<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, 1998 Commission File Number 0-21537

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

            Delaware                                    93-1211114
(State or other jurisdiction of             (IRS Employer Identification Number)
    incorporation or organization) 

          25651 Atlantic Ocean Drive, Suite A-1, Lake Forest, CA 92630
                    (Address of principal executive offices)

                                  949-455-9724
                           (Issuer's telephone number)

        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, 1998 were $2,521,561

As of September 22, 1998 there were 3,709,671 outstanding 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 September 22, 1998
based on the average bid and asked price on such date was $3,982,695.

                      DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of Form 10-KSB is incorporated herein by
reference to the registrant's definitive Proxy Statement relating to its 1998
Annual Meeting of Stockholders which will be filed with the Commission within
120 days after the end of the registrants fiscal year.

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

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                             PACIFIC BIOMETRICS, INC.

                               INDEX TO FORM 10-KSB
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<S>                                                                          <C>

PART I

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 RESULTS OF OPERATIONS................  14

ITEM 7 - FINANCIAL STATEMENTS............................................  20

ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
          ACCOUNTING AND FINANCIAL DISCLOSURES...........................  20

PART III

ITEM 9 -  DIRECTORS AND OFFICERS OF THE REGISTRANT.......................  21

ITEM 10 - EXECUTIVE COMPENSATION.........................................  21

ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
          AND MANAGEMENT.................................................  21

ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................  21

ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K...............................  21

</TABLE>

                                       2
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                                     PART I

ITEM 1  - BUSINESS

GENERAL

Pacific Biometrics, Inc. ("PBI" or the "Company") was incorporated in Delaware
in May 1996. PBI 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.

PBI owns an established specialty reference laboratory and is engaged in
developing and commercializing non-invasive technologies for use in diagnostics
and laboratory services 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 specialty reference
laboratory supports the development and commercialization process for PBI as
well as providing services to other diagnostic and pharmaceutical manufacturers.

The Company believes it possesses the following key competitive advantages:

     -    Patented technology platforms with multiple product applications.

     -    Focus on substantial and growing markets in need of NON-INVASIVE
          diagnostic techniques.

     -    Vertical product integration of the diagnostic patch tests with our
          specialty laboratory to control quality and capture additional revenue
          and profit.

PBI's intellectual property position in both sweat and saliva collection 
technology is based on thirteen issued U.S. patents and four pending U.S. 
patents with respect to the Company's Sweatpatch-TM- and SalivaSac-Registered 
Trademark- technology. The Company has invested approximately $3,412,000 in 
research and development and approximately $819,000 for the acquisition of 
technology rights during 1998 and 1997. 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. The Company has 32 full 
time and 5 part time employees as of August 31, 1998 and works closely with 
several independent consultants.

The Company's focus is to (i) successfully comply with U.S. Food and Drug 
Administration ("FDA") approval requirements for the domestic market and 
commercialize the Osteopatch-TM- for the foreign markets (ii) evaluate the 
feasibility of non-invasive glucose testing using SalivaSac-Registered 
Trademark- (iii) identify collaborative and strategic partners to develop 
other applications for the Company's platform technologies and (iv) expand 
the specialty reference laboratory business.

SWEATPATCH-TM- - SWEAT COLLECTION DEVICE

This patented transdermal collection device provides a non-invasive biological
sample that is designed to compete effectively with 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, which the Company believes
will yield more accurate results. The Minnesota Mining and Manufacturing Company
("3M") manufactures the patch for PBI pursuant to a supply agreement with
Sudormed, Inc. ("Sudormed"), the licensor of the patch technology.

                                       3

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SALIVASAC-Registered Trademark- - SALIVA COLLECTION & PROCESSING DEVICE

This proprietary device, developed by the Company, collects a non-invasive 
saliva sample that the Company believes will be able to compete effectively 
with blood and urine testing in various applications. The 
SalivaSac-Registered Trademark-, 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 enzymes, food and other contaminants. The Company 
believes SalivaSac-Registered Trademark- design will lend itself to 
point-of-care diagnostic applications. The SalivaSac-Registered Trademark-, 
as a sample collection device, can be combined with currently available 
testing technologies to permit new non-invasive diagnostic test applications.

PRODUCTS

Sweatpatch-TM- Applications: 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. The Company is dependent on 3M for the supply of patches and on
Metra for supply of antibodies used in the Osteopatch-TM- system (see "Reliance
on Licenses, Distributors, Suppliers and Manufacturers").

Due to the stable nature of the sweat sample collected from the Osteopatch-TM-,
the patch can be sent by regular mail to a laboratory for analysis. Since the
Osteopatch-TM- utilizes a proprietary assay, PBI will be able to capture revenue
from both the sale of the Osteopatch-TM- and from the analysis performed at
PBI's laboratory. This unique vertical product integration will permit PBI to
maximize revenue and develop a strong relationship with the distributors and
users of the product. In international markets, PBI will license other
laboratories to process the patch, and PBI will monitor the quality of their
operations through a proficiency-testing program. To support PBI's Italian
distributor, Segix Italia S.p.A. ("Segix"), the Company has authorized one
laboratory in Italy to perform data analysis.

SalivaSac-Registered Trademark- Applications: The Company had been awarded 
two National Institute of Health Small Business Innovative Research ("SBIR") 
Phase I grants to research this technology for non-invasive glucose 
monitoring. As a result of this research the Company is using its 
SalivaSac-Registered Trademark- 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-Registered Trademark- device, as it appears to exclude substances 
that interfere with accurate glucose measurements. However, there can be no 
assurances that the Company will be able to successfully develop the 
SalivaSac-Registered Trademark- for such use.

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
believes that 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.
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.

Diabetes Market: According to the American Diabetes Association ("ADA"), an
estimated 16 million Americans suffer from diabetes. However, the Centers for
Disease Control ("CDC") estimates that in the U.S. alone, only half of all
diabetics have actually been diagnosed. The ADA has issued guidelines to screen
everyone over the age of 45 every three years. In 1997, the total cost of
diagnosing and treating diabetes in the U.S. was estimated to be $98 billion. In
1996, the U.S. market for home blood glucose monitoring was nearly $1 billion
and is expected to grow to $1.7 billion by 2001.


                                       4

<PAGE>

PRODUCT PIPELINE

OTHER APPLICATIONS

Based on preliminary studies conducted by the Company and others, the 
Sweatpatch-TM- and SalivaSac-Registered Trademark- have numerous potential 
applications, which may permit PBI to develop, or license the development of 
diagnostic and non-diagnostic applications including but not limited to:

     -    Assessment of nutritional status
     -    Monitoring of drugs of abuse (SalivaSac-Registered Trademark- only)
     -    Therapeutic drug monitoring of anti-rejection drugs for transplant
          patients
     -    Monitoring of HIV drug therapies 
     -    Monitoring of patient compliance in clinical trials 
     -    Measurement of hormones 
     -    Measurement of cardiac markers

The Company is seeking collaborative relationships to further the development
and commercialization of these potential applications.

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 twelve laboratories designated worldwide
(six 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.

DEVELOPMENTS DURING FISCAL 1998

In December 1997, the Company executed a license agreement ("Sudormed
License") with Sudormed, which provides the Company an exclusive worldwide
license to all medical diagnostic applications of Sudormed's skin patch
technology. This new 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 allows for the development of
all other potential applications of such technology, except for those relating
to alcohol and drugs of abuse.

Pursuant to the Sudormed License, the Company is 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 include a lump-sum payment of $1.6 million due in December 1998.
Through this license, the Company believes that it will be able to expand the
use of the skin patch technology, thereby broadening its platform technology,
building on its research expertise from the Osteopatch-TM- development, and
strengthening its position in the non-invasive testing marketplace. However, PBI
will need to raise additional funding to make the required payments or risk
losing the license (see Management Discussion and Analysis of Financial
Condition and Results of Operations).

In December 1997, the Company entered into a Technical Development and License
Agreement ("Actimed Agreement") with ActiMed Laboratories, Inc.
("ActiMed,"). The Actimed Agreement provides the Company with exclusive
worldwide rights to ActiMed's patented analyte detection technology in the field
of saliva glucose testing. 

                                       5

<PAGE>
The Company intends to combine this technology with the Company's patented 
SalivaSac-Registered Trademark- technology to develop a saliva glucose 
testing system, with applications in screening for and monitoring of diabetes.

In conjunction with the Actimed Agreement, the Company has entered into a
development program with ActiMed, which the Company will fund on a mutually
agreed budget by ActiMed and the Company, and will pay ActiMed a royalty based
on future sales of products developed under this arrangement that use ActiMed's
thin film and dye technology.

In January 1998, the Company completed a clinical utility study for the
Osteopatch-TM- involving over 200 patients at 14 osteoporosis centers to support
the Company's 510(k) notification application with the FDA, which was submitted
in February 1998. In May 1998, the Company announced that it received a letter
from the FDA in response to its 510(k) application. Based on this letter and
subsequent discussions with the FDA, the Company is working with the FDA to
define the trials required to provide additional information and resubmit its
510(k) application. The Company has initiated some of the work that is required
to provide such additional information (see Management Discussion and Analysis
of Financial Condition and Results of Operations).

On February 20, 1998, the Company consummated the sale of 925,000 shares of
Series A Convertible Preferred Stock ("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 ("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.

In March 1998, the Company and its subsidiaries entered into a Loan and Security
Agreement ("Loan Agreement") relating to a $1 million term loan ("Loan")
with Silicon Valley Bank ("Bank"). 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 has not yet drawn down any amounts under the Loan and is in the process
of negotiating certain terms of the Loan Agreement and raising equity capital 
in order to be in compliance with all Loan Agreement covenants.

In July 1998, the Company signed a License, Supply and Distribution Agreement
("Distribution Agreement") with Segix for the Company's Osteopatch-TM-
diagnostic system for the Italian market. The Distribution Agreement contains
provisions requiring minimum purchases, investment in marketing, foreign
currency adjustment mechanisms, unit price adjustment mechanisms, and
exclusivity for the territory of Italy, Vatican City and San Marino. The
Distribution Agreement has an initial term of ten years. Execution of the
Distribution Agreement gives the Company access to the Italian market through
Segix's 70 person direct sales force. Segix is preparing to launch the
Osteopatch-TM- for the Italian market in the beginning of 1999.

In August 1998, the Company announced that it had retained R&R Capital Group to
assist in raising capital for the Company's anticipated funding requirements.
The Company also announced in August 1998 that it had retained new auditors,
Grant Thornton LLP, to replace its former auditors who had resigned in June
1998.

The Company owns rights to a sample preparation device marketed under the 
name SPINPRO-Registered Trademark-, which simplifies and improves the methods 
used for performing the testing of HDL cholesterol. In June 1997, the Company 
suspended production of SPINPRO-Registered Trademark- units and is currently 
seeking a partner or buyer for the product and technology. The Company is 
involved in two arbitration proceedings with former subcontractors related to 
the manufacturer of SPINPRO-Registered Trademark-. As of the date of this 
report, the Company does not believe that the proceedings will have a 
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 the SPINPRO-Registered Trademark- assets. 
                                       6
<PAGE>

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, 1998 was approximately $4,662,000. The Company's
accumulated deficit at June 30, 1998 was approximately $16,346,000, 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 mergers in
1996. No assurance can be given that the net loss and accumulated deficit will
not continue to increase or that the Company will ever achieve profitable
operations. The Company has not had an extensive operating history and revenues
to date have been limited. 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 will be required to conduct significant research, development,
testing and regulatory compliance activities that, together with projected
general and administrative expenses, are expected to result in significant
operating losses for at least the next twelve months. Revenues that the Company
may receive in the next twelve months will be limited to revenues received from
the Company's laboratory operations, payments under research or product
development relationships and payments under license agreements which may be
established and revenues received in connection with the Osteopatch-TM- product
hrough the Segix Distribution Agreement for Italy. There can be no assurance,
however, that the Company will be able to establish any such relationships or
enter into any such license agreements. The Company's ability to achieve
profitability depends upon its ability to successfully complete, either alone or
with others, development of its potential medical diagnostic products, conduct
clinical trials, obtain required regulatory approvals, and manufacture and
market its products or enter into license agreements, on acceptable terms. In
the event that the Company enters into any future license or collaborative
arrangements, such arrangements may adversely affect the Company's profit
margins on its potential products. The Company may never achieve significant
revenue or profitable operations.

EARLY STAGE OF DEVELOPMENT AND TECHNOLOGICAL UNCERTAINTIES. The Company is at an
early stage of development. Except for revenues from its laboratory, all of the
Company's potential products are currently in research and development, and no
significant recurring product revenues have been generated to date. A
significant portion of the Company's resources have been, and for the
foreseeable future will continue to be, dedicated to the Company's research
programs and the development of potential medical diagnostic products emanating
therefrom. There can be no assurance that the Company will be able to develop a
commercial product from these projects.

The potential medical diagnostic products currently under development and other
potential applications of the Company's technology currently under examination
by the Company may 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'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. As a result, there can be no assurance that the Company's research and
development activities will result in any commercially viable products.

                                       7

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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 and the Osteopatch-TM-. 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 Company has no current source of 
revenues or capital other than through the potential exercise of the publicly 
held Warrants, which are currently out of the money. Based upon its current 
plans, the Company believes that its anticipated cash flows from operations, 
together with the proceeds from the Preferred Stock sale completed in 
February and May of 1998 and existing debt arrangements, will be sufficient 
to meet the Company's operating expenses through December 1998. The Company 
has renegotiated the Sudormed License to defer certain monthly payments until 
January 1, 1999 which combined with the December 31, 1998 obligation will 
total approximately $2 million due related to the maintenance of the license. 
Failure to meet these obligations would result in a default under the 
Sudormed License, which would have a material adverse effect on the Company 
including possible loss of the Osteopatch-TM- product. The Company will need 
to raise at least an additional $2 million in new funding to continue 
anticipated research, development, testing and regulatory compliance 
activities related to the Osteopatch-TM- and other potential products under 
development. Additionally, the adequacy of the Company's available cash 
equivalents and revenue from operations to sustain current and anticipated 
levels of operations are subject to a number of variables including 
maintaining and increasing existing laboratory revenues and profitability, 
performance of products in clinical trials, the level and timing of research 
and development costs necessary to obtain FDA clearance of the Osteopatch-TM- 
and other products under development, the costs and timing associated with 
commercial production and marketing of such products, the execution and 
maintenance of definitive agreements with key partners, intensified 
competition, third party reimbursement, technology obsolescence prior to 
successful commercialization, and the acceptability of terms related to 
anticipated sources of debt or equity capital.

The Company is currently in the process of seeking additional funding through
public or private financing or collaborative or other arrangements with
corporate partners. There can be no assurance, however, that additional
financing will be available from any of these sources, or if available, will be
available on acceptable terms. If adequate funds are not available, the Company
may be required to delay, scale back or eliminate one or more of its research
and development programs, including but not limited to the development of the
Osteopatch-TM- or to obtain funds through entering into arrangements with
collaborative partners or others that may require the Company to relinquish
rights to certain of its technologies or potential products that the Company
would not otherwise relinquish.

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
("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.

Although the Company believes that the Osteopatch-TM- and its other products
currently under development will be classified as "Class II" medical devices
allowing the Company to use the more expedient 510(k) notification procedure,
there can be no assurance that the FDA will not require the Company to submit
the more cumbersome and lengthy pre-market approval ("PMA") application. The
Company will attempt to market its products pursuant to Section 510(k) of the
Food, Drug and Cosmetic Act ("FDC Act"), which would require filing a 510(k)
submission, but not a PMA application. According to the FDA's Office of Device
Evaluations Annual Report, during 1997, the average 510(k) review time was
approximately three months, significantly shorter than the PMA application
review process, which approximated six months. There can be no assurance,
however, that the 510(k) review process will not take more than three months or
that the FDA will not require the Company to submit a PMA application. The
510(k) process requires 


                                       8

<PAGE>

that the Company show, among other things, that its product is substantially 
equivalent to another legally marketed product. The Company may begin 
marketing once the FDA issues an order allowing the product to be marketed. 
If a medical device does not qualify for the 510(k) notification procedure, 
the Company must file a PMA application, which requires more extensive 
clinical testing and submissions and involves a longer process of regulatory 
review and approval.

The Company believes that its osteoporosis product will be classified as a 
"Class II" medical device, and the Company submitted on February 9, 1998 a 
510(k) notification with respect to the Osteopatch-TM-. The Company is 
relying on (i) the fact that the FDA has already cleared the skin patch, 
which has been licensed to the Company by Sudormed, as a general sample 
collection device and as a perspiration collection device for diagnosis of 
five drugs of abuse (opiates, PCP, THC, cocaine and amphetamines) and thereby 
may be expected to clear the skin patch as a collection device for 
pyridinoline ("Pyd") and deoxypyridinoline ("Dpd") and (ii) the fact that the 
FDA has cleared Metra's 510(k) submissions for its immunoassay test kits, 
which measure Pyd and Dpd levels in "first morning void" urine samples. If 
the Company is able to demonstrate a correlation between Pyd and/or Dpd 
levels in perspiration and urine, the Company believes that its osteoporosis 
product can be shown to be substantially equivalent to medical devices (i.e., 
diagnostic kits for measurement of Pyd and/or Dpd levels in urine) which the 
FDA has already cleared for marketing and thus qualifying the Company's 
product under the 510(k) notification procedure. However, in May 1998, the 
Company announced that it received a letter from the FDA in response to its 
510(k) application. Based on this letter and subsequent discussions with the 
FDA, the Company is working with the FDA to define the trials required to 
provide additional information and resubmit its 510(k) application.

The Company will have to expand existing clinical studies and conduct 
additional clinical studies, which may take approximately six to nine months 
to complete. The Company will not be able to resubmit its 510(k) application 
until the spring of 1999 at the earliest. Although the Company was hopeful 
for a determination of substantial equivalence by the FDA in 1998 based on 
its first 510(k) submission, it is likely, depending on the extent and review 
required of additional information requests by the FDA, that such 
determination will be delayed until at least the third calendar quarter of 
1999. There can be no assurance that the Company will be able to meet all of 
its financial and business objectives, in which event, the Company may be 
forced to curtail certain projects including the Osteopatch-TM-. The preceding
statements regarding the Company's FDA submission involves risks and 
uncertainties with respect to the extent and timing of the FDA process and 
are further subject to several variables. Many of such variables are beyond 
the Company's control, including, but not limited to, the technical and 
financial ability of the Company to comply with the FDA's informational 
requests and to conduct additional clinical studies if necessary, and the 
classification of the Osteopatch-TM- product as a 510(k) device. The Company 
is currently seeking to raise additional capital to fund its development 
projects and other capital needs.

The FDA may respond to the Company's 510(k) notification (as resubmitted)
by directing the Company to file a PMA application for the osteoporosis 
product. Despite the Company's correlation studies and clinical tests, 
the FDA may consider perspiration too different from urine as a medium 
for Pyd and/or Dpd. If the Company is required to file a PMA application for 
its osteoporosis product, the Company may be required to conduct substantial 
additional research and clinical tests before doing so, and would be unable 
to file a PMA application until the clinical work is complete. Even if the 
FDA permits the Company to proceed with a 510(k) notification, the FDA may 
require the Company to support its notification with additional research and 
clinical test data, resulting in a longer process of regulatory review than 
is typical for 510(k) notifications.

UNCERTAINTY OF PROTECTION OF PATENTS AND INTELLECTUAL PROPERTY RIGHTS; RISK OF
PATENT INFRINGEMENT LIABILITY. The Company's success depends on its ability to
obtain future patents, protect existing patents, licenses, intellectual property
rights, trade secrets, and to operate without infringing upon the proprietary
rights of others and prevent others 

                                      9
<PAGE>

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.

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 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.

RISKS INHERENT IN INTERNATIONAL TRANSACTIONS. The Company plans to market its
products to customers both in the U.S. and abroad; however, 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. 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 international business operations. 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 business, financial condition and 
results of operations.

MANUFACTURING LIMITATIONS. The Company's dependence upon third parties for the
manufacture of its products may adversely affect the Company's profit margins
and its ability to develop and deliver such products on a timely and competitive
basis.

DEPENDENCE ON COLLABORATORS. The Company's strategy for the research,
development and commercialization of its potential medical diagnostic products
has and will require the Company to enter into various arrangements with
corporate collaborators, licensors, licensees and others, and may therefore be
dependent upon the subsequent success of these outside parties in performing
their responsibilities. There can be no assurance that the Company will be able
to establish collaborative arrangements or license agreements that the Company
deems necessary or acceptable to develop and commercialize its potential
products or that such collaborative arrangements or license agreements will be

                                     10

<PAGE>

successful. Moreover, certain of the collaborative arrangements that the Company
may enter into in the future may place responsibility for pre-clinical testing
and human clinical trials and for preparing and submitting applications for
regulatory approval for potential products on the collaborative partner. Should
a collaborative partner fail to develop or commercialize successfully any
potential product to which it has rights, the Company's business, financial
condition and results of operations may be materially adversely affected. In
addition, there can be no assurance that the collaborative partner will not be
pursuing alternative competing technologies or developing competing products
either on their own or in collaboration with others, including the Company's
competitors, as a means for developing diagnostic processes for the diseases or
disorders targeted by the Company's collaborative programs.

RELIANCE ON LICENSES, DISTRIBUTORS, SUPPLIERS AND MANUFACTURERS. The Company 
has licensed technologies with respect to the development of the 
Osteopatch-TM-, other Sweatpatch-TM- related products and 
SalivaSac-Registered Trademark- applications. The Company has entered into 
arrangements with Sudormed with respect to the Osteopatch-TM- and other 
Sweatpatch-TM- related development projects, Metra with respect to the 
Osteopatch-TM-, and ActiMed with respect to development of 
SalivaSac-Registered Trademark- applications.

Pursuant to the terms of the Sudormed License and Actimed Agreement, the Company
is obligated to exercise diligence in bringing potential products to market and
to make certain royalty payments. In addition, in some instances, the Company is
responsible for making minimum royalty payments without generating sales and may
incur costs of filing and prosecuting patent applications. Each license
agreement is terminable by either party, upon notice, if the other party
defaults in its obligations. The Company licensed the technology for development
of its Osteopatch-TM- product from the owner of the patents covering such
technology pursuant to arrangements requiring minimum quarterly royalty
payments. The termination or cancellation of any of the Company's material
license arrangements would have a material adverse effect on the Company's
business, financial condition and results of operations.

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, if such suppliers
become unable or unwilling to continue to produce products or components for the
Company according to the Company's specifications, or to meet the Company's
delivery schedules, the Company's operations could be materially disrupted,
especially over the short term, resulting in a material adverse effect on its
results of operations or the success or timing of necessary clinical trials.

There is no assurance that the Company's distributors and suppliers will remain
in business or honor their arrangements with the Company. The Company has
entered into a supply agreement with Sudormed, the licensor of the technology
relating to the Sweatpatch-TM- for the production of the Osteopatch-TM- product.
The supply agreement requires minimum annual purchases of the Osteopatch-TM- or
Sweatpatch-TM- products. Failure to purchase the required annual minimum amounts
would result in a default under the license agreement relating to the technology
incorporated into the Osteopatch-TM- and Sweatpatch-TM- and possible loss of
exclusivity. Loss of such license, loss of the supplier or failure of the
supplier to comply with GMP will have a material adverse effect on the Company's
business, financial conditions and results of operations.

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. One customer individually accounted for
approximately 33 percent of the Company's total sales in fiscal 1998 and
approximately 36 percent of the Company's total sales in fiscal 1997. Sales to
the Company's five largest customers represented approximately 67 percent and 77
percent of total sales in fiscal 1998 and fiscal 1997, respectively. As the
Company's laboratory operations grow, the Company expects that its dependence on
any one or group of customers will diminish.


                                     11

<PAGE>

POSSIBLE DELISTING OF SECURITIES FROM NASDAQ SMALL CAP MARKET; DISCLOSURE 
RELATING TO LOW-PRICED STOCKS. The Company's failure to meet the maintenance 
criteria for continued listing on the Nasdaq Small Cap Market for any reason 
may result in the discontinuance of the inclusion of the Company's securities 
on the Nasdaq Small Cap Market. To qualify for continued inclusion on the 
Nasdaq Small Cap Market, a company will have to maintain (a) either 
$2,000,000 in net tangible  assets (total assets minus total liabilities and 
goodwill); market capitalization of $35,000,000; or net income of $500,000 in 
the most recently completed fiscal year or two of the last three most 
recently completed fiscal years; and (b) a market value of the public float 
of $1,000,000. In addition, continued inclusion requires two market-makers 
and a minimum bid price of $1.00. In the event of Nasdaq Small Cap Market 
delisting, trading, if any, in the Company's securities may then continue to 
be conducted on the OTC Electronic Bulletin Board or in the non-Nasdaq 
over-the-counter market. As a result, an investor may find it more difficult 
to dispose of, or to obtain accurate quotations as to the market value of the 
Company's securities and it could become more difficult for the Company to 
raise capital.

GLOSSARY OF TERMS

ANALYTES: A chemistry term denoting a biological substance or drug that is
measured to indicate some physiological or health state; e.g., glucose is the
analyte of interest in monitoring treatment of diabetics.

ANTIBODIES: A protein produced in the body to neutralize an antigen (a protein
that chemically identifies a molecule or cell).

ASSAYS: A system by which the amount of a biological substance is measured;
includes, e.g., immunoassays, the measurement of a substance from its
interaction with a specific antibody.

BIOCHEMICAL MARKERS OF BONE LOSS: Certain specific molecules produced from the
degradation of bone proteins. Bone products are delivered to blood and then to
urine and sweat. The amount of the bone molecules measured in these fluids in a
specified interval is related to the amount of bone degraded or lost in that
time.

ENZYMES:  Proteins whose function is to degrade other biological molecules.

OSMOTIC DRIVER: A substance (usually a sugar or a salt) that, when dissolved,
establishes an osmotic gradient. An osmotic gradient is a physical situation in
which one side of a membrane has a high concentration of a substance, and the
other side has a smaller concentration. As a consequence, water flows from the
low concentration side to the high side. In this way, small molecules and water
can be carried through a semipermeable membrane.

PYRIDINOLINE/DEOXYPYRIDINOLINE: A degradation product of bone resorption.

TRANSDERMAL: Movement of substances from blood across the skin (dermis), chiefly
in sweat. Transdermal also refers to the movement of substances from the surface
of the skin to the underlying tissues and blood (e.g., Nicotine Transdermal
systems).


                                       12
<PAGE>

ITEM 2  - PROPERTIES

The Company's executive offices are located at 25651 Atlantic Ocean Drive, Suite
A-1, Lake Forest, California and its laboratory facilities are located at both
the Lake Forest, California location and in Seattle, Washington. The Company
leases approximately 10,500 square feet of office and laboratory space in Lake
Forest, California pursuant to a five year lease, at an annual rental of
$140,100, which expires on July 31, 2003. 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 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.

ITEM 3  - LEGAL PROCEEDINGS

The Company is not a party to any material legal proceedings. However, on 
September 24, 1997 the Company received from the former manufacturer of 
SPINPRO-Registered Trademark- a demand for arbitration in connection with 
alleged breaches of the contract relating to the manufacture of 
SPINPRO-Registered Trademark-. 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-Registered Trademark-, seeking damages for alleged breach of contract 
with respect to the manufacture of molds for SPINPRO-Registered Trademark- 
parts.

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, 1998.

                                     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 Small Cap Market under the symbol "PBMI"
and under "PBMIW" for the Warrants. Prior to the offering in October 1996, no
established public trading market existed. The following table sets forth the
high and low sales prices for the Common Stock and the Warrants for the fiscal
periods indicated as reported by Nasdaq. The quotations shown represent
inter-dealer prices without adjustment for retail markups, markdowns or
commissions and may not necessarily reflect actual transactions.

<TABLE>
<CAPTION>

                                   COMMON STOCK          WARRANTS
                                 ---------------    ----------------
                                 High      Low        High     Low
                                 ----      -----    -----     ------
<S>                              <C>       <C>      <C>        <C>
Second Quarter ended 12/31/96    5 1/2     2 7/8    3/8        1/8
Third Quarter ended 3/31/97      4 3/8     1 7/8    7/16       1/8
Fourth Quarter ended 6/30/97     2 7/8     1 3/8    3/8        5/32
                                
First Quarter ended 9/30/97      3 7/8     1 11/16  9/16       1/4
Second Quarter ended 12/31/97    3 15/16   2 1/16   9/16       3/16
Third Quarter ended 3/31/98      3 7/8     2 3/8    9/16       1/8
Fourth Quarter ended 6/30/98     3 15/16   2 1/8    5/16       1/8

</TABLE>

The per share closing sales price of the Common Stock was 1 1/2 and the closing
sales price of the Warrants was 3/32 as reported by Nasdaq on September 22,
1998. As of September 22, 1998 the Company had in excess of six hundred fifty
beneficial holders and one hundred twenty record holders of the Common Stock and
had in excess of four hundred beneficial holders and at least ten record holders
of the Warrants.

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 paid or accrued dividends
on the Preferred Stock of $70,093.

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

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

OVERVIEW

PBI was incorporated in Delaware in May 1996 in connection with the acquisition
of BioQuant, a Michigan corporation and 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 mission of PBI is to develop and commercialize non-invasive technologies 
for use in medical diagnostics and laboratory services 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. PBI's intellectual property position in sweat and saliva 
collection technology is based on thirteen issued U.S. patents and four 
pending U.S. patents with respect to the Company's Sweatpatch-TM- and 
SalivaSac-Registered Trademark-.

Expenses consist, and are expected to continue to consist, primarily of
operating expenses necessary to conduct the commercial laboratory operation,
research and development costs for products under development, administration
expenses and payment of license and royalty fees to maintain the Company's 
intellectual property rights.

                                       14

<PAGE>

As of June 30, 1998, the Company had an accumulated deficit of $16,346,447 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.

RESULTS OF OPERATIONS

The following tables compare the periods ending June 30, 1998 and June 30, 1997
and June 30, 1996 as shown in the attached financial statements 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 from the
financials.

Laboratory revenues:

<TABLE>
<CAPTION>

   6/30/98       6/30/97      6/30/96     98 vs. 97     97 vs. 96    98 vs. 97    97 vs. 96
   -------       -------      -------     ---------     ---------    ---------    ---------
<S>              <C>           <C>           <C>          <C>           <C>          <C>
   $2,385        $2,119        $1,131        $266         $988          13%          87%

</TABLE>

Laboratory revenues increased in 1998 and in 1997 based on the increase in 
the testing and consulting work performed on clinical trials managed by third 
parties.

Product revenues:
<TABLE>
<CAPTION>

   6/30/98       6/30/97      6/30/96     98 vs. 97     97 vs. 96    98 vs. 97    97 vs. 96
   -------       -------      -------     ---------     ---------    ---------    ---------
<S>               <C>           <C>         <C>            <C>           <C>         <C>
    $112          $325          $240        ($213)         $85          -66%         35%

</TABLE>

Product revenues declined in 1998 due to the cessation of SPINPRO-Registered 
Trademark- sales partially offset by initial Osteopatch-TM- revenue from 
PBI's foreign license and distribution agreements. Product revenues increased 
in 1997 due to an increase in sales of SPINPRO-Registered Trademark- products 
as compared to 1996.

Clinical trial management revenues:

<TABLE>
<CAPTION>

   6/30/98       6/30/97      6/30/96     98 vs. 97     97 vs. 96    98 vs. 97    97 vs. 96
   -------       -------      -------     ---------     ---------    ---------    ---------
<S>               <C>           <C>         <C>            <C>           <C>         <C>
     $25          $345          $286        ($320)         $59          -93%         21%

</TABLE>

Clinical trial management revenues declined in 1998 as PBI focused resources on
internal clinical trial management. Clinical trial management revenues increased
in 1997 due to a significant diagnostic trial being managed by PBI.

Laboratory expenses and cost of goods sold:

<TABLE>
<CAPTION>

   6/30/98       6/30/97      6/30/96     98 vs. 97     97 vs. 96    98 vs. 97    97 vs. 96
   -------       -------      -------     ---------     ---------    ---------    ---------
<S>              <C>           <C>           <C>          <C>           <C>          <C>
   $2,098        $1,711        $1,364        $387         $347          23%          25%

</TABLE>

In 1998 expenses and costs increased despite a decrease in total revenues from
$2.8 million to $2.5 million. Costs increased primarily due to a large
low-margin laboratory contract that was started and completed during fiscal 
1998 and a decrease in the mix of higher margin consulting services. Costs 
related to revenue increased in 1997, but the increases were less than the 
increase in total revenues due to economies of scale, investment in labor 
saving technology and an increased mix of specialty services.

Research and product development:

<TABLE>
<CAPTION>

   6/30/98       6/30/97      6/30/96     98 vs. 97     97 vs. 96    98 vs. 97    97 vs. 96
   -------       -------      -------     ---------     ---------    ---------    ---------
<S>              <C>            <C>         <C>           <C>           <C>          <C> 
   $2,388        $1,024         $467        $1,364        $557          133%         119%

</TABLE>

Research and development costs increased in 1998 and in 1997 as PBI 
implemented its plan to develop the Osteopatch-TM- and performed additional 
research for other Sweatpatch-TM- and SalivaSac-Registered Trademark- 
technology applications.

                                       15

<PAGE>

Selling, general and administrative:

<TABLE>
<CAPTION>

   6/30/98       6/30/97      6/30/96     98 vs. 97     97 vs. 96    98 vs. 97    97 vs. 96
   -------       -------      -------     ---------     ---------    ---------    ---------
<S>              <C>           <C>           <C>          <C>           <C>          <C>
   $2,168        $1,575        $1,041        $593         $534          38%          51%
</TABLE>

Selling, general and administrative costs increased in 1998 primarily due to
development of sales and marketing resources. General and administrative costs
increased in 1997 primarily due to the additional costs of being a publicly held
company.

Other income and expense:

<TABLE>
<CAPTION>

   6/30/98       6/30/97      6/30/96     98 vs. 97     97 vs. 96    98 vs. 97    97 vs. 96
   -------       -------      -------     ---------     ---------    ---------    ---------
<S>               <C>          <C>         <C>           <C>           <C>           <C>
    ($47)          $7           $27         ($54)         ($20)        -771%         -74%

</TABLE>

The decrease in 1998 is primarily due to other expense related to the 
write-down of the value of SPINPRO-Registered Trademark- assets. Other income 
in 1997 reflected interest income earned on funds received in the Company's 
IPO offset by the reserve established for the SPINPRO-Registered Trademark- 
product line.

Net loss:

<TABLE>
<CAPTION>

   6/30/98       6/30/97      6/30/96     98 vs. 97     97 vs. 96    98 vs. 97    97 vs. 96
   -------       -------      -------     ---------     ---------    ---------    ---------
<S>             <C>           <C>          <C>           <C>            <C>           <C>
  ($4,612)      ($1,577)      ($7,561)     ($3,035)      $5,984         192%         -79%

</TABLE>

The net loss increased in 1998 as PBI experienced lower total revenues, 
invested in laboratory sales and Osteopatch-TM- marketing programs, clinical 
trials and regulatory expenses associated with the Osteopatch-TM- and 
researched applications for the Sweatpatch-TM- and SalivaSac-Registered 
Trademark- technology. The net loss decreased in 1997 compared to 1996, which 
included a one-time non-cash $6.4 million charge resulting from the merger in 
June of 1996.

LIQUIDITY AND CAPITAL RESOURCES

FINANCING

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.

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.

In March 1998, the Company and its subsidiaries entered into the Loan Agreement
relating to a $1 million term loan with the Bank. 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 has not yet drawn down any amounts under the Loan Agreement
and is in the process of raising equity capital and renegotiating certain 
terms of the Loan Agreement in order to be in compliance.

                                       16
<PAGE>

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 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 equity capital
in order to draw additional funding from this arrangement.

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, which were set to expire on January 31, 1998. The exercise price
of $12.00 was not changed.

PRODUCTS AND SERVICES

In July 1997, the Company signed a letter of intent outlining research
collaboration terms with ActiMed. In December 1997, the Company entered into the
Actimed Agreement, which provides the Company with exclusive worldwide rights to
ActiMed's patented analyte detection technology in the field of saliva glucose
testing. In conjunction with the Actimed Agreement, the Company has entered into
a development program with ActiMed, which the Company will fund on a mutually
agreed budget by ActiMed and the Company, and will pay ActiMed a royalty based
on future sales of products developed under this arrangement that use ActiMed's
thin film and dye technology.

In August 1997, the Company announced an agreement with Segix for a market and
technical evaluation of the Company's Osteopatch-TM- diagnostic system for the
Italian market. In July 1998, the Company signed the Distribution Agreement with
Segix. This agreement allows the Company access to the Italian market through
Segix's 70 person direct sales force.

In September 1997, the Company announced that it had signed a letter of intent
with Sudormed, Inc. and Sudor Partners which would provide to the Company an
exclusive world-wide license to all applications (except for those relating to
alcohol and drugs of abuse) of the skin patch technology. In December 1997, the
Company executed the Sudormed License. The Company is obligated to pay Sudormed
approximately $3 million over a twenty month period plus an ongoing royalty
payment based on the amount of sales of products developed under the Sudormed
License, including a lump-sum payment of $1.6 million in December 1998. The
Sudormed License also provides terms that are more favorable for the Company
regarding price, royalties and minimum purchases as compared to the prior
Osteopatch-TM- supply agreement with Sudormed. However, PBI will need to raise
additional funding to make such required payments or risk losing the license.
Loss of the license would have a material adverse effect on the Company,
including possible curtailment of the Osteopatch-TM- project.

In May 1998, the Company announced that it received a letter from the FDA in 
response to its 510(k) application that was submitted in February 1998. Based 
on this letter and subsequent discussions with the FDA, the Company is 
working with the FDA to define the trials to provide additional information 
and resubmit its 510(k) application. The Company will have to expand existing 
clinical studies and conduct additional clinical studies, which may take 
approximately six to nine months to complete. The Company will not be able to 
resubmit its 510(k) application until the Spring of 1999 at the earliest. 
Although the Company was hopeful for a determination of substantial 
equivalence by the FDA in 1998 based on its first 510(k) submission, it is 
likely, depending on the extent and review required of additional information 
requests by the FDA, that such determination will be delayed until at least 
the third calendar quarter of 1999. There can be no assurance that the 
Company will be able to meet all of its financial and business objectives, in 
which event, the Company may be forced to curtail certain projects, including 
Osteopatch-TM-. The preceding statements regarding the Company's FDA 
submission involves risks and uncertainties with respect to the extent and 
timing of the FDA process and are further subject to several variables. Many 
of such variables are beyond the Company's control, including, but not 
limited to, the technical and financial ability of the Company to comply with 
the FDA's informational requests and to conduct additional clinical studies 
if necessary, and the classification of the Osteopatch-TM- product as a 
510(k) device. The Company is currently seeking to raise additional capital 
to ensure it will be able to fund its development projects.

The FDA may respond to the Company's 510(k) notification (as resubmitted)
by directing the Company to file a PMA application for the osteoporosis
product. Despite the Company's correlation studies and clinical tests, the 


                                       17
<PAGE>

FDA may consider perspiration too different from urine as a medium for Pyd 
and/or Dpd. If the Company is required to file a PMA application for its 
osteoporosis product, the Company may be required to conduct substantial 
additional research and clinical tests before doing so, and would be unable 
to file a PMA application until the clinical work is complete. Even if the 
FDA permits the Company to proceed with a 510(k) notification, the FDA may 
require the Company to support its notification with additional research and 
clinical test data, resulting in a longer process of regulatory review than 
is typical for 510(k) notifications.

The Company owns rights to a sample preparation device marketed under the 
name SPINPRO-Registered Trademark-, which simplifies and improves the methods 
used for performing the testing of HDL cholesterol. In June 1997, after 
utilizing certain key SPINPRO-Registered Trademark- inventory components 
purchased from the former manufacturer and making shipments to customers to 
meet their requirements, the Company suspended production at the former 
manufacturer's location and placed all SPINPRO-Registered Trademark- 
equipment and inventory in storage to await potential relocation to a new 
facility or sale of this product line. The suspension of production has not 
had a material effect on the Company's operations or financial condition, 
since SPINPRO-Registered Trademark- revenues and operating margins have not 
been material to date. The Company is currently seeking a partner or buyer 
for the product and technology. The Company is involved in two arbitration 
proceedings with former subcontractors related to the manufacturer of 
SPINPRO-Registered Trademark-. At June 30, 1998, the Company determined that 
it was not feasible to continue the production of the SPINPRO-Registered 
Trademark- product and that amounts, if any, from the disposition of the 
related asset would not be significant. Therefore, an impairment loss for the 
net book value of the related asset of $126,000 was recorded.

FUTURE OPERATIONS

The Company expects to continue to incur significant operating losses for at 
least twelve months due to anticipated research, development, testing and 
regulatory compliance activities, and projected general and administrative 
expenses. The Company anticipates, based on currently proposed plans and 
assumptions relating to its operations, that the net proceeds of the 
Preferred Stock, together with projected revenues from operations and debt 
arrangements, will be sufficient to satisfy its operating expenses required 
through December 1998. The Company has renegotiated the Sudormed License to 
defer certain monthly payments until January 1, 1999 which combined with the 
December 31, 1998 obligation will total approximately $2 million related to 
the maintenance of the license. Failure to meet these obligations would 
result in a default under the Sudormed License, which would have a material 
adverse effect on the Company including possible loss of the Osteopatch-TM- 
product. The Company will need to raise at least an additional $2 million in 
new funding to continue anticipated research, development, testing and 
regulatory compliance activities related to the Osteopatch-TM- and other 
potential products under development.

The Company is actively working to raise the funds mentioned above and 
additional funds to cover longer-term requirements for product research and 
development. The Company has also significantly reduced its operating 
expenses in order to conserve existing cash resources. In August 1998, the 
Company announced that it had retained R&R Capital Group to assist in raising 
capital. However there can be no assurance that such external sources of 
funding will be available on terms favorable to the Company, in which event, 
the Company may be required to delay, scale back or eliminate one or more of 
its research and development programs, including but not limited to the 
development of the Osteopatch-TM-. Alternatively, the Company may obtain 
funds through entering into arrangements with collaborative partners or 
others that may require the Company to relinquish rights to certain of its 
technologies or potential products that the Company would not otherwise 
relinquish, or require substantial dilution or changes in stockholder rights 
in order to raise additional funds.

The adequacy of the Company's available cash equivalents and revenue from 
operations to sustain current and anticipated levels of operations are 
subject to a number of variables including maintaining and increasing 
existing laboratory revenues and profitability, performance of products in 
clinical trials, the level and timing of research and development costs 
necessary to obtain FDA clearance of products under development, the costs 
and timing associated with commercial production and marketing of such 
products, the execution of definitive agreements with key partners, 
intensified competition, third party reimbursement, and technology 
obsolescence prior to successful commercialization.

Successful future operations depend primarily upon the Company's ability to 
develop applications for the Sweatpatch-TM- and SalivaSac-Registered 
Trademark- technology and attract joint venture partners or license specific 
applications. The Company's strategy 

                                       18
<PAGE>

for the research, development and commercialization of its potential medical
diagnostic products has and will require the Company to enter into various
arrangements with collaborators, licensors, licensees and others, and may
therefore be dependent upon the subsequent success of these outside parties in
performing their responsibilities. There can be no assurance that the Company
will be able to establish collaborative arrangements or license agreements that
the Company deems necessary to develop and commercialize its potential products
or that such collaborative arrangements or license agreements will be successful
or on acceptable terms.

A significant part of the Company's future operations depend upon the ability 
to complete development of the Osteopatch-TM- product, obtain FDA clearance, 
and achieve successful product commercialization. There can be No assurance 
that the Company will be able to meet its objective to develop and 
commercialize a cost-effective osteoporosis related diagnostic product. The 
risks facing the Company include raising required capital to continue 
development efforts and the ability to obtain regulatory approval which is 
dependent upon such factors as the results of clinical trials, the decisions 
of regulatory officials, and potential changes in regulations, all of which 
may be beyond the control of the Company. In addition, successful 
commercialization of any product will be dependent upon market acceptance, 
competition, technological change, and dependence on collaborators for 
research, development and marketing assistance.

The Company's future operations also depend on its ability to grow a profitable
reference laboratory operation. Although the Company has increased laboratory
revenues, has operated the laboratory at a profit and has established
cardiovascular and osteoporosis expertise, there can be no assurances that the
Company will be able to continue such growth or maintain profitability on
contracts for laboratory services. In addition, contracts are entered into for a
specified period (usually less than a year) but can be canceled at any time.
During fiscal 1998, the Company completed two large contracts and is currently
operating the laboratory at substantially less than full capacity. Accordingly,
the laboratory operation can be dependent on a few large contracts and the
Company's ability to replace such contracts upon expiration or termination, of
which there can be no assurance.

YEAR 2000

Work began in 1997 within PBI's Information Systems department to analyze the
impact of the approaching turn of the century on PBI's systems. Major basic
systems (servers, network operating system) have already been determined to be
complaint. The accounting application is guaranteed by the manufacturer to be
compliant, as is the database engine. Currently under analysis is the laboratory
information system ("LIS") application and the laboratory instrumentation.
Minimal alterations to the LIS application are expected. A comprehensive plan
for acquiring information from instrument vendors and addressing any upgrades or
other contingency plans is in process.

STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income".
SFAS No. 130, which is effective for fiscal years beginning after December 15,
1997 and requires restatement of earlier periods presented, establishes
standards for the reporting and display of comprehensive income and its
components in a full set of general purpose financial statements. Comprehensive
income is defined as the change in equity of a business enterprise during a
period from transactions and other events and circumstances from non-owner
sources. The implementation of SFAS No. 130 is not expected to have a material
effect on the Company's results of operations.

In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information". SFAS No. 131, which is effective for fiscal
years beginning after December 15, 1997 and requires restatements of earlier
periods presented, established standards for the way that a public enterprise
reports information about key revenue-producing segments in the annual
financials statements and selected information in interim financial reports. It
also establishes standards for related disclosures about products and services,
geographic areas and major customers. The implementation of SFAS No. 131 is not
expected to have a material effect on the Company's current reporting.



                                       19
<PAGE>

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

On June 22, 1998, the Company received the written resignation of Coopers &
Lybrand L.L.P. ("C&L") as the Company's independent auditors. During the
Company's two most recent fiscal years ended June 30, 1997, C&L's reports on the
Company's financial statements contained no adverse opinion or disclaimer of
opinion, nor were they qualified or modified as to uncertainty, audit scope, or
accounting principles, except as follows:

         C&L's report dated September 5, 1996 (issued prior to the Company's
         initial public offering of securities), on the Company's financial
         statements for the fiscal year ended June 30, 1996 contained the
         following paragraph:

                  "The accompanying consolidated financial statements have been
                  prepared assuming that the Company will continue as a going
                  concern. As discussed in Note 18 to the financial statements,
                  the Company had experienced recurring losses from operations
                  and cash flow shortages, and has reported deficiencies in
                  working capital and stockholders' equity. 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 Note 18. The consolidated financial
                  statements do not include any adjustments that might result
                  from the outcome of this uncertainty".

During the Company's two most recent fiscal years ended June 30, 1997, and
through June 22, 1998, there were no disagreements with C&L on any matter of
accounting principles or practices, financial statement disclosure, auditing
scope or procedure which disagreements, if not resolved to the satisfaction of
C&L, would have caused it to make reference to the subject matter of the
disagreement in connection with its report, except that the Company, based on a
review by C&L of the Company's unaudited financial statements, amended a press
release which previously reported third quarter results. In an amended press
release, the Company reported a non-cash adjustment of $187,400, reflecting
accelerated depreciation of certain license rights, which adjustment increased
losses by a like amount. Additionally, the Company increased its loss per share
by $0.26 as a result of such accelerated depreciation and an adjustment for
imputed dividends associated with the grant of an option to acquire preferred
stock. Such amended results were included in the Company's Quarterly Report on
Form 10-QSB as filed with the Commission on May 15, 1998.

The Company requested C&L to furnish it with a letter addressed to the
Securities and Exchange Commission stating whether C&L agrees with the
statements contained in the second and third paragraphs above. A copy of the
letter from C&L to the Securities and Exchange Commission was filed as Exhibit 1
with Form 8-K filed with the Commission on June 26, 1998 (File No. 0-21537).

The Company engaged Grant Thornton LLP as its independent auditors as disclosed
in its Current Report on Form 8-K filed with the Commission on July 29, 1998
(File No. 0-21537).

                                       20
<PAGE>

                                    PART III

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

Incorporated by reference to the Company's Proxy Statement for Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within 120
days after the close of the fiscal year ended June 30, 1998.

ITEM 10 - EXECUTIVE COMPENSATION

Incorporated by reference to the Company's Proxy Statement for Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within 120
days after the close of the fiscal year ended June 30, 1998.

ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
          MANAGEMENT

Incorporated by reference to the Company's Proxy Statement for Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within 120
days after the close of the fiscal year ended June 30, 1998.

ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Incorporated by reference to the Company's Proxy Statement for Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within 120
days after the close of the fiscal year ended June 30, 1998.

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)  Form 8-K reports were filed during the last quarter of the period
          covered by this report as follows:

          (i)  Current Report on Form 8-K filed with the Commission on June 26,
               1998 (File No. 0-21537) relating to the resignation of the
               Company's former auditors.

                                       21
<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, 1998 ...........................   F-3

Consolidated Statements of Operations for the years ended
     June 30, 1998 and 1997, and for the period from inception
     (December 1992) to June 30, 1998 ....................................   F-4

Consolidated Statements of Cash Flows for the years ended
     June 30, 1998 and 1997, and for the period from inception
     (December 1992) to June 30, 1998 ....................................   F-5

Consolidated Statements of Stockholders' Equity for the
     period from inception (December 1992) to June 30, 1998 ..............   F-7

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, 1998 and 
the related consolidated statements of operations and cash flows for the 
years ended June 30, 1998 and 1997, and for the period from inception 
(December 1992) to June 30, 1998, and the consolidated statement of 
stockholders' equity for the period from inception (December 1992) to June 
30, 1998. 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 generally accepted auditing 
standards. 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 
financial 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, 1998, and the consolidated results 
of its operations and its cash flows for the years ended June 30, 1998 and 
1997, and for the period from inception (December 1992) to June 30, 1998, in 
conformity with generally accepted accounting principles.

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 deficiencies in 
working capital and stockholders' equity. Also, the Company has significant 
amounts of debt maturing on December 31, 1998. 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 Note 3. 
The consolidated financial statements do no include any adjustments that 
might result from the outcome of this uncertainty.

                                       GRANT THORNTON LLP


Irvine, California
September 11, 1998


                                     F-2


<PAGE>

                           PACIFIC BIOMETRICS, INC.
                     (A COMPANY IN THE DEVELOPMENT STAGE)
                          CONSOLIDATED BALANCE SHEET
                                 JUNE 30, 1998

<TABLE>

<S>                                                                    <C>
                                     ASSETS

Current assets:
    Cash and cash equivalents........................................  $  2,244,056
    Accounts receivable, net of allowance for doubtful
      accounts of $90,137............................................       292,567
    Inventory........................................................       196,891
    Prepaid expenses.................................................       223,531
                                                                       ------------
         Total current assets........................................     2,957,045
Property and equipment, net..........................................       656,673
Other assets:
    Technology licenses..............................................     2,626,642
    Restricted cash..................................................       100,000
    Deposits and other...............................................        28,447
                                                                       ------------
         Total assets................................................  $  6,368,807
                                                                       ------------
                                                                       ------------

                          LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
    Notes payable to related parties.................................  $    253,664
    Accounts payable.................................................       374,703
    Accrued payroll related and other liabilities....................       349,917
    Advances from customers..........................................         9,918
    Technology license payable.......................................     2,174,138
    Capital lease obligations........................................       248,980
                                                                       ------------
         Total current liabilities...................................     3,411,320
                                                                       ------------

Technology license payable - long term portion.......................        80,913
Capital lease obligations - long term portion........................       352,942
                                                                       ------------
         Total long term liabilities.................................       433,855
                                                                       ------------

Commitments and contingencies (Note 13)

Stockholders' equity:
    Preferred stock, $0.01 par value, 5,000,000 shares
      authorized, 1,550,000 shares issued and outstanding............        15,500

    Commonstock, $0.01 par value, 30,000,000 shares
      authorized, 3,709,671 shares issued and outstanding............        37,097

    Additional paid-in capital Common Stock..........................    13,762,868
    Additional paid-in capital Preferred Stock.......................     5,054,614
    Deficit accumulated during the development stage.................   (16,346,447)
                                                                       ------------
         Total stockholders' equity..................................     2,523,632
                                                                       ------------
         Total liabilities and stockholders' equity..................  $  6,368,807
                                                                       ------------
                                                                       ------------
</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, 1998 AND 1997, AND FOR THE PERIOD
                 FROM INCEPTION (DECEMBER 1992) TO JUNE 30, 1998

<TABLE>
<CAPTION>
                                                                                              FOR THE PERIOD
                                                                                              FROM INCEPTION
                                                                                             (DECEMBER 1992)
                                                                                               TO JUNE 30,
                                                     1998                   1997                   1998
                                                     ----                   ----             ---------------
<S>                                              <C>                    <C>                    <C>
Revenue........................................  $  2,521,561           $  2,788,570           $  7,534,243
                                                 ------------           ------------           ------------
Operating expenses:
    Laboratory and cost of goods sold..........     2,097,874              1,710,808              5,673,360
    Research and product development...........     2,387,640              1,024,096              4,638,665
    Selling, general and administrative........     2,168,424              1,575,266              6,142,550
    Purchased in-process research and
          product development..................                                                   6,373,884
    Amortization of intangible assets..........       432,154                 62,500              1,023,022
                                                 ------------           ------------           ------------
          Total operating expenses.............     7,086,092              4,372,670             23,851,481
                                                 ------------           ------------           ------------
Operating loss.................................    (4,564,531)            (1,584,100)           (16,317,238)
                                                 ------------           ------------           ------------
Other income (expense):
    Interest expense...........................      (181,932)              (145,835)              (393,781)
    Interest income............................       137,936                147,940                291,464
    Grant and other income (expense)...........        (3,309)                 4,766                 73,108
                                                 ------------           ------------           ------------
                                                      (47,305)                 6,871                (29,209)
                                                 ------------           ------------           ------------
Net loss.......................................  $ (4,611,836)          $ (1,577,229)          $(16,346,447)
                                                 ------------           ------------           ------------
                                                 ------------           ------------           ------------

Basic and diluted net loss per share...........  $      (1.79)          $       (.51)          $     (10.99)
                                                 ------------           ------------           ------------
                                                 ------------           ------------           ------------
Basic and diluted weighted average
    shares outstanding.........................     3,707,807              3,081,516              1,669,372
                                                 ------------           ------------           ------------
                                                 ------------           ------------           ------------
</TABLE>

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


                                    F-4

<PAGE>

                            PACIFIC BIOMETRICS, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
       FOR THE YEARS ENDED JUNE 30, 1998 AND 1997, AND FOR THE PERIOD FROM
                   INCEPTION (DECEMBER 1992) TO JUNE 30, 1998

<TABLE>
                                                                                                               FOR THE PERIOD
                                                                                                               FROM INCEPTION
                                                                                                               (DECEMBER 1992)
                                                                        1998                   1997           TO JUNE 30, 1998
                                                                        ----                   ----           ----------------
<S>                                                                 <C>                    <C>                    <C>
  Cash flows used in operating activities:
    Net loss......................................................  $ (4,611,836)          $ (1,577,229)          $(16,346,447)

Adjustments to reconcile net loss to net cash
   used in operating activities:
    Depreciation..................................................       284,555                 79,665                428,862
    Amortization of technology licenses...........................       432,154                 62,500                594,654
    Common stock issued for services..............................                              220,800                767,326
    Services provided for subscription receivable.................                                                      55,556
    Amortization of goodwill......................................                                                     428,368
    Purchased in-process research and
        product development expense...............................                                                   6,373,884
    Amortization of discount on technology license payable........       116,572                                       116,572
    Write off of Spinpro-Registered Trademark- Asset..............       126,323                100,000                226,323
    Changes in assets and liabilities:
       Accounts receivable........................................       176,748               (216,904)              (135,345)
       Other receivables..........................................                               31,200                 37,751
       Inventory..................................................      (171,102)                (5,952)              (170,383)
       Prepaid expenses and other.................................       (44,726)              (157,985)              (204,244)
       Accounts payable and accrued liabilities...................       236,638               (164,342)               477,417
       Deferred compensation......................................                                                      34,996
       Advances from customers....................................      (108,515)              (169,830)              (202,179)
                                                                     ------------           ------------           ------------
           Net cash used in operating activities..................    (3,563,189)            (1,798,077)            (7,516,889)
                                                                     ------------           ------------           ------------

Cash flows from investing activities
    Cash acquired in connection with mergers.......................                                                    221,698
    Advances to BioQuant prior to acquisition, net.................                                                   (145,000)
    Capital expenditures...........................................      (94,166)              (136,897)              (292,558)
    Organizational costs...........................................                                                     (5,000)
    Deposits and other.............................................                                                     (4,702)
    Proceeds from sale of short-term investments...................      973,110                                       973,110
    Purchase of short-term investments.............................                            (973,110)              (973,110)
                                                                     ------------           ------------           ------------
           Net cash provided by (used in)  investing
              activities...........................................      878,944             (1,110,007)              (225,562)
                                                                     ------------           ------------           ------------
</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 CASH FLOWS
         FOR THE YEARS ENDED JUNE 30, 1998 AND 1997, AND FOR THE PERIOD
                FROM INCEPTION (DECEMBER 1992) TO JUNE 30, 1998

<TABLE>
<CAPTION>
                                                                                                               FOR THE PERIOD
                                                                                                               FROM INCEPTION
                                                                                                               (DECEMBER 1992)
                                                                        1998                   1997           TO JUNE 30, 1998
                                                                        ----                   ----           ----------------
<S>                                                                   <C>                 <C>                     <C>
Cash flows from financing activities
    Common stock sold for cash.....................................                          8,085,005               9,548,905
    Payments on technology license agreements......................    (818,756)                                      (918,756)
    Borrowings from related parties................................                                                    859,963
    Preferred stock issuance.......................................   3,100,000                                      3,100,000
    Cost of equity.................................................     (21,034)            (1,790,290)             (1,811,325)
    Preferred stock dividends paid.................................     (16,445)                                       (16,445)
    Common stock  exercise proceeds................................       1,750                 26,503                  28,253
    Proceeds (repayments) with related parties.....................       1,250               (146,198)               (144,948)
    Repayment of First Bridge loan.................................                           (250,000)                      0
    Repayment of bank borrowings...................................                           (175,967)               (246,616)
    Proceeds of Second Bridge Loan.................................                                                  1,000,000
    Repayment of Second Bridge Loan................................                                                 (1,000,000)
    Prepaid financing costs........................................     (13,446)                18,000                 (25,446)
    Transfer to restricted cash....................................                           (100,000)               (100,000)
    Payments on capital lease obligations..........................    (221,713)               (35,172)               (287,078)
                                                                     ------------           ------------           ------------
Net cash provided by financing activities..........................   2,011,606              5,631,881               9,986,507
                                                                     ------------           ------------           ------------
   Net change in cash and cash equivalents.........................    (672,639)             2,723,797               2,244,056
   Cash and cash equivalents, beginning of period..................   2,916,695                192,898                       0
                                                                     ------------           ------------           ------------
    Cash and cash equivalents, end of period.......................  $2,244,056            $ 2,916,695             $ 2,244,056
                                                                     ------------           ------------           ------------
                                                                     ------------           ------------           ------------
Supplemental disclosure of cash flow information:
   Cash paid during the year for interest..........................  $   65,360             $ 145,835               $ 393,782
                                                                     ------------           ------------           ------------
                                                                     ------------           ------------           ------------
</TABLE>

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


                                    F-6


<PAGE>



                            PACIFIC BIOMETRICS, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
         FOR THE PERIOD FROM INCEPTION (DECEMBER 1992) TO JUNE 30, 1998

<TABLE>
<CAPTION>
                                                           Common Stock                      Preferred Stock     
                                                      -------------------  Subscription      ---------------     
                                                       Shares     Amount    Receivable       Shares   Amount     
                                                     ---------   --------  -------------    -------  -------
<S>                                                   <C>        <C>       <C>               <C>      <C>        
Common stock issued for cash at                                                                                  
  inception (December 1992)                           511,862     $5,119    ($245,000)                           
Cash received in satisfaction of                                                                                 
  subscription receivable                                                     161,000                            
Net loss                                                                                                         
                                                    ---------- ---------    ---------     ----------   -------
  Balance, June 30, 1993                              511,862      5,119      (84,000)          0          0     
                                                                                                                 
Common stock issued in connection with                                                                           
  purchase of technology license and services          62,561        569      (55,556)                           
Cash received in satisfaction of                                                                                 
  subscription receivable                                                      84,000                            
Cash received in satisfaction of                                                                                 
  subscription receivable                                                      38,578                            
Stockholder loans converted to equity                                                                            
Common stock issued for cash                            4,739         47                                         
Net loss                                                                                                         
                                                    ---------- ---------    ---------     ----------   -------
  Balance, June 30, 1994                              579,162      5,735      (16,978)          0          0     
                                                                                                                 
Services provided in satisfaction of                                                                             
  subscription receivable                                                      16,978                            
Stockholder loans converted to equity                                                                            
Common stock issued for services and                                                                             
  loan guarantees                                      47,867        479                                         
Common stock issued in connection with                                                                           
  acquisition of Pacific Biometrics, Inc.                                                                      
  (a Washington corporation)                          189,061      1,891                                         
Common stock issued for cash                           42,181        422                                         
Conversion from $0.01 par value to no par value                                                                  
  common stock                                                 2,011,392                                         
Net loss                                                                                                         
                                                    ---------- ---------    ---------     ----------   -------
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 exercise
  of 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 
                                                    ---------- ---------    ---------     ----------   -------
                                                    ---------- ---------    ---------     ----------   -------
</TABLE>

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

                                      F-7

<PAGE>


<TABLE>
<CAPTION>
                                                                                       Deficit
                                                           Preferred      Common     Accumulated             
                                                           Additional   Additional   during the               
                                                            Paid-in       Paid-in    Development             
                                                            Capital       Capital       Stage         Total
                                                       -----------     -----------     ----------   ----------
<S>                                                         <C>         <C>          <C>              <C>
Common stock issued for cash at                                                                               
  inception (December 1992)                                               $494,881                    $255,000
Cash received in satisfaction of                                                                              
  subscription receivable                                                                              161,000
Net loss                                                                                 (199,455)    (199,455)
                                                       -----------     -----------     ----------   ----------
  Balance, June 30, 1993                                         0         494,881       (199,455)     216,545
                                                                                                              
Common stock issued in connection with                                                                        
  purchase of technology license and services                               54,987                           0
Cash received in satisfaction of                                                                              
  subscription receivable                                                                               84,000
Cash received in satisfaction of                                                                              
  subscription receivable                                                                               38,578
Stockholder loans converted to equity                                      310,000                     310,000
Common stock issued for cash                                                49,953                      50,000
Net loss                                                                                 (732,874)    (732,874)
                                                       -----------     -----------     ----------   ----------
  Balance, June 30, 1994                                         0         909,821       (932,329)     (33,751)
                                                                                                              
Services provided in satisfaction of                                                                          
  subscription receivable                                                                               16,978
Stockholder loans converted to equity                                      324,963                     324,963
Common stock issued for services and                                                                          
  loan guarantees                                                           80,021                      80,500
Common stock issued in connection with                                                                        
  acquisition of Pacific Biometrics, Inc.                                                                   
  (a Washington corporation)                                               143,109                     145,000
Common stock issued for cash                                               553,478                     553,900
Conversion from $0.01 par value to no par value                                                               
  common stock                                                          (2,011,392)                          0
Net loss                                                                               (1,664,190)  (1,664,190)
                                                       -----------     -----------     ----------   ----------
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 exercise
  of 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
                                                       ----------    ------------   -------------  ----------
                                                       ----------    ------------   -------------  ----------
</TABLE>

        
              The accompanying notes are an integral part of these
                       consolidated financial statements.
                                                         
                                       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 an early stage company 
engaged in the development and commercialization of non-invasive diagnostics 
and laboratory services 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 also 
operates a specialty reference laboratory, which supports the development and 
commercialization process for PBI as well as other diagnostic and 
pharmaceutical manufacturers.

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.

The Company's focus is to (i) finalize development and commercialize the 
Osteopatch-TM- (ii) evaluate the feasibility of non-invasive glucose testing 
using SalivaSac-Registered Trademark- (iii) identify collaborative and 
strategic partners to develop other applications for its platform technologies 
and (iv) expand its specialty reference laboratory business.

Except for the revenues from laboratory services, all of the Company's 
potential products are currently in research and development, and no revenues 
have been generated to date. Consequently, the Company is a development stage 
enterprise.

The majority of the outstanding stock of PBI, after the Mergers, was owned by 
the former stockholders of PBI-WA and therefore the acquisition of PBI-WA was 
accounted for as a reverse acquisition. The merger with BioQuant was accounted 
for as a purchase transaction with PBI-WA as the acquirer of BioQuant. 
Therefore, financial results of BioQuant prior to June 28, 1996 are not 
included in the accompanying consolidated financial statements. All 
outstanding shares of stock, options and warrants of PBI-WA and BioQuant were 
exchanged for similar securities of PBI-Delaware.

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

In connection with the signing of a new facility lease in Seattle, Washington, 
the Company is required to maintain $100,000 as a security deposit throughout 
the term of the lease. This amount has been recorded as restricted cash on the 
accompanying consolidated balance sheet.

                                    F-9

<PAGE>

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 (Note 15).

TECHNOLOGY LICENSES

The Company has an exclusive worldwide license for the use of a transdermal 
perspiration collection device for all medical diagnostic applications of 
Sudormed's skin patch technology. In addition, the license allows for the 
development of all other potential applications of such technology, except for 
those relating to alcohol and drugs of abuse. This new license agreement 
replaced the Company's previous license agreement with Sudormed for the skin 
patch technology, which was for the single application of measuring bone loss 
markers in sweat, which is the basis for the Company's Osteopatch-TM- system.

In exchange for the rights described above, the Company will pay Sudormed 
approximately $3 million over a twenty month period plus an ongoing royalty 
payment based on the amount of sales of products developed under this license. 
Such payments include a lump-sum payment of $1.6 million due in December 1998 
(Note 7).

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 have 
been recorded at the net present value of the future payment stream and are 
being amortized over four years. The amount charged to expense in connection 
with amortizing licensing fees was $432,154 and $62,500 for the years ended 
June 30, 1998 and 1997 respectively, and $594,654 for the period from 
inception to date.

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 basis 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 fair value of the 
Company's financing arrangments can not be practically determined due to the 
unique nature of these financial instruments.

                                 F-10

<PAGE>

STOCK-BASED COMPENSATION

The Company has adopted the disclosure-only provisions of SFAS No. 123, 
"Accounting for Stock-Based Compensation." SFAS 123 defines a fair value based 
method of accounting for stock options granted to employees. Fair value of the 
stock option is determined considering factors such as the exercise price, the 
expected life of the option, the current price of the underlying stock and its 
volatility, expected dividends on the stock, and the risk-free interest rate 
for the expected term of the option. Under the fair value based method, 
compensation cost is measured at the grant date based on the fair value of the 
award and is recognized over the service period. Pro forma disclosures for 
entities that elect to continue to measure compensation cost under the 
intrinsic method provided by Accounting Principles Board Opinion No. 25 must 
include the effects of all awards granted in fiscal years that begin after 
December 15, 1994.

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.

BASIC AND DILUTED NET LOSS PER SHARE

Net loss per share is calculated in accordance with Statement of Financial 
Accounting Standards (SFAS), No. 128, "Earnings per Share", which supersedes 
APB Opinion No. 15, "Earnings per Share". Net loss per share for all periods 
presented has been restated to reflect the adoption of SFAS 128. 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 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.

STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income". 
SFAS No. 130, which is effective for fiscal years beginning after December 15, 
1997 and requires restatement of earlier periods presented, establishes 
standards for the reporting and display of comprehensive income and its 
components in a full set of general purpose financial statements. 
Comprehensive income is defined as the change in equity of a business 
enterprise during a period from transactions and other events and 
circumstances from non-owner sources. The implementation of SFAS No. 130 is 
not expected to have a material effect on the Company's results of operations.

In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an 
Enterprise and Related Information". SFAS No. 131, which is effective for 
fiscal years beginning after December 15, 1997 and requires restatements of 
earlier periods presented, established standards for the way that a public 
enterprise reports information about key revenue-producing segments in the 
annual financials statements and selected information in interim financial 
reports. It also establishes standards for related disclosures about products 
and services, geographic areas and major customers. The implementation of SFAS 
No. 131 is not expected to have a material effect on the Company's current 
reporting.

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.

                                    F-11

<PAGE>

RECLASSIFICATIONS

Certain reclassifications have been made to the consolidated statement of 
operations for 1997 and for the period from inception to date in order to 
conform to the 1998 presentation.

RISKS AND UNCERTAINTIES

The Company's products require approvals from the U.S. Food and Drug 
Administration (FDA) and international regulatory agencies prior to 
commercialized sales. There can be no assurance that the Company's products 
will receive any of the required approvals. If the Company is denied such 
approvals or if such approvals are delayed, it would have a material adverse 
effect on the Company.

3.   GOING CONCERN

The Company has experienced recurring losses from operations and cash flow 
shortages, and has deficiencies in working capital and stockholders' equity. 
Also, the Company has significant amounts of debt maturing on December 31, 
1998. 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 
described below. The consolidated financial statements do not include any 
adjustments that might result from the outcome of this uncertainty.

In views of the matters described in the preceding paragraph, recoverability 
of a major portion of the recorded asset amounts shown in the accompanying 
balance sheet is dependent upon continued operations of the Company, which in 
turn is dependent upon the Company's ability to meet its financing 
requirements on a continuing basis, to maintain present financing, and to 
succeed in its future operations.

Management has taken the following steps to revise its operating and financial 
requirements, which it believes are sufficient to provide the Company with the 
ability to continue in existence. These steps include significant reductions 
in expenses and staffing, delay of research and development projects, 
renegotiations of contractual commitments and engagement of an 
investment-banking firm to raise capital.

The Company anticipates, based on currently proposed plans and assumptions 
relating to its operations, that the Company's current cash and cash 
equivalents and short-term investments, together with projected revenues from 
operations and debt arrangements will be sufficient to satisfy its operating 
expense requirements through December 1998. The Company is actively working to 
raise additional funds through equity or debt arrangements to cover 
longer-term requirements.

4.   CONCENTRATION OF CREDIT RISK

The Company has cash deposits at U.S. banks and financial institutions, which 
exceed federally insured limits at June 30, 1998. The Company is exposed to 
credit loss for amounts in excess of insured limits in the event of 
non-performance by the institution; however, the Company does not anticipate 
non-performance.

Two customers individually accounted for approximately 33 percent and 17 
percent of the Company's total sales in fiscal 1998. Three customers 
individually accounted for approximately 36 percent, 13 percent and 11 percent 
of the Company's total sales in fiscal 1997. Sales to the Company's five 
largest customers represented approximately 67 percent and 77 percent of total 
sales in fiscal 1998 and fiscal 1997, 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.

The Company relies on two vendors to supply licensed technology necessary for 
the Company's Osteopatch-TM- product. The Company has a contractual agreement 
with the suppliers and management does not feel the concentration exposes the 
Company to significant risk in the near term.

                                     F-12

<PAGE>

5.  Property and Equipment

Property and equipment consists of the following at June 30, 1998:

<TABLE>

<S>                                                                                            <C>
Laboratory equipment.............................................................              $ 162,508
Computer equipment...............................................................                131,125
Office furniture and equipment...................................................                 70,858
Leasehold improvements...........................................................                 32,421
Equipment held under capital leases..............................................                551,122
                                                                                               ---------
Gross property and equipment.....................................................                948,034
Less accumulated depreciation and amortization...................................               (291,361)
                                                                                               ---------
Net property and equipment.......................................................              $ 656,673
                                                                                               ---------
                                                                                               ---------
</TABLE>

6.   CAPITAL LEASES

In April 1997, the Company entered into a capital equipment leasing facility 
with Transamerica Business Credit Corporation, to provide credit for equipment 
purchase up to $1,500,000. The related equipment serves as collateral for the 
debt. The Company has received gross proceeds of $329,154 as of June 30, 1998, 
and $376,808 as of June 30, 1997, which was used to purchase production and 
laboratory equipment. The Company issued 51,429 warrants in connection with 
these financings (Note 11). The Company is required to raise additional equity 
capital in order to draw additional funding from this arrangement.

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, 1998 are as follows:

<TABLE>

<S>                                                          <C>
                  1999                                       $ 296,463
                  2000                                         264,921
                  2001                                          83,532
                  2002                                          30,829
                  2003                                          10,172
                                                             ---------
                  Total minimum payments                       685,917
                  Less amount representing interest            (83,995)
                                                             ---------
                  Obligations under capital leases             601,922
                  Less current portion                        (248,980)
                                                             ---------
                  Long term portion                          $ 352,942
                                                             ---------
                                                             ---------
</TABLE>

7.   FINANCING

LINE OF CREDIT

In March 1998, the Company and its subsidiaries entered into a Loan and 
Security Agreement relating to a $1 million term loan with Silicon Valley 
Bank. The Company must comply with certain minimum financial standards and 
ratios, including a minimum stated net worth and 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, and as such did not have the 
ability to draw any amounts from this credit facility. At June 30, 1998, there 
were no amounts outstanding on this line.

                                        F-13

<PAGE>
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.

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. See Note 12 for calculation of beneficial conversion and imputed 
preferred stock dividend.

TECHNOLOGY LICENSE PAYABLE

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. Future maturities of the 
technology license payable are as follows:

<TABLE>
<CAPTION>
                                                    Year Ended June 30,
                                                    -------------------
             <S>                                    <C>
             1999                                      $ 2,174,138
             2000                                           80,913
                                                       -----------
                                                       $ 2,255,051
                                                       -----------
                                                       -----------
</TABLE>

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, 1998. At June 30, 
1998, the Company has net operating loss carryforwards available to offset 
future taxable income for federal tax purposes of approximately $11 million; 
such carryforwards expire in various years through 2013. 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.

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
                                                        --------
             From inception to June 30, 1998            $876,322
                                                        --------
                                                        --------
</TABLE>
                                       F-14
<PAGE>

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, 1998, 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
          1998                                                           0                 $      0
                                                                   -------                 --------
          For the period from inception to June 30, 1998           309,508                 $822,882
                                                                   -------                 --------
                                                                   -------                 --------
</TABLE>

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.

                                        F-15

<PAGE>

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:

<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          $   0.46          (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
                                              --------------         --------        ---------
                                              --------------         --------        ---------

</TABLE>

The weighted average contractual life remaining of options outstanding at June 
30, 1998 is approximately 4 years. The following information applies to 
options outstanding at June 30, 1998:

<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            5           $0.13           309,606            $0.13

$0.42 - $0.63      118,040            6           $0.53           118,040            $0.53

$2.38 - $3.50      848,924            4           $3.36           189,424            $3.43

$3.70 - $5.00      210,884            3           $4.35           118,084            $4.46
               -----------                                    -----------       ------------

                 1,487,454                                       735,154            $1.74
               -----------                                   -----------       ------------
               -----------                                   -----------       ------------
</TABLE>

STOCK-BASED COMPENSATION

The Company has adopted the disclosure-only provisions of SFAS No. 123. Had 
compensation cost been determined based on the fair value of stock options 
granted in 1998 and 1997 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,            For the Period from
                         --------------------------------------     Inception (December 1992)
                             1998                    1997                to June 30, 1998
                         -------------           -------------      -------------------------
<S>                      <C>                     <C>                <C>
Net loss:
  As reported            $  (4,611,836)          $  (1,577,229)          $  (16,346,447)
  Pro forma              $  (5,180,379)          $  (2,318,067)          $  (18,928,904)
Loss per share:
  As reported            $       (1.79)          $       (0.51)          $       (10.99)
  Pro forma              $       (1.94)          $       (0.75)          $       (12.54)
</TABLE>


                                            F-16

<PAGE>

The fair value of each option grant was estimated on the date of the grant 
using the Black-Scholes option pricing model. The assumptions used for the 
Black-Scholes computation for the years ended June 30, 1998 and 1997 are as 
follows: the risk-free interest rate was the U.S. Treasury Bond rate for the 
corresponding grant date ranging from 5.97% to 6.64% in 1998 and 1997; the 
exercise price is equal to the fair market value of the underlying stock at 
the grant date; the expected life of the option is the term to expiration, 
ranging from 1-10 years; volatility is 82.4% in 1998 and 93.5% in 1997; and 
the common stock will pay no dividends.

The weighted fair value of options granted during the years ended June 30, 
1998 and 1997 for which the exercise price approximates the market price on 
the grant date was $2.31 and $2.76, respectively.

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 entitles the holder to purchase one share of common stock 
at an exercise price of $12.00. The warrants expire on June 30, 1999. These 
warrants are redeemable by the Company under certain conditions at a 
redemption price of $.10 per warrant. As of June 30, 1998, the Company has not 
redeemed any of these warrants.

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. 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 9). 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 March 1998, Silicon Valley Bank was issued 15,094 warrants in conjunction 
with the credit agreement (Note 7). 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.

                                       F-17

<PAGE>

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

Warrants exercisable at June 30, 1998          $2.63 - $12.00          $   10.63        2,056,293
                                               --------------      ----------------     ---------
                                               --------------      ----------------     ---------
</TABLE>

12.  EARNINGS PER SHARE

As the Company had a net loss from continuing operations for 1998, 1997 and 
for the period from inception to June 30, 1998, basic and diluted net loss per 
share are the same.

Net loss applicable to common stockholders includes $70,093 in cumulative 
dividends on the convertible preferred stock during the year ended June 30, 
1998, 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. 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.

                                     F-18

<PAGE>

Basic and diluted net loss per common share for 1998, 1997 and for the period 
from inception to June 30, 1998 were calculated as follows:

<TABLE>
<CAPTION>

                                                                                     For the Period
                                                                                     from Inception
                                           1998                    1997             to June 30, 1998
                                       ------------           ------------          ----------------
<S>                                    <C>                    <C>                   <C>
Net Loss                               $ (4,611,836)          $ (1,577,229)          $(16,346,447)

Preferred Stock cumulative
  dividend                                  (70,093)                     0                (70,093)

Imputed dividend on Preferred
  Stock issued                           (1,937,500)                     0             (1,937,500)
                                       ------------           ------------          ----------------

Net Loss available to Common
  stockholders                         $ (6,619,428)          $ (1,577,229)          $(18,354,039)
                                       ------------           ------------          ----------------
                                       ------------           ------------          ----------------

Basic and diluted net
  loss per share                       $      (1.79)          $      (0.51)          $     (10.99)
                                       ------------           ------------          ----------------
                                       ------------           ------------          ----------------

Weighted average shares
  outstanding                             3,707,807              3,081,516              1,669,372
                                       ------------           ------------          ----------------
                                       ------------           ------------          ----------------
</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 $289,032 and $222,033 for the years ended 
June 30, 1998 and 1997, respectively, and $849,486 for the period from 
inception to June 30, 1998.

     Future minimum lease payments are as follows:

<TABLE>
<CAPTION>

                                                                    Year Ended June 30,
                                                                    -------------------
<S>                                                                 <C>
               1999................................                         349,583
               2000................................                         383,745
               2001................................                         392,622
               2002................................                         402,793
               2003................................                         412,963
               Thereafter..........................                       1,028,582
                                                                          ---------
                                                                         $2,970,288
                                                                          ---------
                                                                          ---------
</TABLE>


TECHNOLOGY AND MANUFACTURING AGREEMENTS

The Company has entered into a license agreement with respect to its 
osteoporosis technology. This agreement provides for royalty payments to the 
licensors as defined in the agreement, with minimum royalty payments of 
$15,000 each quarter. As of June 30, 1998, the Company has made all required 
royalty payments and had prepaid future royalty requirements of $90,000.

                                    F-19

<PAGE>

The Company has also entered into a supply agreement with an affiliate of the 
owners of the technology that requires certain minimum purchases to retain the 
exclusive use of the licensed technology. This agreement required the Company 
to purchase a minimum of 100,000 units by March 31, 1998. As of June 30, 1998, 
all minimum purchase requirements to date have been met. The Company is 
obligated to purchase 400,000 additional units by June 30, 1999 and each year 
thereafter. Failure to make the necessary payments by the Company could risk 
the exclusivity of the technology license that the Company currently holds.

EMPLOYMENT AND NONCOMPETITION AGREEMENTS

The Company has entered into employment and noncompetition agreements with 
four executives. These agreements specify that the executives may not engage 
in any competitive activity for periods ranging from 9 months to 2 years 
following termination. The agreements will provide for compensation of nine 
months salary, bonuses and benefits in the event of termination without cause. 
Subsequent to June 30, 1998, an executive, who is covered by such agreements, 
resigned. The Company estimates it will incur a severance liability of 
approximately $102,000.

LEGAL PROCEEDINGS

On September 24, 1997, the Company received from the former manufacturer of 
SPINPRO-Registered Trademark- a demand for arbitration in connection with 
alleged breaches of the contract relating to the manufacture of 
SPINPRO-Registered Trademark- (Note 15). 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-Registered Trademark-, seeking damages for 
alleged breach of contract with respect to the manufacture of molds for 
SPINPRO-Registered Trademark- parts.

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. At June 
30, 1997, the Company's deferred compensation obligation was $65,413. 
Compensation expense in connection with these agreements was $30,417 for the 
year ended June 30, 1997 and $65,413 for the period from inception to June 30, 
1998. There was no deferred compensation incurred for the year ended June 30, 
1998. In 1997, the liability for deferred compensation of $65,413 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 had entered into a contract for management and consulting services 
with a company owned by certain of the Company's stockholders. The Company 
incurred $186,000 for management and consulting services provided during the 
year ended June 30, 1996 and $300,098 for the period from inception to June 
30, 1998. The liability for management consulting services under the contract 
of $187,000 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.

The Company paid $41,349 and $28,172 to related parties for reimbursement of 
expenses during the years ended June 30, 1998 and 1997, respectively, and $124, 
936 for the period from inception to June 30, 1998.

During fiscal 1997, the Company issued 64,000 shares of common stock valued at 
$220,800 to Directors in exchange for services.

15.  IMPAIRMENT OF LONG-LIVED ASSETS

During 1997, the Company received notification of the termination of its 
manufacturing agreement with a third party related to the production of the 
SPINPRO-Registered Trademark- product. As a result of this termination, the 
Company had reimbursed the third party for the value of molds and production 
equipment through the form of a capital equipment leasing facility (Note 6). 
As of June 30, 1997, the remaining inventory, molds and production equipment 
had been relocated to a

                                    F-20

<PAGE>

storage facility.

At June 30, 1998, the Company determined that it was not feasible to continue 
the production of the SPINPRO-Registered Trademark- product and that amounts, 
if any, from the disposition of the related asset would not be significant. 
Therefore, the Company has recorded an impairment loss for the net book value 
of the related asset of $126,000.

16.  SUBSEQUENT EVENTS

In July 1998, the Company signed a License, Supply and Distribution Agreement 
with Segix Italia, S.p.A. ("Segix") for the Company's Osteopatch-TM- 
diagnostic system for the Italian market. The 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.

                                    F-21

<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: September 24, 1998                    Pacific Biometrics, Inc.

                                             By  /s/ PAUL G. KANAN
                                                --------------------------------
                                             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.

<TABLE>

<S>                         <C>                                 <C>
/s/PAUL G. KANAN            President, Chief Executive          Dated:  September 24,1998
-----------------------     Officer and Director (principal
Paul G. Kanan               executive officer)

/s/PETER B. LUDLUM          Vice President, Chief Financial     Dated: September 24,1998
-----------------------     Officer and Accounting Officer
Peter B. Ludlum             and Secretary
                            (principal financial officer)

/s/ ELLEN A. RUDNICK        Chairman of the Board               Dated: September 24,1998
-----------------------
Ellen A. Rudnick

/s/MARY L. CAMPBELL         Director and Treasurer              Dated: September 24,1998
-----------------------
Mary L. Campbell

/s/CRAIG M. GOLDSTONE       Director                            Dated: September 24,1998
-----------------------
Craig M. Goldstone

/s/DOUGLAS S. HARRINGTON    Director                            Dated: September 24,1998
-----------------------
Douglas S. Harrington
</TABLE>

                                        
<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. ****
</TABLE>

                                         
<PAGE>

<TABLE>

<S>       <C>
10.28 --  Amended and Restated License Agreement, dated December 30, 1997, by
          and between Sudormed, Inc. 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.*****
21.1 --   Subsidiaries.*
25.1 --   Powers of Attorney appear on the signature page in Part II of the
          Registration Statement filed on September 6, 1996.* 
27.1 --   Financial Data Schedule.
-------------------------------------------------------------------------------------
</TABLE>

*       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.