event that Saigene fails to make cash payments due on July 15 or
August 15, 2000.

Saigene failed to satisfy certain conditions relating to payments as required
and defaulted on the Purchase Agreement and the Amendment. Saigene requested a
further extension to January 20, 2001 to complete the Purchase Agreement and the
Company and Saigene signed a Second Amendment to Agreement of Purchase and Sale
of Assets, dated August 4, 2000 (the "Second Amendment").

In exchange for this extension, Saigene agreed to the following additional
terms. Saigene paid the Company $50,000 on May 22, 2000 and $75,000 on July 19,
2000 as part of the purchase price. Saigene will pay $20,000 on each of August
28th, September 20th, October 20th, November 20th and December 20, 2000. One
half of each $20,000 payment will be credited toward the purchase price and
one-half of each payment will be consideration paid for the additional time
extension. Payments toward the purchase price will be credited against the
escrow payment required at the time of closing. All payments made according to
the Second Amendment will be forfeited by Saigene if they fail to make any of
the required payments, including the closing payments. Saigene and the Company
have further agreed that Saigene may extend the January 20, 2001 Closing Date on
a month-by-month basis by increasing the monthly payments to $30,000 beginning
January 20, 2001. One-half of each payment would be credited to the purchase
price and one-half of each payment would be consideration for the additional
time extension. The Company has the right to terminate the Purchase Agreement at
the end of any extension period by giving 20 days prior written notice.

Saigene failed to complete the Purchase Agreement on January 20, 2001 but has
elected to extend the Closing Date on a month-by-month basis having made all
required payments due through December 20, 2000 and all payments due from
January 20, 2001 through August 20, 2001.

There can be no assurance that Saigene will be able to complete the Purchase
Agreement as amended or consummate the transactions contemplated therein.
Failure to complete this transaction would return operational control of the
laboratory to the Company. While the laboratory would have less debt as a result
of the Amendment, there can be no assurance that the Company will be financially
capable of maintaining the laboratory operation and no assurance that another
buyer could be found in a timely manner. This could force the Company to seek
protection from creditors under the bankruptcy laws.


14.  RELATED PARTY TRANSACTIONS

The Company has entered into deferred compensation agreements with four of its
senior executives. The agreements provide that a specified portion of their
salaries be deferred until they elect to receive the deferred amount. Deferred
compensation expense in connection with these agreements was $88,000 and
$119,533 for the years ended June 30, 2001 and 2000, respectively, and $558,363
for the period from inception to June 30, 2001. In 1997, the liability for
deferred compensation of $64,413 was converted to a promissory note bearing
annual interest at 7% and is payable on demand. In 1999, the liability for
deferred compensation of $198,583 was converted to a promissory note bearing
annual interest at 7% and is payable on demand. This obligation is included with
notes payable to related parties on the






                                      F-22

<PAGE>

accompanying consolidated balance sheet. The Company has not made any interest
payments since September of 1998. Deferred compensation of $295,368 to senior
executives and other current & former employees was due as of June 30, 2001 and
is not part of the above-mentioned notes payable.

The Company had entered into a contract for management and consulting services
with a company owned by certain of the Company's stockholders. The Company
incurred $109,000 and $186,000 for management and consulting services provided
during the years ended June 30, 1995 and 1996, respectively, and $295,000 for
the period from inception to June 30, 2001. The liability for management
consulting services under the contract of $187,000 as of June 30, 1996 was
converted in 1997 to a promissory note bearing annual interest at 7% and is
payable on demand. This obligation is included with notes payable to related
parties on the accompanying consolidated balance sheet. The management contract
was terminated effective June 28, 1996.


15.  IMPAIRMENT OF LONG-LIVED ASSETS

The Minnesota Mining and Manufacturing Company (3M), as a party in possession of
secured property, has not informed the Company of its plans for the Sudormed
assets. This includes the SkinPatch(TM) technology rights, which are part of the
Company's OsteoPatch(TM) product. The Company had sought to reestablish certain
rights to this technology in order to create additional value for the Company's
other intellectual property related to the OsteoPatch(TM). Without an agreement
with 3M, the Company's OsteoPatch(TM) assets may not have any value and the
Company expensed all of these assets in March 1999. The amount of the write down
was $2,078,000 (see Note 6).


                                      F-23