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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-KSB [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934  [  ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 
 Commission File Number 0-21537 Pacific Biometrics, Inc.  Delaware
    
    93-1211114(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 220 West Harrison Street
Seattle, Washington 98119
(Address of principal executive offices) (206) 298-0068
(Issuers telephone number) Securities registered under Section 12(b) of the Exchange Act:      (none) Securities registered under Section 12(g) of the Exchange Act:     Common Stock, $0.01 par value per share Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. [X] Yes [  ] No Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of registrants 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. [  ] Issuers revenues for its most recent fiscal year: $4,801,248 As of September 15,
2004, there were 13,048,820 shares of the Companys common
stock issued and outstanding, and the aggregate market value of such common
stock held by non-affiliates was approximately $5,607,508, based on the average
of the bid ($0.70) and asked ($0.85) prices of such stock on that date. Documents Incorporated By Reference: The Companys definitive proxy statement
for the annual meeting of stockholders, which will be filed with the Securities
and Exchange Commission within 120 days after the close of the fiscal year
2004, is incorporated by reference in Part III hereof. Transitional Small Business Disclosure Format (Check one):  Yes [  ] No [X]




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PACIFIC BIOMETRICS, INC.Form 10-KSB Annual ReportTable of ContentsPagePART IItem 1.
    
    Description of Business
    
    
    2Item 2.
    
    Description of Property
    
    
    24Item 3.
    
    Legal Proceedings
    
    
    25Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    25PART IIItem 5.
    
    Market for Common Equity, Related Stockholder Matters and Small Business Issuer
Purchase of Equity Securities
    
    
    25Item 6.
    
    Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    27Item 7.
    
    Financial Statements
    
    
    37Item 8.
    
    Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
    
    
    37Item 8A.
    
    Controls and Procedures
    
    
    37Item 8B.
    
    Other Information
    
    
    38PART IIIItem 9.**
    
    Directors and Executive Officers of the Registrant
    
    
    38Item 10.**
    
    Executive Compensation
    
    
    38Item 11.**
    
    Security Ownership of Certain Beneficial Owners and Management, and
Related Stockholder Matters
    
    
    38Item 12.**
    
    Certain Relationships and Related Transactions
    
    
    39Item 13.
    
    Exhibits and Reports on Form 8-K
    
    
    39Item 14.**
    
    Principal Accountant Fees and Services
    
    
    41SIGNATURES
    
    
    
    
    42EXHIBIT 10.1BEXHIBIT 10.1CEXHIBIT 14.1EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
   **
    
    Information contained in Items 9 through 12 and Item 14 of Part III are incorporated by reference from the
definitive proxy statement for our 2004 annual meeting of shareholders, which will be filed with the Securities
and Exchange Commission within 120 days after the close of the 2004 fiscal year. -i-




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CAUTIONARY NOTICE REGARDING FORWARD LOOKING STATEMENTS This Annual Report on Form 10-KSB contains certain forward-looking statements,
including statements about  
    
    our existing working capital and cash flows and whether and
how long these funds will be sufficient to fund our operations,
    
    the success of our business development efforts and our
ability to enter into work orders for laboratory services and
generate revenues,
    
    the development of new services and products and the
expansion of the market for our current services and products,
    
    implementing aspects of our business plan and strategies,
    
    financing goals and plans,
    
    our raising of additional capital through future equity and debt financings. The forward-looking statements in this Annual Report reflect managements
current views and expectations with respect to our business, strategies,
products, future results and events and financial performance. All statements
other than statements of historical fact, including future results of
operations or financial position, made in this Annual Report on Form 10-KSB are
forward looking. In particular, the words believe, expect, intend,
anticipate, estimate, desire, goal, may, will, variations of such
words, and similar expressions identify forward-looking statements, but are not
the exclusive means of identifying such statements and their absence does not
mean that the statement is not forward-looking. These forward-looking
statements are subject to certain risks and uncertainties, including those
discussed below. Our actual results, performance or achievements could differ
materially from historical results as well as those expressed in, anticipated
or implied by these forward-looking statements. We do not undertake any
obligation to revise these forward-looking statements to reflect any future
events or circumstances. For a discussion of some of the factors that may affect our business, results
and prospects, see ITEM 1.  DESCRIPTION OF BUSINESS  Risk Factors Affecting
the Business of the Company beginning on page 14. Readers are urged to
carefully review and consider the various disclosures made by us in this Report
and in our other reports previously filed with the Securities and Exchange
Commission, including our periodic reports on Forms 10-KSB and 10-QSB, and
those described from time to time in our press releases and other
communications, which attempt to advise interested parties of the risks and
factors that may affect our business, prospects and results of operations. -1-




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PART I 
 ITEM 1. DESCRIPTION OF BUSINESS. General We provide specialty central laboratory services to support pharmaceutical and
diagnostic manufacturers in the conduct of human clinical research, for use in
their drug discovery and development efforts. Our clients include a number of
the worlds largest multi-national pharmaceutical, biotechnology and diagnostic
companies. Our well-recognized specialty areas include cardiovascular disease
(dyslipidemia, atherosclerosis, and coronary heart disease), diabetes (and
obesity), and bone and joint diseases (osteoporosis and arthritis). Coupled
with our specialty testing, we also have central laboratory capability and
provide full-service central laboratory support for multi-center clinical
trials, including routine safety lab tests (general chemistry, hematology, and
urinalysis). Our company is a Delaware corporation, incorporated in May 1996,
and we conduct our operations primarily through our wholly-owned subsidiary,
Pacific Biometrics, Inc., a Washington corporation. Business Strategy Specialty reference and central laboratory services companies like ours
typically derive substantially all of their revenue from the research,
development and marketing expenditures of the pharmaceutical and biotechnology
industries. Participants in the pharmaceutical and biotechnology industries
typically outsource a significant quantity of these services to both central
labs and specialty reference labs. In addition, central laboratories outsource
to specialty reference labs some of the specialty testing where the central
laboratory lacks expertise. We believe that such outsourcing will continue and
may increase in the future because of many factors, including continuing
pressures on the pharmaceutical and biotechnology industries to contain costs,
limitations on pharmaceutical companies internal capacity, a need for faster
development time for new drugs, research in multiple countries simultaneously,
stringent government regulation, and expertise that pharmaceutical companies or
central labs may lack internally. We believe the investment and amount of time
required to develop new drugs has been increasing, and that these trends create
opportunities for companies like ours to provide our expertise and services to
help reduce the time in the drug development process and make the process of
drug development more efficient. Our strategy is to meet the needs for outsourcing, by pharmaceutical and
biotechnology companies and other central laboratories, and to assist in
enhancing the drug development process by developing and delivering innovative
services that apply science and technology to provide high quality service
within our areas of specialty. Our primary business strategy is to continue our focus on providing high
quality specialty central laboratory services in our core areas, including
cardiovascular disease and bone and joint diseases. In addition, we also
intend to pursue other strategies identified below to further our business.
However, because of the significant expense associated with some of these
strategies, we may not pursue some of these strategies unless our revenues
increase significantly or we are able to raise equity or debt financing to
adequately fund these strategies. There can be no assurance that we will
pursue any or all of the strategies below or if pursued, that any of such
strategies will be successful. Increase Specialty Areas In addition to our core specialties of cardiovascular disease and bone and
joint diseases, our goal is to further expand our specialty laboratory
expertise within our other existing specialty areas (including diabetes,
obesity, metabolic syndrome, and osteoarthritis), as well as to develop new
fields where we can provide our laboratory services (including rheumatoid
arthritis and immunogenicity testing for biologic drugs). Further, to strengthen our specialty central lab services, in August 2002,
we acquired certain DNA-based proprietary technologies, processes and
equipment. See Technologies and Products  Saigene Technologies and Saigene
Investment Transaction. This novel intellectual property (patented and
patent-pending) includes a proprietary isothermal DNA amplification method
(LIDA) and a genetic method for distinguishing live from dead cells (Cell
Viability). We are in the process of transferring these assets into our
wholly owned subsidiary, PBI Technology, Inc. We intend to further develop and
leverage these technologies to enhance our specialty laboratory activities in
the area of pharmacogenetic testing and offer attractive prospects for licenses
to companies interested in in vitrodiagnostics, biothreat, food safety testing
and other applications. See also MANAGEMENTS -2-




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DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 
Impairment of Technology Assets. Diversify Customer Base Another of our goals is to diversify our customer base. Historically, our
two largest customers have been Pfizer, Inc. and Procter & Gamble
Pharmaceuticals, Inc. During fiscal years 2004, 2003 and 2002, Pfizer
represented approximately 36%, 76% and 63%, respectively, of our total
revenues. In May 2003, we entered into a master contractor service agreement
with Procter & Gamble Pharmaceuticals and started performing services on work
orders submitted under that agreement, and for fiscal 2004, Procter & Gamble
Pharmaceuticals represented approximately 40% of our total revenues. We
currently have no significant work orders with either of these two customers
and, accordingly, we expect revenues from both of these customers to decrease
in fiscal 2005, both on an absolute and a percentage basis. Because our
revenue has been concentrated in these one or two large customers, we can be
materially adversely impacted by any delays in undertaking clinical studies or
submitting samples for testing services, any early termination or reductions in
work orders or clinical studies, or any decreases in the volume or timing of
new work orders. This was evidenced by the results for the quarter ended
December 31, 2003, in which our total revenue from these two customers
decreased to approximately $40,000, representing only 7% of our revenues. We
are actively pursuing business development and marketing activities to broaden
our customer and revenue base. Create Global Central Laboratory We believe that in the central laboratory services business it is
important to provide a broad range of drug research and development services
globally. Through partnering with a major central laboratory, we believe that
we can compete with central laboratories that have offices, monitoring sites
and laboratories in many countries around the globe. We have commenced and
expect to continue discussions with several major central laboratory services
companies about potential partnering relationships. Acquisitions and Strategic Relationships Our customers and our competitors have experienced significant
consolidation over the last several years and we expect that trend to continue.
The uncertainty caused by the consolidation trend may result in other
companies in the industry seeking to form strategic relationships or joint
ventures or to be acquired in order to stay competitive. This may make it
possible for us to make strategic acquisitions that are complementary to our
existing services and that expand our ability to serve our clients. We are
also exploring other strategic alternatives for our business and operations,
which may include joint ventures, co-marketing relationships, or other
strategic relationships. Additionally, we will evaluate, as appropriate, any
potential business combinations involving our company as a whole, or involving
a portion of our assets. Information Technology We intend to focus future capital expenditures and investments in
carefully selected hardware and software products, information technology
systems and networks. During fiscal 2005, we intend to invest in our
information technology systems. We believe capital improvements in these areas
are important to meet the changing demands of drug development by improving and
facilitating our data reporting and storage capabilities and our communications
with clients. Services Specialty Reference Laboratory Services Our specialty reference laboratory in Seattle, Washington has established
itself as a technical leader due to our strong expertise in certain core areas.
Our three general areas of expertise include  
    
    cardiovascular disease (dyslipidemia, atherosclerosis, and coronary heart disease),
    
    diabetes (and obesity), and -3-




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
    
    bone and joint diseases (osteoporosis and arthritis). Management believes that among prospective new drugs, these areas of expertise
represent three of the top ten areas of focus by the pharmaceutical industry. With respect to cardiovascular disease, we are one of the leaders in lipid
services for clinical drug development in the U.S. Our expertise is
concentrated on the measurement of cardiovascular disease markers, especially
cholesterol and lipoproteins, including HDL, LDL and, HDL and LDL subfractions,
remnant cholesterol, apolipoproteins, Lp, and lipoprotein fraction
compositions. Furthermore, the Pacific Biometrics Research Foundation, a
non-profit organization affiliated with us, is one of only three U.S.
standardization centers in the National Clinical Reference Method Laboratory
Network sponsored by the Centers for Disease Control and the National Heart
Blood & Lung Institute. There are only ten such laboratories worldwide. We are enhancing our activities in the area of diabetes and related
disorders, notably obesity and metabolic syndrome. Metabolic syndrome is a
collection of abnormalities that include central obesity, dyslipidemia (low HDL
cholesterol and high triglycerides), insulin resistance, pre-diabetes, and
pre-hypertension. In the U.S. the prevalence of metabolic syndrome is
estimated at 47 million individuals (Heart Disease and Stroke Statistics  2003
Update, American Heart Association). People with metabolic syndrome are at
increased risk for cardiovascular disease and associated morbidity and
mortality and as a result this population is coming under increased scrutiny
for pharmacological intervention. Because of our established strengths in
testing for lipids, cardiovascular risk and diabetes, we believe we are
well-positioned to take advantage of this emerging area of pharmaceutical drug
development. Moreover, we are expanding our test menu in areas related to
diabetes and metabolic syndrome, notably in markers of inflammation, such as
hsCRP, IL-6, TNF-a, sCD40L and Lp-PLA2. As it relates to bone and joint diseases, we are active in promoting the
standardization of bone metabolism biomarkers, and are involved in technologies
for monitoring treatment response in diseases such as osteoporosis. We have
used our bone biomarker assays in osteoporosis to manage the first
proficiency-testing programs for bone-resorption markers. We developed our
expertise in osteoporosis laboratory assessments through our work with
diagnostic manufacturers of assays for bone markers such as Ostex
International, Inc. and Metra Biosystems, Inc., in addition to pharmaceutical
manufacturers of drugs that prevent bone loss such as Merck & Co., Inc. and The
Procter & Gamble Company. In the areas of bone metabolism and womens health,
we also specialize in the measurement of hormones including pyridinolines,
various C- and N- terminal telopeptides, procollagens, osteocalcin and
bone-specific alkaline phosphatase. In addition, in November 2003, we entered into an agreement with Nordic
Bioscience Diagnostics A/S under which our laboratory has been named the
exclusive testing site in North America for Nordics proprietary arthritis
marker CartiLaps® ELISA. This test was developed and produced by Nordic to
detect fragments of type II collagen in urine. Type II collagen is the major
structural component of joint cartilage, and degradation of type II collagen is
a critical step in the progression of both rheumatoid arthritis and
osteoarthritis. We have added this test as part of our services to
pharmaceutical and biotech companies in support of clinical research in
arthritis, as a means to detect and monitor rheumatoid arthritis and
osteoarthritis disease progression and therapeutic effectiveness. On June 29,
2004, we were notified by Nordic that our agreement with them will be amended
effective September 25, 2004 to be non-exclusive, and that should there be no
additional increases in the level of the CartiLaps® ELISA business generated by
us by September 25, 2004, it is their intention to take subsequent steps to
terminate the agreement in its entirety. Further, to strengthen our specialty central laboratory services, in
August 2002 we acquired certain DNA-based proprietary technologies, processes,
and equipment. See Technologies and Products  Saigene Technologies and
Saigene Investment Transaction. This novel intellectual property (patented
and patent-pending) includes a proprietary isothermal DNA amplification method
(LIDA) and a genetic method for distinguishing live from dead cells. We are in
the process of transferring these assets into our wholly owned subsidiary, PBI
Technology, Inc. We intend to further develop and leverage these technologies
to enhance our specialty laboratory activities in the area of pharmacogenetic
testing and offer attractive prospects for licenses to companies interested in
in vitrodiagnostics, biothreat, food safety testing and other applications. -4-




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In connection with these stated areas of expertise, we offer a variety of
services through our specialty reference laboratory, including  
    
    clinical testing services,
    
    development of laboratory reference methods,
    
    development of clinical trial protocols, and
    
    contract research and development. Our involvement with clients frequently begins at the protocol design stage.
Clinical trial support includes coordinating the receipt of specimens from
investigative sites, processing the samples and reporting the consolidated data
to study sites and sponsors. The extensive knowledge we have in test
development and our close collaboration with diagnostic manufacturers
frequently allow us to offer novel tests to our clinical-research clients
before such tests are commercially available. Central Laboratory Services Coupled with our expertise in specialty testing, we also have central
laboratory capability and provide full-service central laboratory support for
multi-center clinical trials, including routine safety lab tests (general
chemistry, hematology and urinalysis). Our operations support clinical trials
by producing study-specific supplies, coordinating the receipt of specimens
from clinical sites, processing the samples, generating test databases, and
reporting data to sites and sponsors. We generally provide central laboratory services in support of Phase I and
Phase II FDA clinical trials. These trials are typically smaller and more
geographically focused than Phase III trials. Through partnering with another major central laboratory, we intend to
compete with other central laboratories that have offices, monitoring sites and
laboratories in countries around the globe, both for Phase I and Phase II
trials, as well as Phase III trials. We have commenced and expect to continue
discussions with several major central laboratory services companies about
potential partnering relationships. We may not be able to successfully
complete any such partnering relationship or that such a relationship will
successfully generate revenue. Technologies and Products During fiscal 2004, we formed a new wholly owned subsidiary, PBI Technology,
Inc., for the purpose of holding, developing and seeking commercialization of
certain of our technologies and intellectual property portfolio, including our
isothermal DNA amplification method (LIDA), our Cell Viability technology, and
Saliva Sac®. These technologies are described in more detail below. We are
in the process of transferring these technology assets into PBI Technology. Saigene Technologies In August 2002, we acquired certain technology from Saigene Corporation,
including certain DNA-based proprietary technologies, processes and equipment.
(See Saigene Investment Transaction and Note 14 to the Notes to Consolidated
Financial Statements). This novel intellectual property (patented and
patent-pending) includes a proprietary isothermal DNA amplification method
(LIDA) and a genetic method for distinguishing live from dead cells. Since August 2002, we have been engaged in further research and
development efforts with regard to these acquired technologies, and we recently
were issued two patents on these technologies by the U.S. Patent and Trademark
Office. On January 28, 2003, we were issued U.S. Patent No. 6,511,804,
entitled A Selective Assay for Determining the Identity of Live Microorganisms
in a Mixed Culture. This patent encompasses a technology for discriminating
live cells from dead cells and may have potential application towards pathogen
detection and testing for drug-resistant microorganisms. We are currently
developing a test that can distinguish drug-susceptible from drug-resistant
Mycobacterium tuberculosis, the causative agent of tuberculosis infections in
humans. This new test would reduce the diagnostic time for a drug-resistant
tuberculosis infection from three weeks to only two days. -5-




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In addition, on March 21, 2003, we were issued U.S. Patent No. 6,531,300
entitled Target Amplification of Nucleic Acid with Mutant RNA Polymerase.
This patent encompasses a technology that provides a method to amplify genetic
material and may play a strategic role in our development of proprietary
molecular technologies. Management believes that the acquisition of these technology assets and
associated intellectual property from Saigene may provide potential future
value to our company and our business to the extent the technologies can be
successfully developed and exploited. As of June 30, 2004, these technology
assets still require additional development prior to commercialization and
their future value, as well as timing of their ongoing development, is
dependent upon additional capital being available to fund continuing research
and development. We expect to need additional capital to fund continuing
research and development efforts related to these technologies, and there are
no assurances that such funds will be available to us. In fact, Saigene has
informed us that in order to develop and commercialize these technologies, we
will likely require in the near term a capital infusion in excess of $5
million. Moreover, management believes that a minimum additional $15 million
would be required to achieve regulatory approval and commercialization of these
technologies and the technologies that may be acquired under the option
agreement. We intend to seek suitable financing to continue research and
development efforts, commence the regulatory approval process and
commercialization of the technologies, but we may not be able to obtain such
financing, on favorable terms or at all. While we intend to continue to pursue development efforts, partnership,
licensing or other means to realize the value of these intangible assets,
current conditions led us to believe that the value of these assets may not be
recoverable over their remaining useful lives, and thus should be written off.
Accordingly, we have written off the entire balance ($476,874) of technology
assets as of June 30, 2004. See MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS  Impairment of Technology
Assets. As such, although we believe these technologies are valuable assets, we
may not be able to successfully develop these technologies and they may not
generate revenue. In addition, even if we are ultimately successful in
developing products from these technologies, those products would likely be
subject to regulatory approval, and could always be the subject of litigation
or other claims from competitors or others with respect to such products or the
patents and methodologies upon which they are based. Other Technologies During the 1990s, we developed an intellectual property position in sweat
and saliva collection technologies. In 1998, due to lack of funding and our
failure to obtain FDA approval for resultant products, we suspended all further
development efforts relating to these technologies and products. We
subsequently wrote off the value of these assets on our balance sheet in 1999.
We believe there may be potential commercial application for some of these
technologies, but we currently have no plans to resume any active development
efforts relating to these technologies or products. Set forth below is a brief description of some of these technologies: SalivaSac®  saliva collection & processing device. This proprietary
device, developed by us, collects a non-invasive saliva sample that we had
hoped would be able to replace blood and urine testing in various applications.
The SalivaSac®, which contains a small quantity of a substance that acts as an
osmotic driver, is placed in the mouth and rapidly fills with an ultrafiltrate
of saliva that is filtered as it passes through the semi-permeable outer
membrane. The resulting fluid is clear, easy to use, and does not contain
interfering substances. The SalivaSac®, as a sample collection device, can be
combined with currently available testing technologies to permit new,
non-invasive diagnostic test applications. We believe the SalivaSac® design
has the potential to lend itself to point-of-care diagnostic applications,
including as a screening product to detect diabetes in the general population,
or as a monitoring product to produce detailed quantitative measurements of
blood glucose levels. Monitoring Markers of Bone Metabolism. This patented technology involves
a method to measure the presence or absence of markers, typically cross-linked
amino acids such as pyridinoline, from body fluids such as sweat. The presence
of these markers can be considered useful to ascertain possible bone disease
states or conditions. -6-




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Other Intellectual Property In addition to the technologies acquired from Saigene and our patented
technologies, we have developed certain computer software and internal
procedures and products intended to enhance the quality and effectiveness of
our services. Although our intellectual property rights are important to our
results of operations, we believe that such factors as the technical expertise,
knowledge, ability and experience of our laboratory professionals are more
important, and that, overall, these technological capabilities provide
significant benefits to our clients. Customers / Marketing We provide specialty reference and central laboratory services to, among
others, the pharmaceutical and biotechnology industries. We also act as a
subcontractor for large central laboratories for our specialty reference
laboratory services. In fiscal years 2004 and 2003, our customers included
companies ranging from the worlds largest pharmaceutical companies and
biotechnology companies to small and start-up organizations. Over the past
several years, our two largest customers for our laboratory services have been
Pfizer, Inc. and Procter & Gamble Pharmaceuticals, Inc. In fiscal years 2004
and 2003, Pfizer represented approximately 36% and 76%, respectively, of our
total gross revenues, and in fiscal 2004, Procter & Gamble represented
approximately 40% of our total revenues. We currently have no significant work
orders with either of these two customers and, accordingly, we expect revenues
from both of these customers to decrease in fiscal 2005, both on an absolute
and a percentage basis. In addition, for fiscal years 2004 and 2003, our top
five customers accounted for approximately 86% and 88%, respectively, of our
gross revenues. Our scientific expertise is an integral and interrelated part of our marketing
and sales process. Our Chief Science Officer and our Chief Medical Officer are
directly involved in sales and marketing and, as part of the sales process,
often are involved with customers at the protocol design stage. Our extensive
knowledge in test development and our close collaboration with diagnostic
manufacturers frequently allow us to offer novel tests to our clinical research
clients before such tests are commercially available. Additionally, our
affiliation with the Centers for Disease Control through our affiliate, Pacific
Biometrics Research Foundation, which allows us to participate in the
development of reference methods, creates further expertise that we can bring
to bear on our clients testing needs. By marketing and selling our expertise,
we believe we have a competitive advantage over our competitors. Contractual Arrangements Our contracts with customers are, for the most part, either fixed price or
fee-for-service with a cap. To a lesser extent, contracts are fee-for-service
without a cap. In cases where the contracts are fixed price, we generally bear
the cost of overruns, but we benefit if the costs are lower than we
anticipated. In cases where our contracts are fee-for-service with a cap, the
contracts contain an overall budget for the trial based on time and cost
estimates. If our costs are lower than anticipated, the customer generally
benefits from the savings. If our costs are higher than estimated, we bear the
responsibility for the overrun unless the increased cost is a result of a
change requested by the customer, such as an increase in the number of patients
to be enrolled or the type or amount of data to be collected. Contracts may
range from a few months to several years depending on the nature of the work
performed. For most contracts, a portion of the contract fee is paid at the
time the study or trial is started with the balance of the contract fee payable
in installments upon the progress of the work completed or achievement of
milestones over the study or trial duration. We recognize revenue in the
period that we perform the related services. We have master contractor service agreements with each of our two large
customers, Pfizer, Inc. and Procter & Gamble Pharmaceuticals, Inc. (one of
which was entered into in February 2002 and the other in May 2003). Under
these master service agreements, we perform laboratory research services based
on work orders submitted to us by the customer. There is no guaranteed minimum
number of work orders or revenues to us under either agreement. Each work
order is separately negotiated with the customer and is usually limited to a
specific project with limited duration. Most of our contracts may be terminated at any time by the customer either
immediately or upon notice. Our contracts typically entitle us to receive
payment for fees earned by us up to the time of termination and -7-




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reimbursement for out-of-pocket costs incurred prior to termination. In
certain limited instances, our contracts also entitle us to a termination fee
or payment for the costs of winding down the terminated projects. Most of our contracts also provide for the customer to indemnify us for any
third party damages and claims arising from our providing services under the
contract. The typical exception to this indemnification is that no
indemnification will be provided if the damage or claim results from our
negligence or intentional misconduct. Competition The specialty reference and central laboratory services industries have many
participants ranging from small, limited-service providers to a limited number
of full-service laboratories with global capabilities. For specialty reference laboratory services in our areas of expertise, we
primarily compete against in-house departments of pharmaceutical companies,
other full-service and limited service specialty and central laboratory
services organizations and, to a lesser extent, universities. Many of these
organizations have significantly greater resources than we do. Our significant
competitors in specialty reference laboratory services include Esoterix Inc.,
ARUP Laboratories, Synarc, Inc., and the Mayo Clinic. In the central laboratory services area, we primarily compete against in-house
departments of pharmaceutical companies, full-service and limited-service
specialty and central laboratory services organizations and, to a lesser
extent, universities. Many of these organizations have significantly greater
resources than we do and many have international operations. Our significant
competitors in central laboratory services include Covance Central Laboratory
Services, Inc., PPD, Inc., Quintiles Transnational Corp., Parexel International
Corporation, MDS Inc. and Quest Diagnostics Incorporated, among others. There is significant competition for customers on the basis of many factors for
both specialty reference and central laboratory services, including  
    
    technological expertise and efficient drug development processes,
    
    reputation for on-time quality performance,
    
    strengths in various geographic markets and global reach,
    
    ability to manage large-scale clinical trials both domestically and internationally,
    
    expertise and experience in specific areas,
    
    scope of service offerings,
    
    size,
    
    price,
    
    ability to acquire, process, analyze and report data in a time-saving and accurate manner, and
    
    expertise and experience in health economics and outcomes services. While size and global reach are more important competitive factors in central
laboratory services business, we believe that technological expertise is more
important for specialty reference laboratory services. Except as to size and
international capacity where we know certain other competitors have an
advantage, we believe we compete very favorably in a majority of these areas,
particularly with respect to our technical expertise in our three specialty
areas. Government Regulation Our laboratory services are subject to various regulatory requirements designed to ensure the quality and integrity of
our laboratory testing in support of clinical trials. The industry standards for conducting clinical laboratory testing
are embodied in the Clinical Laboratory Improvement Amendments of 1988 (CLIA). As a medical test site in the
State of Washington, we have established quality assurance programs at our laboratory facilities which monitor
ongoing compliance with CLIA. In addition, we are a CAP-certified test site. This certification provides external
monitoring for CLIA compliance by the College of American Pathologists (CAP) on a yearly basis. -8-




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The industry standards for conducting preclinical laboratory testing are
embodied in the Good Laboratory Practice (GLP) regulations as defined by the
FDA. It is managements experience that the pharmaceutical industry generally
does not require compliance with the GLP regulations, other than specific
provisions for discrete tests. Although we do not perform testing related to
preclinical research, we do comply with specific sections of the GLP
regulations, at our discretion, when it is either important to our clients or
is perceived by management as advantageous to our quality assurance program. Our clinical laboratory services are subject to industry standards for the
conduct of clinical research and development studies that are embodied in the
regulations for Good Clinical Practice (GCP). The FDA and other regulatory
authorities require that test results submitted to such authorities be based on
studies conducted in accordance with GCP. Noncompliance with GCP can result in
the disqualification of data collection during the clinical trial. We are subject to licensing and regulation under federal, state and local laws
relating to hazard communication and employee right-to-know regulations, the
handling and disposal of medical specimens and hazardous waste and radioactive
materials, as well as the safety and health of laboratory employees. Our
laboratory is subject to applicable federal and state laws and regulations
relating to the storage and disposal of all laboratory specimens including the
regulations of the Environmental Protection Agency, the Nuclear Regulatory
Commission, the Department of Transportation, the National Fire Protection
Agency and the Resource Conservation and Recovery Act. Although we believe
that we are currently in compliance in all material respects with such federal,
state and local laws, failure to comply could subject us to denial of the right
to conduct business, fines, criminal penalties and other enforcement actions. In addition to its comprehensive regulation of safety in the workplace, the
Occupational Safety and Health Administration has established extensive
requirements relating to workplace safety for health care employers, whose
workers may be exposed to blood-borne pathogens such as HIV and the hepatitis B
virus. Our employees receive initial and periodic training focusing on
compliance with applicable hazardous materials regulations and health and
safety guidelines. In the past few years, both the United States and foreign governments have
become more concerned about the disclosure of confidential personal data. The
European Union prohibits the disclosure of personal confidential information,
including medical information, to any entity that does not comply with certain
security safeguards. The U.S. Department of Health and Human Services recently
promulgated final regulations under the Health Insurance Portability and
Accountability Act of 1996 (HIPAA) that will govern the disclosure of
confidential medical information in the United States. We do not process IIHI
(Individually Identifiable Health Information) during any phase of our business
practices related to clinical testing. We therefore are currently exempt from
HIPAA regulations. The regulations of the U.S. Department of Transportation, the U.S. Public
Health Service and the U.S. Postal Service apply to the surface and air
transportation of laboratory specimens. We also comply with the International
Air Transport Association regulations, which govern international shipments of
laboratory specimens. Furthermore, when materials are sent to a foreign
country, the transportation of such materials becomes subject to the laws,
rules and regulations of such foreign country. Laurus Debt Investment Effective May 28, 2004, we entered into a financing arrangement with Laurus
Master Fund, Ltd., a New York City based investment fund. The financing
consisted of a $2.5 million secured convertible note with a term of three
years. In connection with the financing, we also issued to Laurus a warrant to
purchase up to 681,818 shares of common stock at an exercise price of $1.25
exercisable at any time prior to May 28, 2011. Under the terms of the note, we started making monthly payments of accrued
interest only beginning on July 1, 2004. In addition, the note provides for
monthly payments of principal in the amount of $83,333.33, plus accrued
interest, commencing December 1, 2004. The note bears interest at an initial
rate equal to the prime rate plus two percent (2%). The interest rate on the
note is subject to reduction on a month by month basis if specified conditions
are met. In particular, if (a) we register the common stock underlying the
note and warrant on a registration -9-




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statement declared effective by the SEC, and (b) our common stock is trading at
a 25% or greater premium to the note conversion price, then the interest rate
will be adjusted downward by 2.0% for each incremental 25% increase over the
note conversion price. Alternatively, if (x) we have not registered the common
stock under an effective registration statement, but (y) our common stock is
trading at a 25% or greater premium to the note conversion price, then the
interest rate will be adjusted downward by 1.0% for each incremental 25%
increase over the note conversion price. We have filed a registration
statement with the SEC to register for resale the shares underlying the Laurus
note and warrant. As of the date of this Annual Report, the registration
statement has not yet been declared effective. For any cash payments we make on the note (e.g., any amounts due that are not
converted into common stock), we are required to pay an amount equal to 102% of
the principal amount due. In addition, we can prepay the note at any time upon
payment of an amount equal to 130% of the then-outstanding principal balance,
plus accrued and unpaid interest. Laurus has the option at any time to convert any or all of the outstanding
principal and accrued and unpaid interest on the note into shares of our common
stock at an initial conversion price of $1.06 per share. In addition, for each
monthly payment under the note, Laurus will be obligated to convert a portion
of the monthly payment into common stock at the applicable conversion price, so
long as  
    
    the average closing price of the common stock (for the five
trading days immediately preceding the payment date) is greater than
$1.22 per share (which represents 115% of the note conversion price,
based on the initial conversion price of $1.06),  
    
    such amount being converted does not exceed 25% of the
aggregate dollar trading volume for such immediately preceding five
trading days, and  
    
    the shares of common stock underlying the note are registered
under an effective registration statement with the SEC. The note conversion price (initially $1.06 per share) is subject to certain
anti-dilution adjustments, including full ratchet anti-dilution if we issue
convertible or equity securities at a price per share less than the conversion
price. However, the following issuances will not trigger the anti-dilution
adjustments to the conversion price:  
    
    pursuant to options, warrants, or other rights to acquire our
common stock that were outstanding as of May 28, 2004;  
    
    pursuant to securities that may be issued under any employee
stock option and/or any stock plan adopted by us;  
    
    pursuant to stock options and/or stock granted under our
stock option plan for our officers, directors, employees and
advisors pursuant to arrangements, plans or contracts approved by
our board of directors;  
    
    upon conversion of any of our preferred stock outstanding as
of May 28, 2004; and  
    
    in connection with acquisition transactions approved by our
board of directors provided, however, that the aggregate
consideration for any individual acquisition may not exceed
$2,500,000 without the prior written consent of Laurus. The terms of Laurus convertible note and warrant prohibit conversion of the
note or exercise of the warrant to the extent that conversion of the note and
exercise of the warrant would result in the holder, together with its
affiliates, beneficially owning in excess of 4.99% of our outstanding shares of
common stock. A holder may waive the 4.99% limitation upon 75 days prior
written notice to us. Also, this limitation does not preclude the holder from
converting or exercising the note or warrant and selling shares underlying the
note or warrant in stages over time where each stage does not cause the holder
and its affiliates to beneficially own shares in excess of the limitation
amount. As security for our obligations to Laurus, we and each of our subsidiaries
granted to Laurus a blanket security interest in all of our assets, and we
entered into a stock pledge with Laurus for the capital stock in our
subsidiaries. If an event of default occurs under the note or the other
investment agreements, 130% of the unpaid principal -10-




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balance on the note, plus accrued interest, shall become immediately due and
Laurus shall be entitled to payment of a default interest rate of 1.5% per
month on all amounts due under the note. Events of default include the
following:  
    
    a failure to pay interest and principal payments under the
note within three days of when due;  
    
    a breach by us of any material covenant or term or condition
of the note or in any of the investment agreements, if not cured
within 30 days of such breach;  
    
    a breach by us of any material representation or warranty
made in the note or in any of the investment agreements;  
    
    if we make an assignment for the benefit of our creditors, or
a receiver or trustee is appointed for us, or any form of bankruptcy
or insolvency proceeding is instituted by us, or any involuntary
proceeding is instituted against us if not vacated within 60 days;  
    
    the filing of any money judgment or similar final process
against us for more than $250,000, which remains unvacated, unbonded
or unstayed for a period of 44 days;  
    
    if our common stock is suspended for 5 consecutive days or
for 5 days during any 10 consecutive days from a principal market or
pursuant to an SEC stop order; and  
    
    a failure by us to timely deliver shares of common stock when
due upon conversions of the note. Upon an event of default, Laurus will be entitled to specified remedies,
including remedies under the Uniform Commercial Code. With respect to the assets of our subsidiary, PBI Technology Inc., Laurus has
agreed that those assets will be automatically released from Laurus security
interest upon the occurrence of any of the following, provided that an event of
default has not occurred:  
    
    our obtaining financing in excess of $1,000,000 to be secured
by such PBI Technology assets;  
    
    our entering into a definitive strategic joint venture
arrangement where the PBI Technology assets are contributed to the
venture; or  
    
    our entering into one or more bona fide licensing agreements
with unaffiliated third parties on commercially reasonable terms and
providing for either (a) up front payments and royalties which based
on such third partys projected sales, would reasonably be expected
to produce, in the aggregate, more than $1,000,000 in gross revenue,
or (b) a grant of security interest in the licensed technology to
the third party licensee. We have agreed to register with the SEC for resale the shares of common stock
that are issuable upon conversion of the note and upon exercise of the warrant.
Under the registration rights agreement, we are obligated to (a) file a
registration statement with the SEC on or before July 3, 2004, and (b) use our
best efforts to have the registration statement declared effective not later
than October 1, 2004. We filed a resale registration statement with the SEC on
June 29, 2004 for the shares underlying the Laurus note and warrant; however,
as of the date of this Annual Report, the registration statement has not yet
been declared effective We will be required to maintain the effectiveness of
the registration statement for up to three years, until May 28, 2007. If we
fail to comply with our registration obligations, Laurus will be entitled to
certain specified remedies, including monetary liquidated damages. In
particular, for each 30 days (or such pro rated number of days) that we are out
of compliance with our registration obligations, we will be subject to a
liquidated damage assessment of 2% of the outstanding principal amount of the
note. Laurus has agreed, pursuant to the securities purchase agreement between Laurus
and us that neither Laurus nor any of its affiliates and investment partners
will (and will not cause any other person or entity to) engage in short sales
of our common stock for as long as the convertible note is outstanding. Short
sales are contracts for the sale of shares of stock that the seller does not
own, or certificates which are not within the sellers control, so as to be
available for delivery at the time when, under applicable rules, delivery must
be made. We also agreed with Laurus that for a limited period of up to 30 days following
the closing date, we could accept additional secured pari passudebt financing
for up to an additional $1.0 million by an investor reasonably acceptable to us
and Laurus. However, we were not successful in closing on additional funds
within such time frame. -11-




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In conjunction with the financing, we paid a closing fee equal to $87,500 to
the manager of Laurus, $29,500 for Laurus legal and due diligence expenses and
$1,500 to the escrow agent. In addition, we paid placement agent fees of
$75,000 to our broker, Source Capital Group, Inc. For any amounts of the
outstanding principal and accrued and unpaid interest owing on the note that
are converted into shares of our common stock, we are also obligated to pay our
broker additional placement agent fees of 4% of the amount being converted, for
maximum additional fees of up to $100,000. In addition, we issued to our
broker a five-year warrant, exercisable as and to the extent that amounts owing
under the Laurus note are converted into common stock, for up to 181,818 shares
of common stock at an exercise price of $1.25 per share. We also incurred
approximately $34,500 in legal fees related to the Laurus transaction. We recorded the $193,500 in placement agent fees and expenses we paid to Laurus
as deferred financing costs, which are being amortized to general and
administrative expenses at the rate of $5,375 per month over the 36-month life
of the note beginning in June 2004, leaving an unamortized balance of $188,125
at June 30, 2004. We also recorded discounts of $683,962 and $573,266,
respectively, representing the intrinsic value of the beneficial conversion
feature of the secured convertible note and value allocated to 681,818
warrants. At June 30, 2004, of the total $1,257,228 of initially recorded
discounts, we had amortized $21,746 as interest expense, and $1,235,482
remained unamortized and will be amortized, using the effective interest
method, over the remaining life of the secured convertible note or upon its
earlier conversion. The balance due under the secured convertible note is
shown net of the remaining unamortized discount on our balance sheet. We
estimated the valuation of the beneficial conversion feature and the warrant
for 681,818 shares using the Black-Scholes pricing model and other assumptions
we deemed reasonable. See Note 8 to Notes to Consolidated Financial
Statements. Saigene Investment Transaction On August 28, 2002, we purchased certain technology, intellectual property and
equipment assets from Saigene Corporation pursuant to an asset purchase
agreement. The purchased technologies include certain DNA amplification and
cell viability and related technologies and processes. In consideration for the purchased assets, we issued to Saigene a total of
6,541,430 shares of our common stock, and we issued an additional 458,570
shares of our common stock to certain of Saigenes designees. In addition, we
executed an option agreement with Saigene whereby we have the right, in our
sole discretion, to purchase certain additional assets from Saigene in exchange
for, at our election, either $5,147,118 in cash, the issuance of an additional
1,715,706 shares of our common stock, or a combination of cash and shares, and
the assumption of additional liabilities associated with such transferred
assets. We have not exercised the option agreement and it continues in full
force and effect. Further, in connection with the Saigene asset purchase agreement in fiscal 2003
(or the dates otherwise noted), the following additional actions were taken:  
    
    We entered into an amended and restated management agreement
with Saigene, under which Saigene continued to operate and manage
our laboratory (through August 31, 2004) in exchange for a monthly
management fee. The original monthly management fee of $90,000 was
reduced to $70,000 effective July 1, 2003, further reduced from
$70,000 to $40,000 effective February 1, 2004, and further reduced
to $20,000 effective June 15, 2004. Subsequently, in July 2004, we
and Saigene agreed to terminate the management agreement effective
August 31, 2004, thereby eliminating the management fee payable to
Saigene after that date;  
    
    We agreed with Saigene to terminate a prior purchase
agreement, dated June 22, 2000, for the proposed purchase by Saigene
of our laboratory operations;  
    
    Holders of our Series A preferred stock consented to an
amendment of the Certificate of Designation with respect to the
rights and preferences of the Series A preferred stock, and agreed
to convert all accrued dividends (approximately $910,000) on the
Series A preferred stock into an aggregate of 150,000 shares of our
common stock; -12-




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
    
    We entered into consulting arrangements with Paul Kanan and
Terry Giles, who then were former founders and officers, and are now
current directors;  
    
    Several of our current and former employees agreed to convert
$933,472 of deferred compensation and notes payable into warrants
and options to purchase an aggregate of 301,541 shares of our common
stock; and  
    
    Each of Saigene, Paul Kanan, Terry Giles and certain other
holders of our common stock agreed not to sell any of our securities
until August 28, 2003, except at a price per share equal to or
greater than $3.00, in a private transaction, in a transaction
solely for estate planning, or, in the event we completed a private
financing, at a per share price equal to or greater than the per
share price set forth in such private financing. Subsequently, in December 2002, we entered into an investment agreement with
Saigene, reflecting a contribution by Saigene to us toward the development and
commercialization of the technologies we acquired from Saigene. Under the
terms of this investment agreement, Saigene:  
    
    executed in our favor a promissory note in the principal
amount of $200,000 payable on or before September 30, 2003 (the
principal amount and accrued interest on which was subsequently paid
in full by Saigene on September 30, 2003 by tender of 72,072 shares
common stock held by Saigene at an attributed value of $3.00 per
share and $2.36 cash);  
    
    assumed a creditor obligation (that we had previously assumed
pursuant to the Saigene asset purchase agreement) in the aggregate
amount of approximately $229,000;  
    
    assumed another creditor obligation in the aggregate amount of approximately $150,000; and  
    
    surrendered for cancellation 10,000 shares of our common stock held in Saigenes name. Employees At September 15, 2004, we had 25 full-time employees and 2 part-time employees
for a total of 27 employees, 19 of who were employed in laboratory operations,
laboratory administration and client services (including our Chief Medical
Officer and Chief Scientific Officer), 1 was employed in sales, marketing and
business development, and 7 were employed in administrative capacities. One of
our employees holds an M.D. degree, three others hold Ph.D. degrees, and two
others hold masters degrees or other postgraduate degrees. None of our
employees are represented by labor unions. We believe that our relationships
with our employees are good. In November and early December, 2003, we implemented certain cost reductions
and deferrals which included generally all of our employees. In addition to
headcount reductions, all of our senior management and certain other employees
accepted salary deferrals ranging from 15% to 20%, and the majority of our
other employees were subjected to the State of Washingtons Shared Work
Program. Under the State of Washingtons Shared Work Program, full-time
employees hours worked may be reduced by up to 50%, and the employees are
eligible to apply for unemployment benefits for the reduction in hours worked.
Effective mid-March, we began ramping up to work on a clinical services
contract with a pharmaceutical company for a study with anticipated revenues of
approximately $1.4 million that was substantially completed by June 30, 2004
and we pulled most of our employees out of the Shared Work Program most of our
employees. As a further cost reduction, effective February 1, 2004, we changed the prior
salary deferrals, which we had implemented with our senior management and
certain other employees, into salary reductions, and we made one-time grants of
stock options in connection with the reductions. Other than for three
department managers who have been restored to full salary effective March 16,
2004, our Chief Executive Officer who was restored to near full salary
effective July 1, 2004, and one other manager who became a part time employee
effective September 1, 2004, these salary reductions are continuing for three
employees, with no further stock options granted in connection with the
reductions. Effective March 1, 2004, the prior salaries deferred from December
2003 and January 2004 were paid pro rata monthly through June 30, 2004. -13-




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In addition, pursuant to our prior management agreement with Saigene, through
August 31, 2004, Saigene provided operational and management services for our
laboratory, in exchange for a monthly management fee. During fiscal 2004, the
original monthly fee of $90,000 was reduced to $70,000 effective July 1, 2003,
further reduced from $70,000 to $40,000 effective February 1, 2004, and further
reduced to $20,000 effective June 15, 2004. Subsequently, in July 2004, we and
Saigene agreed to terminate the management agreement effective August 31, 2004,
thereby eliminating the management fee payable to Saigene after that date.
Under this management arrangement, Saigene had made available to us the
services of up to five contract employees. Available Information We make available free of charge on our website at www.pacbio.com, our Annual
Report on Form 10-KSB, Quarterly Reports on Form 10-QSB, Current Reports on
Form 8-K and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably
practicable after such reports are electronically filed with, or furnished to,
the SEC. Risk Factors Affecting Our Business The following discussion in this Annual Report on Form 10-KSB contains
forward-looking statements regarding our company, our business, prospects and
results of operations that involve risks and uncertainties. Our actual results
could differ materially from the results that may be anticipated by such
forward-looking statements and discussed elsewhere in this Report. Factors
that could cause or contribute to such differences include, but are not limited
to, those discussed below, as well as those discussed under the captions
Business and Managements Discussion and Analysis of Financial Condition and
Results of Operations as well as those discussed elsewhere in this Report. In
evaluating our business, prospects and results of operations, readers should
carefully consider the following factors in addition to other information
presented in this Report and in our other reports filed with the Securities and
Exchange Commission that attempt to advise interested parties of the risks and
factors that may affect our business, prospects and results of operations. See
Cautionary Notice Regarding Forward Looking Statements.  During fiscal 2004, we experienced a significant decrease in revenue.
Our revenue is unpredictable and varies significantly from quarter to
quarter. In fiscal 2004, our revenue decreased to approximately $4,801,000 from
approximately $5,765,000 in fiscal 2003. We experienced significant
quarterly fluctuations and reductions in revenue during fiscal 2004.
Specifically, for the quarters ended March 31, 2004 and December 31, 2003 our
revenue was approximately $548,000 and $542,000, respectively, down from
approximately $2,088,000 and $1,668,000, respectively, for the comparable
quarters of fiscal 2003. We ended fiscal 2004 with slightly improved revenue,
recognizing approximately $331,000 and $1.1 million, respectively, in revenue
in the third and fourth quarters from a clinical services study that we
substantially completed by June 30, 2004. However, even with the improvement
to revenue and positive impact on earnings in the quarter ended June 30, 2004
resulting from this study, we incurred a net loss for the quarter and fiscal
year ended June 30, 2004. Our revenue depends in large part on receiving new
clinical or diagnostic studies from our customers, and we cannot predict the
timing or amount of revenue we may recognize from quarter to quarter. During
fiscal 2005, we are planning to make additional investments in our business
development, technology infrastructure, operations and other areas of our
business in an effort to become more competitive and to increase our revenue.
These efforts will use significant amounts of time, effort and funding. These
efforts may not be successful in generating additional revenue.  We have historically had working capital deficits. If our revenues do
not increase, our losses, cash and working capital position may worsen. Although we ended fiscal 2004 with approximately $2.9 million in cash
(having raised $2.5 million in gross proceeds from our secured debt financing
effective May 2004 and approximately $1.9 million in gross proceeds from our
private placement of common stock that closed in March 2004), we regularly have
had cash flow shortages and deficiencies in working capital. We also have
significant amounts of past due debt, including approximately $239,000 of
accounts payable that was 90 or more days old as of June 30, 2004. At June 30,
2004, we had cash, cash equivalents, and accounts receivable totaling
approximately $3,308,000 and working capital of approximately $1,415,000. For
the quarter and year ended June 30, 2004, respectively, we had losses from -14-




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operations of approximately $490,000 and $1,717,000, and for the fiscal
year ended June 30, 2003, we had operating losses of approximately $1,087,000.
At June 30, 2004, we had an accumulated deficit of approximately $23,119,000. Currently, our cash, cash equivalents, and accounts receivable are being
used to fund our operating losses. Accordingly, unless revenues increase, we
will likely continue to experience significant losses and our cash and working
capital positions will be adversely impacted into fiscal 2005. To improve our
cash position, we are actively seeking to (i) increase revenues, (ii) raise
debt or equity financing, and (iii) cut expenses significantly. Our efforts to
improve our cash position, reduce expenses and generate revenue may not be
successful. Our future capital requirements depend upon many factors, including, but
not limited to:  
    
    the timing and number of clinical trials by customers, the
number of samples submitted to us for testing, and the amount of
revenues generated from these tests;  
    
    our ability to enter into and build relationships with new
customers, and obtain additional projects from existing customers;  
    
    our ability to participate in and win bids from RFPs
(requests for proposals) for clinical tests;  
    
    capital expenditure requirements, including for research and
development efforts, upgrading or replacing laboratory equipment and
making investments in information technology;  
    
    delays or early terminations of clinical testing agreements with customers;  
    
    our plans to pursue additional business strategies;  
    
    our ability to manage our cash flow, including by managing or
reducing our expenses, such as insurance and professional fees of
our accountants and attorneys associated with being a public
company; and  
    
    other business and economic factors that may occur from time
to time. None of these factors can be predicted with certainty. Additionally, if we
desire to invest in our laboratory technology or research and development, we
will require as much as $3-5 million in additional financing.  We closed on $2.5 million in senior secured convertible debt financing
effective in May 2004. Our ability to make required payments of principal
and interest on the debt depends primarily on cash flow from operations,
which may not be sufficient to service the debt. Effective May 28, 2004, we closed on a $2.5 million debt financing with
Laurus Master Funds Ltd., and issued a three year term note, with monthly
payments of interest only that commenced July 1, 2004, and monthly principal
payments commencing December 1, 2004. See BUSINESS  Laurus Debt Investment.
Based on current interest rates, our monthly cash payments of interest only
would be approximately $13,542 and our monthly cash payments of principal and
interest beginning December 1, 2004 would be approximately $98,542. Our actual
required cash payments on the note will vary depending on interest rates and
whether amounts under the note are converted into our common stock. Our ability to make scheduled monthly payments under the note primarily
depends on our future performance and working capital, including our ability to
increase revenues and cash flows. We currently have other fixed monthly
commitments under various notes payable, equipment and facility leases. See
Notes 7 and 8 to Note to Consolidated Financial Statements for the fiscal
year ended June 30, 2004 included in this annual report. To a certain extent
our ability to increase revenues and control costs are subject to a number of
economic, financial, competitive, regulatory and other factors beyond our
control. However, if our cash flow is insufficient to enable us to service our
debt, we may be forced to find alternative sources of financing, or to take
further drastic measures, including significantly reducing operations, seeking
to sell the company, or pursuing liquidation. Any future alternative sources of
debt or equity financing may not be available to us when needed or in amounts
required, and we currently do not have available to us a bank line of credit or
other general borrowing facility. Alternatively, we may be forced to attempt to
negotiate with our debt holders on our payment terms, which may not be
successful or may be on terms onerous to us. -15-




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We granted a blanket security interest in all of our assets to the holder
of our secured debt. If we are unable to make our required monthly
payments on the debt, or any other event of default occurs, it could have
a material adverse effect on our business and operations, and the debt
holder may foreclose on our assets. As part of our recent debt financing, we granted to the holder
of the debt, a blanket security interest in all of our assets,
including assets of our subsidiaries. See BUSINESS  Laurus Debt
Investment. In the event we default in payment on the debt, or any
other event of default occurs under the financing documents, 130% of
the outstanding principal amount of the note and accrued interest
will accelerate and be due and payable in full. See BUSINESS 
Laurus Debt Investment for a list of such potential events of
default. The cash required to pay such accelerated amounts on the note following an
event of default would most likely come out of our working capital. As we rely
on our working capital for our day to day operations, such a default could have
a material adverse effect on our business, operating results, or financial
condition to such extent that we are forced to restructure, file for
bankruptcy, sell assets or cease operations. In addition, upon an event of
default, the holders of the secured debt could foreclose on our assets or
exercise any other remedies available to them. If our assets were foreclosed
upon, we were forced to file for bankruptcy or cease operations, stockholders
may not receive any proceeds from disposition of our assets and may lose their
entire investment in our stock.  We may need to raise additional capital to fund continuing operations. If
our financing efforts are not successful, we will need to explore
alternatives to continue operations, which may include a merger, asset
sale, joint venture, loans or further expense reductions. Our efforts to reduce expenses and generate revenue may not be successful.
Although we raised $2.5 million in gross proceeds from our secured debt
financing effective in May 2004 and approximately $1.9 million in gross
proceeds from our private placement of common stock that closed in March 2004,
if our revenues do not increase we expect to need to raise additional capital
through equity or debt financing or through the establishment of other funding
facilities in order to keep funding operations. However, in the current market
condition, raising capital has been, and will continue to be difficult, and we
may not receive sufficient funding. For instance, under the terms of our
financing with Laurus, we had the right to seek an additional $1.0 million in
pari passudebt from an investor acceptable to Laurus within 30 days of closing
of the initial financing; however, we were not successful in closing on
additional funds within such time frame. Any future financing that we seek may
not be available in amounts or at times when needed, or, even if it is
available, may not be on terms acceptable to us. Also, if we raise additional
funds by selling equity or equity-based securities, the ownership of our
existing stockholders will be diluted. We are also contemplating other alternatives to enable us to fund
continuing operations, which may or may not occur, including, but are not
limited to, any one or more of the following:  
    
    engaging a financial advisor to explore strategic
alternatives, which may include a merger, asset sale, joint venture
or other similar transaction;  
    
    forming a joint venture with one or more strategic partners
to provide additional capital resources to fund operations; and  
    
    loans from management or employees, salary deferrals and
reductions, work force reductions or other cost cutting mechanisms. These potential alternatives may not be open to us, or may only be
available on unfavorable terms. If we are unable to obtain sufficient cash
either to continue to fund operations or to locate a strategic alternative, we
may be forced to seek protection from creditors under the bankruptcy laws or
cease operations. Any inability to obtain additional cash as needed could have
a material adverse effect on our financial position, results of operations and
ability to continue in existence. During fiscal 2005, we are planning to make
additional investments in our business development, technology infrastructure,
operations and other areas of our business in an effort to become more
competitive and to increase our revenues. These efforts will use significant
amounts of time, effort and funding. -16-




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We have received a going-concern opinion from our independent
accountants. If we cannot fund our operations from revenues or financing
efforts, we may have to change our business plan, significantly reduce or
suspend our operations, sell or merge our business, or file a petition in
bankruptcy. Our negative working capital and any inability to secure additional
financing could have a material adverse effect on whether we would be able to
successfully implement our business plan and our ability to continue as a going
concern. For our fiscal year ended June 30, 2004, our independent accountants
included a going concern emphasis paragraph in their report on our financial
statements, stating that we have suffered recurring losses and have
historically had net working capital deficits. We have experienced significant
recent decreases in our revenues, and we have been actively seeking to decrease
our fixed expenses and other fixed costs with the objective of controlling
expenses while minimizing any adverse impact on our future business
opportunities. However, these conditions raise substantial doubt about our
ability to continue as a going concern. If we cannot generate sufficient
revenue from operations or raise additional financing, we may need to change
our business plan, significantly reduce or suspend our operations (which may
include further reducing our operating expenses and downsizing our staff), sell
or merge our business, or file a petition in bankruptcy.  During each of our past fiscal years, we have depended on one or two
customers for a significant portion of our revenue. Any decrease in
revenue from these customers could materially adversely affect us. During fiscal years 2004 and 2003, respectively, revenues from Pfizer,
Inc. and Procter & Gamble Pharmaceuticals, Inc., our two largest customers,
represented in the aggregate approximately 76% and 78% of our total revenue.
See MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS and BUSINESS  Customers/Marketing. Because our revenue has been
concentrated in these one or two large customers, we can be materially
adversely impacted by decreases in work generated from these customers,
including any delays in undertaking clinical studies or submitting samples for
testing services, any early termination or reductions in work orders or
clinical studies, or any decreases in the volume or timing of new work orders.
This was evidenced by the results for the quarter ended December 31, 2003, in
which our total revenue from these two customers decreased to approximately
$40,000, representing only 7% of our revenues in that quarter. We currently do not have significant open or pending work orders with
either of these two large customers or other pharmaceutical companies. We have
expanded our business development efforts and have continued to submit bids and
proposals to these and other companies for our services, to increase our
revenues and to diversify our customer base. Although we believe that we have
good relations with these two customers and other companies in the industry,
and we expect to receive additional work orders in the future, we cannot
predict the timing or amount of any such additional work or whether we will be
successful in further diversifying our customer base. If we are unsuccessful
in our sales and business development efforts with our existing customers and
potential customers, our revenues for the first quarter and beyond in the 2005
fiscal year will be less than our revenues in the comparable prior periods. In
addition, unless we are able to attract additional customers for medium to
large studies, we will continue to be dependent on one or two large customers
for a substantial majority of our revenue.  Our ability to attract and retain customers depends in large part on our
reputation. If our reputation is harmed, our revenues, business
development, growth and operating results may suffer. We compete with other specialty laboratories and central laboratories in
large part on the basis of our reputation for providing quality results in a
timely manner. Accordingly, timely, effective and quality service is essential
to establishing and maintaining our reputation, as well as to generating
customers and revenue. Our reputation may suffer damage, whether from actions
outside or within our control. If our reputation is harmed, our revenues,
business development, growth and operating results may suffer. -17-




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If we do not generate new customers and new projects from our business
development efforts, our growth may be limited, sales of our services may
decrease and our operating results may suffer. We generally do not have long-term contracts with customers for our
services. In addition, any project we undertake may generally be terminated at
any time by the customer on short notice. As a result, it is difficult for us
to forecast future sales, and our future revenues depend on our ability to
generate new customers and new projects. During fiscal 2005, we are planning
to make additional investments in our business development, technology
infrastructure, operations and other areas of our business in an effort to
become more competitive and to increase our revenues. These efforts will use
significant amounts of time, effort and funding. Our business development
efforts are substantially dependent on our ability to effectively manage our
time, personnel and resources. In particular, our Chief Science Officer and
Chief Medical Officer are often heavily involved in the marketing and business
development process, and time that they spend in this area detracts from their
available time for laboratory and development work. Our success in business
development depends in part on our reputation in the industry and client
perceptions (including as to our laboratory capacity and financial health), and
also to a degree on personal relationships between us and the customer. With
the significant consolidation in the pharmaceutical industry, it is often a
long and complex process in finding and meeting with the right person within
the customer. We also understand that some companies in the pharmaceutical
industry have preferred vendor lists, such that a vendor cannot participate
in RFPs (requests for proposal) or contract with the company unless the vendor
is pre-approved on the list. We are attempting to expand our efforts in this
area. If a client or prospective client has negative perceptions about our
capabilities, our laboratory capacity or our financial health, this may affect
our ability to develop new clients or projects. If our business development
efforts are not successful, our revenues and cash flow may decrease and our
operating results may suffer.  The loss of our key personnel, including our Chief Scientific Officer and
Chief Medical Officer, could adversely affect our business. Our success depends to a significant extent upon the efforts of our senior
management team and other key personnel, and in particular Dr. Elizabeth Leary,
our Chief Scientific Officer, and Dr. Mario Ehlers, our Chief Medical Officer.
In addition to the services they provide in our laboratory services, Drs. Leary
and Ehlers are also important to our business development efforts, both due to
their reputations and skills, as well as their contacts and relationships with
clients and prospective clients. The loss of the services of such personnel
could adversely affect our business. Also, because of the scientific and
technical nature of our business, our success is dependent upon our ability to
attract and retain technologically qualified personnel. There is substantial
competition for qualified personnel, and an inability to recruit or retain
qualified personnel may impact our ability to grow our business and compete
effectively in our industry.  We may bear financial losses because most of our contracts are of a fixed
price nature and may be delayed, terminated or reduced in scope for
reasons beyond our control. Many of our contracts provide for services on a fixed price or
fee-for-service with a cap basis and they may be terminated, delayed or reduced
in scope by the other party either immediately or upon notice. Contract
termination, delay or reduction in scope may occur for a variety of reasons,
most of which are beyond our control, including:  
    
    the failure of the customers products to satisfy safety requirements;  
    
    unexpected or undesired results of the customers products;  
    
    insufficient patient enrollment by the customer;  
    
    insufficient investigator recruitment by the customer;  
    
    the customers decision to terminate the development of a product or to
end a particular study; and  
    
    our failure to perform properly our duties under the contract. Because we primarily receive revenue solely on the basis of the number of
clinical samples we test and process, the loss, reduction in scope or delay of
a large contract or the loss or delay of multiple contracts could materially
adversely affect our business, results of operations, financial condition and
cash flows. Our contracts typically entitle us to receive payment for fees
earned by us up to the time of termination and reimbursement for out-of- -18-




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pocket costs incurred prior to termination. In certain limited instances, our
contracts also entitle us to a termination fee or payment for the costs of
winding down the terminated projects.  Our obligations under our secured debt to Laurus may adversely affect our
ability to enter into potential significant transactions with other
parties. As a result of our financing with Laurus Master Funds in the fourth
quarter of fiscal 2004, we incurred a significant repayment obligation, we
granted a blanket security interest in our assets, and we agreed to certain
restrictive covenants. In particular, for so long as $625,000 in principal is
outstanding under the note, we will need Laurus consent before we can take
certain actions, including the following:  
    
    pay any dividends;  
    
    merge, effect a material reorganization, liquidate or dissolve;  
    
    materially change the scope of our business; or  
    
    create, incur or assume any debt (other than certain trade
debt, equipment financings and debt for the purchase of assets in
the ordinary course of business). Accordingly, unless we obtain Laurus consent, we may not be able to enter into
certain transactions. In addition, in connection with any potential
significant transaction (such as a merger, sale of substantially all our
assets, joint venture, or similar transaction), it is likely that we would have
to pay off the debt obligation to Laurus and have the security interests
released. Although we have the right at any time to prepay our secured debt
obligation, we can only do so upon payment of 130% of the then principal
balance, plus all other amounts owing under the note. See BUSINESS  Laurus
Debt Investment. Based on a principal balance of $2.5 million, a prepayment
would require a cash payment of $3.25 million. These provisions could have the
practical effect of increasing the costs of any potential significant
transaction, and restrict our ability to enter into any such transaction,  We may bear financial risk if we under price our contracts or overrun
cost estimates. Since our contracts are often structured as fixed price or fee-for-service
with a cap, we bear the financial risk if we initially under price our
contracts or otherwise overrun our cost estimates. Such under pricing or
significant cost overruns could have a material adverse effect on our business,
results of operations, financial condition and cash flows.  Our ability to protect our intellectual property is essential to the
growth and development of our products and services. We rely, in part, on patents, trade secrets and know-how to develop and
maintain our competitive position and technological advantage on our existing
intellectual property and any future intellectual property we develop. See
BUSINESS  Technologies and Products. We protect our intellectual property
through a combination of license agreements, trademark, service mark,
copyright, trade secret laws and other methods of restricting disclosure and
transferring title. We have and intend to continue entering into
confidentiality agreements with our employees, consultants and vendors;
entering into license agreements with third parties; and generally seeking to
control access to and distribution of our intellectual property. Risks Relating to Our Industry  Failure to keep pace with changes in the marketplace may cause us to lose
market share and our revenues may decrease. The market for specialty reference and central laboratory services is
subject to rapid technological change and innovation. In particular,
laboratories are regularly developing new assays to incorporate into clinical
testing and have to maintain up-to-date laboratory equipment to stay
competitive. In developing and enhancing our services, we have made, and will
continue to make, assumptions about which features, standards and performance
criteria will be attractive to, or demanded by, our customers. If we implement
features, standards and performance criteria that are different from those
required by our customers or if our competitors introduce products and systems
that better address these needs, market acceptance of our offerings may suffer
or may become obsolete. In that -19-




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event, our market share and revenues would likely decrease. In addition,
clients are requiring that laboratories maintain secure and sophisticated
information technology systems, as a means for storing data and facilitating
communication between the laboratory and the client. Although we continue to
expend efforts and resources in these areas, we may not be successful in
keeping up with customer needs or expectations. In addition, if a client or
prospective client has negative perceptions about our abilities based on our
balance sheet and financial strength, this may affect our ability to develop
new clients or projects. Many of our competitors have greater resources than
we do. We are also exploring potential financing to be used to continue to
update our laboratory service capability; if we are unsuccessful in raising
funds as and when needed, we may, or it may be perceived, that we are less
efficient and less economical than our competitors and we may lose business to
our competitors. If this occurs, it would have a material adverse effect on
our revenues and financial performance.  We may not be able to successfully develop and market new services. We may seek to develop and market new services that complement or expand
our existing business. If we are unable to develop new services and or create
demand for those newly developed services, our future business, results of
operations, financial condition and cash flows could be adversely affected.  We operate in a highly competitive industry, and we may lose or fail to
attract customers for our services to our competitors. Competitors in the specialty reference and central laboratory industry
range from small, limited-service providers to full service global contract
research organizations. Our main competition consists of in-house departments
of pharmaceutical companies, full-service contract research organizations,and,
to a lesser degree, universities. See BUSINESS  Competition. We compete on
a variety of factors, including  
    
    technological expertise and efficient drug development processes,  
    
    reputation for on-time quality performance,  
    
    strengths in various geographic markets and global reach,  
    
    ability to manage large-scale clinical trials both domestically and internationally,  
    
    expertise and experience in specific areas,  
    
    scope of service offerings,  
    
    size,  
    
    price,  
    
    ability to acquire, process, analyze and report data in a time-saving and accurate manner, and  
    
    expertise and experience in health economics and outcomes services. Many of our competitors have greater resources than we do, have global
operations and greater name recognition. If we experience significant
competition which is based on factors which we do not have in our business,
such as global management of projects or size, our business could be materially
adversely affected.  Changes in government regulations could decrease the need for our
services. Governmental agencies throughout the world, but particularly in the United
States, highly regulate the drug development and approval process. See
BUSINESS  Government Regulation. Our business involves performing safety and
efficacy laboratory testing during clinical trials of new pharmaceutical drugs.
Clinical trial laboratory data is used by pharmaceutical and biotechnology
companies in the submission process to the FDA for the marketing approval of a
new drug. Changes in regulations, such as a relaxation in regulatory
requirements or the introduction of simplified drug approval procedures or an
increase in regulatory requirements that we have difficulty satisfying, could
eliminate or substantially reduce the need for our services. Also, government
efforts to contain drug costs and pharmaceutical and biotechnology company
profits from new drugs may have an impact on the drug development and approval
process, and our customers may spend less, or reduce their growth in spending,
on research and development. -20-




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Failure to comply with existing government regulations could result in a
loss of revenue or earnings from a project. Any failure on our part to comply with applicable government regulations
could result in the termination of on-going research or sales and marketing
projects or the disqualification of data for submission to regulatory
authorities. For example, if we failed to validate analytical test methods
performed on samples collected during and in support of a trial or if we fail
to comply with GCP (Good Clinical Practice) regulations, the generated test
data could be disqualified. If this were to happen, we could be contractually
required to repeat the trial at no further cost to our customer, but at
substantial cost to us.  We depend on the pharmaceutical and biotechnology industries. Our revenues depend greatly on the outsourcing expenditures made by the
pharmaceutical and biotechnology industries in research and development.
Accordingly, economic factors and industry trends that affect our clients in
these industries also affect our business. If companies in these industries
were to reduce the number of research and development projects they outsource,
our business could be materially adversely affected. Our customers in the pharmaceutical and biotechnology industries have
experienced significant consolidation over the last several years and we expect
that trend to continue. The uncertainty caused by consolidation, before,
during and after a business combination can result in product delays, changes
in strategy, and consolidation and/or elimination of research and development
efforts. Any of these effects can have a materially adverse affect on us if it
results in testing delays, sample volume reductions or termination of tests.  We must maintain certifications from our customers in order to be
eligible to bid on projects. Many of our customers require our laboratories to be tested from time to
time for certification that we comply with their internal requirements. If we
fail to comply, we will probably be terminated from existing contracts and we
will not be eligible to bid on that customers future projects. While
generally we have been very successful in maintaining certifications and in
gaining new certifications, if we fail certification tests, especially for our
major customers, our business would be materially adversely affected.  We may expand our business through acquisitions. We may review acquisition opportunities. Factors which could affect our
ability to grow successfully through acquisitions include  
    
    difficulties and expenses in connection with integrating the
acquired companies and achieving the expected benefits,  
    
    diversion of managements attention from current operations,  
    
    the possibility that we may be adversely affected by risk
factors facing the acquired companies, and  
    
    acquisitions could be dilutive to earnings, or in the event
of acquisitions made through the issuance of our common stock to the
stockholders of the acquired company, dilutive to the percentage of
ownership of our existing stockholders.  We may be affected by potential health care reform. In recent years, governments of the United States, Europe and Asia have
considered various types of health care reform in order to control growing
health care costs. We are unable to predict what legislative proposals will be
adopted in the future, if any. Implementation of health care reform
legislation that contains costs could limit the profits that can be made from
the development of new drugs. This could adversely affect research and
development expenditures by pharmaceutical and biotechnology companies which
could in turn decrease the business opportunities available to us. In addition,
new laws or regulations may create a risk of liability, increase our costs or
limit our service offerings. -21-




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Special reference and central laboratory services create a risk of
liability. In contracting to work on drug development trials, we face a range of
potential liabilities, including  
    
    errors or omissions in laboratory data being generated
relating to the safety and efficacy of the drug, that could affect
the regulatory approval of the drug, and  
    
    errors and omissions during a trial that may undermine the
usefulness of a trial or data from the trial. While we maintain what we believe is adequate insurance coverage and
obtain contractual indemnifications protecting us against liability arising
from our own actions (other than negligence or intentional misconduct), we
could be materially and adversely affected if we were required to pay damages
or bear the costs of defending any claim which is not covered by a contractual
indemnification provision or which is beyond the level of our insurance
coverage. Due to the rising costs of insurance, we may not be able to maintain
such insurance coverage at levels or on terms acceptable to us.  We rely on air transportation and overnight delivery services. Our laboratories are heavily reliant on air travel for transport of
clinical trial kits and other material and people, and disruption to the air
travel system or package delivery system could have a material adverse effect
on our business. We generally receive revenue only on the basis of clinical
tests actually performed. Accordingly, any non-receipt or delay in receiving
testing materials will impact our ability to generate revenue. Risks Related to Our Common Stock  Because our common stock is traded on the OTC Bulletin Board and is
considered a penny stock, a stockholders ability to sell its shares in
the secondary trading market may be limited. Our common stock is currently quoted for trading on the OTC Bulletin
Board. As a result, the liquidity of our common stock is limited, not only in
the number of shares that are bought and sold, but also through delays in the
timing of transactions, and the lack of coverage by security analysts and the
news media of our company. In addition, because our stock is quoted on the OTC
Bulletin Board, our common stock is subject to certain rules and regulations
relating to penny stock. A penny stock is generally defined as any equity
security that has a price less than $5.00 per share and that is not quoted on
the Nasdaq Stock Market or a national securities exchange. Being a penny stock
generally means that any broker who wants to trade in our shares (other than
with established customers and certain institutional investors) must comply
with certain sales practice requirements, including delivery to the
prospective purchaser of the penny stock a risk disclosure document describing
the penny stock market and the risks associated therewith. In addition,
broker-dealers must take certain steps prior to selling a penny stock, which
steps include:  
    
    obtaining financial and investment information from the investor;  
    
    obtaining a written suitability questionnaire and purchase agreement signed by the investor; and  
    
    providing the investor a written identification of the shares
being offered and the quantity of the shares. If these penny stock rules are not followed by the broker-dealer, the investor
has no obligation to purchase the shares. The application of these
comprehensive rules will make it more difficult for broker-dealers to sell our
common stock, and as a practical matter, these requirements may mean that
brokers are less likely to make recommendations on our shares to its general
customers. As a result, for as long as our common stock is quoted on the OTC Bulletin
Board and subject to these penny stock rules, our stockholders may have
difficulty in selling their shares in the secondary trading market. In
addition, prices for shares of our common stock may be lower than might
otherwise prevail if our common stock were quoted on the Nasdaq Stock Market or
traded on a national securities exchange, like The New York Stock Exchange or
American Stock Exchange. This lack of liquidity may also make it more difficult
for us to raise capital in the future through the sale of equity securities. -22-




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Our quarterly operating results may vary, and these fluctuations could
affect the market price of our stock. Our operating results may vary significantly from quarter to quarter and
are influenced by such factors as  
    
    the commencement, completion or cancellation of large contracts,  
    
    the progress of ongoing contracts,  
    
    seasonality (particularly in the summer months as patient
enrollment and participation in clinical testing typically decreases
coinciding with summer vacations), and  
    
    changes in the mix of our services. We believe that operating results for any particular quarter are not
necessarily a meaningful indication of future results. While fluctuations in
our quarterly operating results could negatively or positively affect the
market price of our common stock, these fluctuations may not be related to our
future overall operating performance.  Our stock price is volatile and your investment in our common stock could
suffer a decline in value. The trading price of our common stock has fluctuated significantly in the
past. The future trading price of our common stock may continue experiencing
wide price fluctuations in response to a number of factors, some of which are
beyond our control, such as  
    
    actual or anticipated fluctuations in revenues or operating results,  
    
    changes in market valuation of companies in our industry generally,  
    
    announcements of research activities and technology
innovations or new products or services by us or our competitors;  
    
    failure to meet expectations of performance,  
    
    developments in or disputes regarding copyrights, trademarks,
patents and other proprietary rights, and  
    
    general economic conditions.  The market for our stock has not been liquid. The average daily trading volume for our common stock during the previous
three months prior to the date of this Annual Report has been less than 3,000
shares. Therefore, holders of our common stock may have difficulty selling
their shares in the public markets. In addition, as of September 15, 2004, a
majority of the issued and outstanding shares of common stock were restricted
securities and were not freely tradable in the public markets, pursuant to Rule
144 or otherwise. As a result of two registration statements we recently filed
for Laurus and certain other selling stockholders, a significant number of
those restricted shares will be registered and will be available for sale
(including shares that may be issued in the future upon conversion of the
Laurus note and upon exercise of outstanding warrants). Sales of a substantial
number of shares of our common stock in the public market (including the shares
offered under the registration statements and shares available for resale under
Rule 144(k) under the Securities Act) or the perception that such sales could
occur, could significantly depress the prevailing market price of our common
stock.  Saigene Corporation owns a significant number of shares of our common
stock and effectively controls our company, which could discourage or
prevent a takeover, even if an acquisition would be beneficial to our
stockholders. Our largest stockholder, Saigene Corporation, beneficially owns more than
35% of our outstanding voting power. Accordingly, this single stockholder may
be able to influence the outcome of stockholder votes, involving the election
of directors, the adoption or amendment of provisions in our certificate of
incorporation and bylaws and the approval of certain mergers or other similar
transactions, such as a sale of substantially all of our assets. Such control
by our existing stockholder could have the effect of delaying, deferring or
preventing a change in control of our company. -23-




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As we issue additional equity securities in the future, including upon
conversion of any of our secured convertible debt, your share ownership
will be diluted. In particular, the secured convertible debt has a full
ratchet anti-dilution provision that could significantly dilute our
stockholders. In connection with our recent debt financing, we issued a $2.5 million
convertible note and warrants to the investor. See BUSINESS  Laurus Debt
Investment. The note is convertible into shares of our common stock at an
initial conversion price of $1.06 per share. At this initial conversion rate,
for example, we would issue 2,358,490 shares upon conversion of $2.5 million
owing under the note. The actual number of shares to be issued will depend on
the actual dollar amount of principal and interest being converted. In
addition, the note carries a full ratchet anti-dilution provision, such that if
we issue in the future convertible or equity securities (subject to certain
exceptions, including stock option grants and issuances in connection with
certain acquisition transactions) at a price less than the initial $1.06
conversion price, the note conversion price will be automatically adjusted down
to that lesser price. For example, if we had a non-exempted issuance at $0.50
per share, the note conversion price would become $0.50, and upon an assumed
conversion of $2.5 million, we would have to issue 5,000,000 shares. In
addition to the conversion rights of the convertible debt, as we issue stock or
convertible securities in the future, including for any future equity financing
or upon exercise of any of the outstanding stock purchase warrants and stock
options, those issuances would also dilute our stockholders. If any of these
additional shares are issued and are sold into the market, it could decrease
the market price of our common stock and could also encourage short sales.
Short sales and other hedging transactions could place further downward
pressure on the price of our common stock.  We do not intend to pay cash dividends, so any return on your investment
must come from appreciation. We have not declared dividends on our common stock in the past, and do not
intend to declare dividends on our common stock in the foreseeable future. In
addition, pursuant to our financing agreements with Laurus Master Fund, Ltd.,
for as long as $625,000 in principal amount is outstanding under the secured
note to Laurus, we may not declare or pay any dividends without Laurus
consent. As a result, any return on your investment in our common stock must
come from increases in the fair market value and trading price of our common
stock.  We may be subject to further sanctions from the SEC if we fail to comply
with the May 10, 2001 Final Judgment. On May 10, 2001, a Final Judgment of Permanent Injunction was issued by
the United States District Court for the District of Columbia ordering us to
file with the SEC, on or before June 29, 2001: (1) our Annual Report on Form
10-KSB for our fiscal year ended June 30, 2000; (2) our Quarterly Reports on
Form 10-QSB for our quarters ended March 31, September 30, and December 31,
2000; and (3) such other periodic reports which may become due prior to the
entry of the Final Judgment. The Final Judgment also ordered us in the future
to file with the SEC, in a timely manner and in proper form, accurate and
complete information and reports as are required to be filed under the U.S.
securities laws. All such delinquent reports were filed on June 29, 2001 and
since that date, we have filed all such subsequent reports by the required due
dates. Accordingly, we believe we are in compliance with the Final Judgment and
we intend to remain so in the future, failing which we might be subject to
sanctions from the SEC. 
 ITEM 2. DESCRIPTION OF PROPERTY. We lease approximately 15,000 square feet of office and laboratory space in
Seattle, Washington for our executive offices and laboratory. This lease has a
term of ten years, expiring on October 31, 2007, and carries an average annual
rental of approximately $233,000 through the remainder of the lease term
subsequent to June 30, 2004. In addition, under the terms of the lease, we are
required to place a $100,000 security deposit in an interest bearing account in
our name, with interest earned accruing to us. This amount has been classified
as restricted cash on the accompanying consolidated balance sheet and has a
current balance of approximately $71,000 as modified by mutual agreement with
the landlord. We believe the leased premises are suitable and adequate for their use. In the
opinion of management, the leased premises are adequately covered by insurance. -24-




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We do not own any real property. We do not have a policy pertaining to
investments in real estate. Our current practice is to invest solely in
short-term money market securities. 
 ITEM 3. LEGAL PROCEEDINGS. We are not a party to any pending material legal proceedings. 
 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 of the fiscal year ended June 30, 2004. 
 PART II 
 ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL
BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES. Common Stock On January 10, 2003, our board of directors approved a 1:3 (one for three)
reverse stock split on our common stock. The reverse split was subsequently
approved by our stockholders and became effective on March 14, 2003. All
shares and per share calculations set forth in this Annual Report on Form
10-KSB reflect the 1:3 reverse stock split. Our common stock is currently quoted for trading on the OTC Bulletin Board
under the symbol PBME. Initially, our common stock began trading in October
1996 (subsequent to the initial public offering) on The Nasdaq Stock Market
under the symbol PBMI. In March 1999, our securities were delisted from The
Nasdaq Stock Market as it failed to meet the maintenance requirements for
tangible net assets and minimum stock price. The stock subsequently traded and
continues to trade on the OTC Bulletin Board. In March 2003, the ticker symbol
for the common stock was changed to PBME from PBMI in connection with the
one-for-three reverse stock split. The following table shows, for each quarter of fiscal 2004 and 2003, the high
and low closing sales prices (as adjusted for the 1:3 reverse stock split
effective March 2003) as reported by the OTC Bulletin Board. The quotations
from the OTC Bulletin Board reflect inter-dealer prices without retail mark-up,
mark-down, or commissions and may not represent actual transactions. OTC Bulletin BoardHigh
    
    LowFiscal 2004:Fourth quarter, ended June 30, 2004
    
    $
    1.25
    
    
    $
    0.80Third quarter, ended March 31, 2004
    
    
    1.25
    
    
    
    0.65Second quarter, ended December 31, 2003
    
    
    2.00
    
    
    
    0.75First quarter, ended September 30, 2003
    
    
    2.00
    
    
    
    0.90Fiscal 2003:Fourth quarter, ended June 30, 2003
    
    
    1.70
    
    
    
    0.52Third quarter, ended March 31, 2003
    
    
    1.10
    
    
    
    0.36Second quarter, ended December 31, 2002
    
    
    0.69
    
    
    
    0.33First quarter, ended September 30, 2002
    
    
    0.75
    
    
    
    0.075
 -25-




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Holders As of September 15,
2004, there were 13,048,820 shares of common stock issued
and outstanding, held by approximately 273 holders of record. Dividends We have never declared or paid any cash dividends with respect to our common
stock, and do not plan to do so in the foreseeable future. There are no dividends accruing on our Series A preferred stock. In September
2002, the holders of Series A preferred stock approved an amendment to the
Certificate of Designation with respect to the rights and preferences of the
Series A preferred stock to, among other things, convert the then-accrued 8%
dividend on the Series A preferred stock into an aggregate of 150,000 shares of
common stock and eliminate any further mandatory dividends on the Series A
preferred stock. As of June 30, 2004, there were no shares of our Series B preferred stock
issued and outstanding. In June 2004, all three holders of Series B preferred
stock voluntarily converted their shares of Series B preferred stock and
accrued and unpaid dividends (approximately $3,295) into a total of 104,294
shares of common stock. Prior to such conversion, there were 33,666.66 shares
of our Series B preferred stock issued and outstanding, and the Series B
preferred stock accrued dividends at a rate of 8% per annum, compounded
quarterly. For the fiscal year ended June 30, 2004, we paid cash dividends on
the Series B preferred stock of approximately $4,000, and approximately $3,295
of accrued and unpaid dividends at May 31, 2004 were converted into shares of
common stock. At June 30, 2004, there were no remaining accrued and unpaid
dividends on the Series B preferred stock. We anticipate that we will retain future earnings for use in the operation and
expansion of our business and do not anticipate paying cash dividends on our
equity in the foreseeable future. Any future determination with regard to the
payment of dividends will be at the discretion of our board of directors and
will be dependent upon our future earnings, financial condition, applicable
dividend restrictions and capital requirements and other factors deemed
relevant by the board of directors. Recent Sales of Unregistered Securities Effective May 28, 2004, we issued to Laurus Master Fund, Ltd. a $2.5 million
secured convertible note with a term of three years, and a warrant to purchase
up to 681,818 shares of common stock at an exercise price of $1.25 exercisable
at any time prior to May 28, 2011. See BUSINESS  Laurus Debt Investment.
The note is convertible into shares of our common stock at an initial
conversion price of $1.06 per share. The conversion price is subject to
certain anti-dilution adjustments, including if we issue convertible or equity
securities (subject to certain exceptions) at a price less than the conversion
price. We agreed to register with the SEC for resale the shares of common
stock that are issuable upon conversion of the note and upon exercise of the
warrant, and we filed a registration statement for the shares on June 29, 2004.
The note and warrant were offered and sold in reliance on the
exemption from registration provided by Rule 506 of Regulation D under the
Securities Act. At closing, we paid cash commissions of $75,000 to our broker,
Source Capital Group, Inc.; in addition, for any amounts of the outstanding
principal and accrued and unpaid interest owing on the note that are converted
into shares of our common stock, we are also obligated to pay our broker
additional placement agent fees of 4% of the amount being converted, for
maximum additional fees of up to $100,000. In addition, we issued to our broker
a five-year warrant, exercisable as and to the extent that amounts owing under
the Laurus note are converted into common stock, for up to 181,818 shares of
common stock at an exercise price of $1.25 per share. In May 2004, we offered to our three holders of Series B preferred stock the
opportunity to voluntarily convert all of their shares of Series B preferred
stock, and all accrued and unpaid dividends thereon through May 31, 2004
(approximately $3,295), into shares of common stock. The conversion ratio was 3
shares of common stock for one share of Series B preferred stock, plus 1 share
of common stock for each $1 in accrued and unpaid dividends. In June 2004, all
three preferred holders accepted our conversion offer and canceled their shares
of Series B preferred stock and accrued and unpaid dividends, and we issued a
total of 104,294 shares of common stock upon such -26-




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conversion and there are no
shares of Series B preferred stock issued and outstanding. The shares of common
stock were issued in reliance on the statutory exemption from registration
provided by Section 4(2) of the Securities Act. 
 ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. You should read the following discussion and analysis in conjunction with our
consolidated audited financial statements and related notes for the fiscal year
ended June 30, 2004, included elsewhere in this Report. Except for historical
information, the following discussion contains forward-looking statements. See
Cautionary Notice Regarding Forward Looking Statements and Risk Factors. Overview We provide specialty central laboratory services to support pharmaceutical and
diagnostic manufacturers in the conduct of human clinical research, for use in
their drug discovery and development efforts. Our clients include a number of
the worlds largest multi-national pharmaceutical, biotechnology and diagnostic
companies. Our well-recognized specialty areas include cardiovascular disease
(dyslipidemia, atherosclerosis, and coronary heart disease), diabetes (and
obesity), and bone and joint diseases (osteoporosis and arthritis). Coupled
with our specialty testing, we also have central laboratory capability and
provide full-service central laboratory support for multi-center clinical
trials, including routine safety lab tests (general chemistry, hematology, and
urinalysis). Our company is a Delaware corporation, incorporated in May 1996,
and we conduct our operations primarily through our wholly-owned subsidiary,
Pacific Biometrics, Inc., a Washington corporation. Critical Accounting Estimates and Policies The discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
estimates including, among others, those affecting revenues, the allowance for
doubtful accounts, and the useful lives of tangible and intangible assets. The
discussion below is intended as a brief discussion of some of the judgments and
uncertainties that can impact the application of these policies and the
specific dollar amounts reported on our financial statements. We base our
estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form our
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ
from these estimates under different assumptions or conditions, or if
management made different judgments or utilized different estimates. Many of
our estimates or judgments are based on anticipated future events or
performance, and as such are forward-looking in nature, and are subject to many
risks and uncertainties, including those discussed below and elsewhere in this
Report. We do not undertake any obligation to update or revise this discussion
to reflect any future events or circumstances. We have identified below some of our accounting policies that we consider
critical to our business operations and the understanding of our results of
operations. This is not a complete list of all of our accounting policies, and
there may be other accounting policies that are significant to our company.
For a detailed discussion on the application of these and our other accounting
policies, see Note 2 to the Consolidated Financial Statements included in this
Report. Revenue Recognition We recognize revenue in the period that the related services are performed.
Historically, a majority of our net revenues have been earned under contracts
which range in duration from six months to eighteen months, but can extend in
duration up to two years or longer. Service contracts generally take the form
of fixed-price arrangements. Under fixed-price contracts, revenue is
recognized as services are performed, with performance generally assessed using
output measures, such as units-of-work performed to date as compared to the
total units-of-work contracted. Changes in the scope of work generally result
in a renegotiation of contract pricing terms. Renegotiated amounts are -27-




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not
included in net revenues until earned and realization is assured. We also
receive advances from certain customers related to the services to be performed
for them. These advances are deferred and recognized as revenue in the period
the related services are performed. Estimates of costs to complete are made,
as appropriate, to provide for losses expected on contracts. Costs are not
deferred in anticipation of contracts being awarded, but instead are expensed
as incurred. All out-of-pocket costs are included in total revenues and
expenses. Impairment of Technology Assets As of June 30, 2004, our periodic assessment of the impairment issues on our
technology assets led us to conclude that the recorded value of those assets
should be written off. We considered our ability to recover the value of our
technology assets from undiscounted cash flows of the related operations. In
particular, factors we considered included: reductions in our workforce,
generally as well as in research and development, in the second and third
quarters of fiscal 2004 (which was then considered to be temporary, but which
has since become more extended); our inability to secure a licensing or other
partnership arrangement to date for the intangible assets; and our inability to
obtain financing specifically for further development of the technology assets
to date. While we have obtained equity and debt funding for our general
operations through the Laurus debt financing in May 2004 and our private
placement in March 2004, and while we intend to continue to pursue development
efforts, partnership, licensing or other means to realize the value of our
intangible assets, we believe that current conditions have changed such that
the value of these assets are now less likely to be recovered in the near term,
and should be written off. Accordingly, as of June 30, 2004, we wrote off the
entire balance of $476,874 of technology assets as an operating expense,
Impairment of technology assets (in accordance with SFAS 144  Accounting
for the Impairment or Disposal of Long-Lived Assets). (See Note 2 to Notes to
Consolidated Financial Statements  Summary of Significant Accounting Policies
 Technology Assets ). We had no comparable expense in fiscal 2003. Beneficial Conversion Feature In accordance with Financial Accounting Standards Board (FASB) Emerging Issues
Task Force Issue (EITF) No. 98-5 and FASB EITF No. 00-27, using the relative
fair value method of Accounting Principles Board Opinion 14 (APB 14), we
recorded a beneficial conversion feature (BCF) related to the issuance of
convertible debt that has conversion features at fixed rates that are
in-the-money when issued and recorded value allocated to warrants issued with
those instruments. The BCF for the convertible instrument and value allocated
to warrants are measured and recognized by allocating a portion of the proceeds
to additional paid-in capital with an offset to a discount on the convertible
instrument. For convertible debt and
related warrants, the recorded discount is amortized
as interest expense using the effective interest method over the life of the
debt. Bad Debt Allowance We endeavor to assess and monitor the creditworthiness of our customers to
which we grant credit terms in the ordinary course of business. We maintain a
provision for doubtful accounts to provide for the possibility that amounts due
to us may not be collected. As of June 30, 2004, the allowance for bad debt
was approximately 6% of
our total accounts receivable. This bad debt provision is monitored on a
monthly basis and adjusted as circumstances warrant. As the recorded bad debt
provision is based upon managements judgment, actual bad debt write-offs may
be greater or less than the amount recorded. Historically bad debt write-offs
have not been material. Operating Expenses Historically, we have segregated our recurring operating expenses among three
categories: laboratory and cost of goods sold; selling, general and
administrative expenses; and research and development. For the fiscal period
ended June 30, 2004, operating expenses also included a fourth category,
impairment of technology assets, as described above. Laboratory expenses and
cost of goods sold consist of amounts necessary to complete the revenue and
earnings process, and includes direct labor and related benefits, other direct
costs, and an allocation of facility charges and information technology costs,
and depreciation and amortization. Also, laboratory expenses and cost of goods
sold include shipping and handling fees and reimbursable out-of-pocket costs.
Laboratory expenses and cost of goods sold, as a percentage of net revenues,
tends, and is expected, to fluctuate from one period to another, as a -28-




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result of
changes in labor utilization and the mix of service offerings involving studies
conducted during any period of time. Selling, general and administrative
expenses include business development activities, sales and marketing expenses
and related commissions, and laboratory administration expenses. Selling,
general and administrative expenses consist primarily of administrative payroll
and related benefit charges, Saigene management fees, legal and accounting
fees, advertising and promotional expenses, administrative travel and an
allocation of facility charges, information technology costs, and depreciation
and amortization. Research and development expenses consist of direct labor
and related benefits, supplies, legal fees for patent applications, travel
expenses, and depreciation and amortization. Impairment of technology assets
resulted from the write-off of our technology assets described above. We depreciate equipment and computers over three to five years, while leasehold
improvements are depreciated over the remaining life of the lease or ten years.
This estimate of a three to five-year useful life on equipment and computers
and a useful life based on the remaining years left on the building lease for
leasehold improvements reflects managements judgment that these useful life
periods reflect a reasonable estimate of the life over which the equipment,
computers and leasehold improvements will be used by us. However, the amount
of depreciation expense we record in any given period will change if our
estimates of the useful life of our equipment, computers or leasehold interests
were to increase or decrease. Results of Operations for the Fiscal Years Ended June 30, 2004 and 2003 Revenues Years EndedDollars in thousands,
    
    June 30,
    
    $
    
    %rounded to nearest thousand
    
    2004
    
    2003
    
    Change
    
    ChangeRevenues
    
    $
    4,801
    
    
    $
    5,765
    
    
    $
    (964
    )
    
    
    (17
    )%
 Our revenues are generated from clinical trials testing services and from
diagnostic services. The approximately 17% decrease in fiscal 2004 revenues
over fiscal 2003 was primarily attributable to a decrease in the size and
number of clinical trials testing services we performed. Except for the March
2004 clinical services contract we entered into and that was substantially
completed by June 30, 2004, these decreases reflect the recent significant
decreases in revenues and open work orders we have been experiencing. With
respect to the March 2004 clinical services contract, we recognized revenues of
approximately $1.4 million during fiscal 2004, of which we recognized
approximately $1.1 million in the fourth quarter (representing approximately
77% of our total revenues for the quarter). Our recent quarterly decreases in revenues reflect the fluctuations and
reductions in testing and open work orders with our historically two largest
customers, Pfizer, Inc. and Procter & Gamble Pharmaceuticals, Inc. Combined
revenues from these two customers were a total of approximately $3.6 million
(75.4% of our total revenues) for the fiscal year ended June 30, 2004, compared
to approximately $4.5 million (78.3% of our total revenues) for the fiscal year
ended June 30, 2003. Excluding the $1.4 million we received from the March 2004
clinical services contract we entered into and that was substantially completed
by June 30, 2004, the decreases in revenues from these customers year over year
is a result of prior work orders having come to completion or the clinical
study having ended or being terminated early, without being replaced with new
work orders for additional testing services. We have historically
been dependent on one or both of these customers for a significant portion of
our revenues, and as such a decline in the volume of services performed for
these customers has a significant impact on our revenues. During the fiscal year ended June 30, 2004, revenue generated from clinical
trials testing services accounted for approximately 82% of our total revenues.
Revenue generated from diagnostic, referral and other services accounted for
approximately 18% of our total revenue during the same period. Historically,
over 90% of our total revenues have been generated from clinical trials. We
expect that clinical trials will continue to account for a significant portion
of our revenues in the future. -29-




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Laboratory Expense and Cost of Goods Sold: Years EndedDollars in thousands,
    
    June 30,
    
    $
    
    %rounded to nearest thousand
    
    2004
    
    2003
    
    Change
    
    ChangeLaboratory Expense and Cost
of Goods Sold
    
    $
    2,763
    
    
    $
    2,801
    
    
    $
    (38
    )
    
    
    (1
    )%Percentage of Revenues
    
    
    58
    %
    
    
    49
    %
 Laboratory expense and cost of goods sold consist primarily of payment of
salaries and related benefits to employees performing analysis of clinical
trial samples, the cost of supplies for analysis of clinical trial samples,
payments to subcontractors of laboratory services, and other expenses such as
payment of business and occupation taxes. During the fiscal years ended June
30, 2004 and 2003, respectively, salaries and related benefits accounted for
approximately 34.6% and 37.7% of total laboratory expense and cost of goods
sold, lab supplies were approximately 23.6% and 24.3%, and outside services
were approximately 19.8% and 16.8%. For the comparable fiscal years ended June 30, 2004 and 2003, laboratory
expense and cost of goods sold decreased approximately 1%. As a percentage of
revenue, laboratory expense and cost of goods sold increased in fiscal 2004 to
approximately 58% from approximately 49% in fiscal 2003. For fiscal years 2004 and 2003, respectively, salaries and related benefits
decreased approximately 10% to approximately $955,000 from $1,057,000, lab
supplies decreased approximately 4% to approximately $653,000 from $680,000,
and outside services increased approximately 16% to approximately $548,000
from $471,000. The decrease in salaries and benefits between the comparable
periods was primarily attributable to a decrease in the number of employees in
this area. The decrease in the components of lab supplies between the
comparable periods were primarily attributable to the decreased supplies
needed to support the commensurate decrease in revenues. The 16% increase in
outside services resulted from approximately $508,000 we paid for outside
services in the first quarter of fiscal 2004 (compared to approximately
$64,000 for the same quarter in fiscal 2003), for outsourcing of testing on a
third-party proprietary assay. However, for the remaining three quarters of
fiscal 2004, fees for outside services totaled approximately $40,000 (compared
to approximately $407,000 for the same period in fiscal 2003), reflecting a
significant decrease in outsourced services incurred within the scope of
earning revenues. The decrease in salaries and related benefits for fiscal years 2004 and 2003
also partially reflects actions we took during fiscal 2004 to control employee
expenses. Through December 31, 2003, as part of our efforts to reduce
expenses, with respect to our laboratory operations, quality assurance, client
services and information technology employees, we terminated employment of
five laboratory employees, had one laboratory employee participate in the
salary deferral / reduction program, and enrolled the remaining 18 laboratory
employees in the Shared Work Program. Effective mid-March 2004, as we began
ramping up to work on the March 2004 clinical services contract, we pulled our
employees out of the Shared Work Program, and incurred overtime expense. We
also restored the employee information technology employee noted above who had
been participating in the salary deferral / reduction program to full salary
effective March 16, 2004. From time to time we will continue to evaluate
re-entering employees in the Shared Work Program based on the timing and
volume of our clinical testing services projects. Research and Product Development: Years EndedDollars in thousands,
    
    June 30,
    
    $
    
    %rounded to nearest thousand
    
    2004
    
    2003
    
    Change
    
    ChangeResearch and Product Development
    
    $
    129
    
    
    $
    214
    
    
    $
    (85
    )
    
    
    (40
    )%Percentage of Revenues
    
    
    3
    %
    
    
    4
    %
 Research and development expenses consist mainly of our expenditures incurred
in connection with development of our LIDA and cell viability technology that
is being transferred into PBI Technology. -30-




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For the comparable fiscal years ended June 30, 2004 and 2003, research and
product development expenses decreased approximately 40% to approximately
$129,000 from $214,000. The decrease was primarily the result of decreased
compensation expense as a result of fewer employees in research and product
development in the current year period over the comparable prior year period.
For the fiscal years ended June 30, 2004 and 2003, the decrease was partially
offset by increased patent related legal expenses, including those related to
establishing a separate technology subsidiary (PBI Technology, Inc.) to more
effectively finance and manage the development of our technology portfolio.
Also, in November 2003, as part of our efforts to reduce expenses, we enrolled
our one employee in research and development in the Shared Work Program, and in
February 2004, this employee was terminated, further reducing our compensation
expense in this area. We anticipate that we will continue to incur research and development expenses
related to the technology held by PBI Technology. However, if we are unable to
increase revenues or raise additional funding to continue to fund our existing
research and development efforts, we will seek to further reduce our research
and development efforts and expenses. Impairment of Technology Assets: Years EndedDollars in thousands,
    
    June 30,
    
    $
    
    %rounded to nearest thousand
    
    2004
    
    2003
    
    Change
    
    ChangeImpairment of Technology Assets
    
    $
    477
    
    
    $
    0
    
    
    $
    477
    
    
    
    100
    %Percentage of Revenues
    
    
    10
    %
    
    
    0
    %
 As of June 30, 2004, we re-assessed impairment issues on our technology assets
and we concluded that the recorded value of those assets should be written off.
We considered our ability to recover the value of those assets from
undiscounted cash flows of the related operations. In particular, factors we
considered included: reductions in our workforce, generally as well as
in research and development, in the second and third quarters of fiscal 2004
(which was then considered to be temporary, but which has since become more
extended); our inability to secure a licensing or other partnership arrangement
for the intangible assets; and our inability to obtain financing specifically
for further development of the technology assets. While we have obtained
equity and debt funding for our general operations through the Laurus debt
financing in May 2004 and our private placement in March 2004, and while we
intend to continue to pursue development efforts, partnership, licensing or
other means to realize the value of our intangible assets, we believe that
current conditions have changed such that the value of these assets are now
less likely to be recovered in the near term, and should be written off.
Accordingly, as of June 30, 2004, we wrote off the entire balance of $476,874
of technology assets as an operating expense, Impairment of technology assets
(in accordance with SFAS 144 Accounting for the Impairment or Disposal of
Long-Lived Assets). (See Note 2 to Notes to Consolidated Financial
Statements  Summary of Significant Accounting Policies  Technology Assets
). We had no comparable write-off or expense in fiscal 2003. Selling, General and Administrative Expense: Years EndedDollars in thousands,
    
    June 30,
    
    $
    
    %rounded to nearest thousand
    
    2004
    
    2003
    
    Change
    
    ChangeSelling, General and
Administrative Expense
    
    $
    3,150
    
    
    $
    3,837
    
    
    $
    (687
    )
    
    
    (18
    )%Percentage of Revenues
    
    
    66
    %
    
    
    67
    %
 Our selling, general and administrative expense consists primarily of
compensation for our executive officers, board members and other selling,
general and administrative personnel, management fees paid to Saigene,
compensation income (expense) on our stock options, legal and accounting fees,
and payments under consulting arrangements. For the comparable years ended June 30, 2004 and 2003, respectively, selling,
general and administrative expense decreased approximately 18% to approximately
$3,150,000 from $3,837,000. As a percentage of revenue, selling, -31-




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general and
administrative expenses were approximately 66% and 67%, respectively, for the
comparable fiscal years ended June 30, 2004 and 2003. The reduction in our selling, general and administrative expenses for the
comparable periods is due in large part to decreased management fees we paid to
Saigene under the terms of the amended and restated management agreement. This
reflects the reduction in monthly management fees, effective July 1, 2003, to
$70,000 from $90,000 and the further reductions of the management fees to
$40,000 per month from $70,000 per month effective February 1, 2004, and to
$20,000 per month from $40,000 per month, effective June 15, 2004. Subsequent
to the end of fiscal 2004, we terminated the management agreement effective
August 31, 2004, thereby eliminating further monthly management fees payable to
Saigene after that date. For the comparable fiscal years ended June 30, 2004
and 2003, respectively, management fees decreased 46% to approximately $680,000
from $1,255,000. Excluding Saigene management fees, selling, general and administrative expenses
were approximately $2,470,000 and $2,582,000 (approximately 51% and 45% as a
percentage of revenue), respectively, for the comparable fiscal years ended
June 30, 2004 and 2003. For the fiscal year ended June 30, 2004, our compensation costs consisted
primarily of salaries and wages, whereas in fiscal 2003, we also incurred
certain contract labor costs and relocation expenses. Contract labor costs in
fiscal 2003 consisted of approximately $74,000 for services provided by our
current Chief Executive Officer under a management agreement with Saigene
before he became our employee, and for contract accounting and contract chief
financial officer services. In fiscal 2003 we hired our Chief Executive
Officer and a Chief Financial Officer, resulting in decreased needs for
contract labor services. Also, in fiscal 2003, we incurred recruiting and
relocation expenses of approximately $115,000 relating to our Chief Medical
Officer and a Business Development Representative, where we had no comparable
expenses in fiscal 2004. Related to the decrease in contract labor services,
we recognized increased salaries and benefits of approximately $190,000 in
fiscal 2004 over fiscal 2003. The increase in salaries and wages was due
primarily to the hiring of our Chief Executive Officer, Chief Financial Officer
and a business development representative during fiscal 2003. These
compensation increases were partially offset by actions we took during fiscal
2004 to control employee expenses, including salary reductions of 15% to 20%
implemented for certain personnel beginning February 1, 2004, enrolling one
administrative employee in the State of Washingtons Shared Work Program,
having one hourly employee agree to reduce her hours worked and terminating
employment of two administrative employees. Effective mid-March 2004, as we
began ramping up to work on our large clinical services contract, we pulled our
employees out of the Shared Work Program and we restored three of the selling,
general and administrative employees who had been participating in the salary
deferral / reduction program to full salary effective March 16, 2004.
Subsequent to the end of fiscal 2004, we reinstated to near full salary our
Chief Executive Officer beginning July 1, 2004 and one other selling, general
and administrative manager became a part time employee effective September 1,
2004, leaving salary reductions continuing for three management level
employees. From time to time we will continue to evaluate re-entering
employees in the Shared Work Program and additional salary deferrals /
reductions based on the timing and volume of our clinical testing services
projects. Selling, general and administrative expenses for the fiscal year ended June 30,
2004 included approximately $149,000 in Board of Director compensation,
compared to approximately $60,000 in fiscal 2003. In addition, under the terms
of consulting agreements dated August 28, 2002 with two of our directors, Terry
Giles and Paul Kanan, we recorded aggregate consulting expenses of $156,000 and
$130,000, respectively, in the comparable fiscal years ended June 30, 2004 and
2003. Selling, general and administrative expenses also include compensation income
(expense) resulting from the May 2002 repricing of all outstanding stock
options to the then-current market price of $0.06. For the comparable fiscal
years ended June 30, 2004 and 2003, respectively, we recognized approximately
$35,000 in income and $129,000 in expense. As of June 30, 2004, 11,139
repriced options remained outstanding. In the future, the amount of
compensation expense (income) we recognize will fluctuate based on the value of
our common stock and the number of options that are outstanding as of each
valuation date. (See Note 11 to Notes to Consolidated Financial Statements). Further changes in our selling, general and administrative expenses include an
increase in legal and accounting expenses of approximately $26,000 between the
respective fiscal years ended June 30, 2004 and 2003 to $374,000 -32-




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from $348,000.
Legal and accounting expenses for fiscal 2004 include costs associated with
our private placement financing in March 2004, our secured convertible debt
financing effective May 2004, and preparation and filing of our two resale
registration statements filed in the third and fourth quarters of fiscal 2004,
as well as costs associated with being a public company. We also incurred
approximately $193,500 in fees and expenses in the fourth quarter of fiscal
2004, related to the secured convertible note financing with Laurus, and we are
amortizing these fees over the anticipated 36-month life of the note, resulting
in approximately $5,375 of expense recognized in June 2004. For fiscal 2003,
legal and accounting expenses included fees incurred in connection with the
Saigene purchase transaction in August 2002. For fiscal 2005, we expect to
continue to amortize these expenses at the rate of $5,375 per month, or $16,125
per quarter. Other Income (Expense): Years EndedDollars in thousands,
    
    June 30,
    
    $
    
    %rounded to nearest thousand
    
    2004
    
    2003
    
    Change
    
    ChangeOther Income (Expense)
    
    $
    (166
    )
    
    $
    2,545
    
    
    $
    (2,711
    )
    
    
    (107
    )%Percentage of Revenues
    
    
    (3
    )%
    
    
    44
    %
 We had approximately $166,000 in other expense in fiscal 2004, compared to
$2,545,000 in other income in fiscal 2003. The fiscal 2003 other income was
primarily due to our reversing a prior reserve and removing the prior
$2,244,040 contingent liability relating to 3M from the balance sheet. (See 
Liquidity and Capital Resources  Reversal of Technology License Payable in
Fiscal 2003 and Note 13 to Notes to Consolidated Financial Statements.) For
fiscal 2004, our net other expense included approximately $42,000 in
Washington state sales and business and occupation tax refunds from a review of
past years tax remittances, approximately $155,000 of interest expense on notes
payable and lease obligations (net of interest income), and approximately
$72,000 from a loss on the receipt of common stock instead of cash in payment
of a $200,000 note receivable and approximately $16,000 in accrued interest
income from a related party (Saigene) (see Note 14 to Notes to Consolidated
Financial Statements). In fiscal 2003, in addition to the reversal of the $2,244,040 contingent
liability referred to above, our net other income included one-time gains on
the restructuring of certain outstanding debt of approximately $169,000,
approximately $(118,000) in net interest expense, and approximately $21,000 of
rent and fees paid to us by Saigene. In addition, primarily during the third
quarter of fiscal 2003, we reassessed all of our existing liabilities and wrote
off some of our old accounts payable and an old lease obligation, resulting in
a one-time gain associated with the write-off in the amount of approximately
$228,000. Net Earnings (Loss): Years EndedDollars in thousands,
    
    June 30,
    
    $
    
    %rounded to nearest thousand
    
    2004
    
    2003
    
    Change
    
    ChangeNet Earnings (Loss)
    
    $
    (1,884
    )
    
    $
    1,457
    
    
    $
    (3,341
    )
    
    
    (229
    )%
 We had a net loss of approximately $1,884,000 in fiscal 2004, reflective of our
significant decrease in revenues during fiscal 2004, compared to net earnings
of approximately $1,457,000 in fiscal 2003. The change in net earnings (loss)
from fiscal 2003 to fiscal 2004 was significantly as a result of our action in
fiscal 2003 to reverse the prior reserve and remove the $2,244,040 contingent
liability relating to 3M from the balance sheet. (See  Liquidity and Capital
Resources  Reversal of Technology License Payable in Fiscal 2003 and Note 13
to Notes to Consolidated Financial Statements.) Excluding the reversal of the contingent liability of $2,244,040, in fiscal
2003 we had a pro forma net loss of approximately $787,000, compared to our net
loss of approximately $1,884,000 in fiscal 2004, representing an approximately
$1,097,000 or 139% increase in net loss over fiscal 2003. -33-




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Excluding the reversal of the contingent liability of $2,244,040, the increase
in our net loss is primarily attributable to our significantly decreased
revenues in the year over year periods, partially offset by improvements in
laboratory expenses and cost of sales, and selling, general and administrative
expenses, and research and product development expenses discussed above, and,
also impacted by the change in other income (expense) discussed above. Liquidity and Capital Resources: We had significant net operating losses for the fiscal year ended June 30, 2004
and revenues for fiscal 2004 were significantly lower than those in the
comparable prior fiscal year. Unless revenues increase, we will likely
continue to experience significant losses and our cash and working capital
positions will be adversely impacted. Our operations historically have
primarily been funded through revenues generated from operations and from the
sale and issuance of our common stock, preferred stock and debt from time to
time. At June 30, 2004, our cash and cash equivalents were approximately $2,941,000,
compared to approximately $440,000 at June 30, 2003. The increase in our cash
and equivalents is primarily attributable to proceeds from our secured
convertible note financing with Laurus in the fourth quarter of fiscal 2004,
our private placement in March 2004 and our borrowings under our $250,000
credit facility with Franklin Funding from August through November 2004, and to
a lesser degree from increased advances from our customers and increased
accrued liabilities. We have no off-balance sheet financing arrangements. As of
June 30, 2004, we also had restricted cash of approximately $71,000 which
represents a security deposit in connection with our office lease in Seattle,
Washington which expires in July 2007. We are obligated to maintain the
restricted cash security deposit through the term of the lease. At June 30, 2004, we had approximately $367,000 in accounts receivable,
compared to approximately $467,000 as of June 30, 2003, reflecting the timing
of revenues billed and collected. Our accounts receivable generally reflects
our billings, and may include one or several individually large customer
receivables from time to time. As described above, in March 2004, we entered
into a clinical services contract with a pharmaceutical company for a study
that we substantially completed by June 30, 2004. We recognized approximately
$331,000 in revenues from this study in the quarter ended March 31, 2004 and
approximately $1.1 million in revenues in the quarter ended June 30, 2004, with
one of our larger mid-quarter billings being paid before quarter-end. As of
June 30, 2004 and March 31, 2004, approximately 41% and 55%, respectively, of
our receivables balances of approximately $367,000 and $481,000, respectively,
was from this clinical services contract. Additionally, given the relatively significant decrease in our revenues for the
quarters ended December 31, 2003 and March 31, 2004 as compared to prior
quarters, accounts receivable as of December 31, 2003 and March 31, 2004
represented a proportionately larger percentage of revenues for each of the
respective quarters, at approximately 77% and 88%, respectively, compared to
26% and 27%, respectively, as of June 30, 2004 and September 30, 2003. This
increase in the percentage of accounts receivable to quarterly revenues was
driven primarily from the significant decreases in revenues that we are
experiencing, and that occurred in those periods. Total liabilities recorded on our balance sheet as of June 30, 2004 were
approximately $3,519,000 compared to approximately $2,714,000 as of June 30,
2003. The increase in liabilities continues to be driven by our net losses, and
is primarily attributable to our $2.5 million secured convertible note (See
BUSINESS  Laurus Debt Investment), and, to a lesser degree, our borrowings
under our $250,000 credit facility with Franklin Funding. As required by U.S.
generally accepted accounting principles, the liability we recorded for the
secured convertible note payable to Laurus represented a discount from the face
value of the note by approximately $1,235,000, related to the valuation of the
beneficial conversion feature and the warrants. However, we are obligated on
the full $2.5 million total principal amount due to Laurus. Accordingly, if
this discount were disregarded, our total liabilities as of June 30, 2004 would
be approximately $4,754,000. At June 30, 2004, we had working capital of approximately $1,415,000, compared
to negative working capital of approximately $685,000 at June 30, 2003. The
approximately $2.1 million improvement in working capital between the fiscal
years is attributable to several changes in the components of working capital.
Changes providing favorable impact include increases in cash, deferred
financing costs related to the secured convertible note financing with Laurus,
and prepaid expenses and other assets, and decreases in accounts payable,
advances from customers, and dividends payable and, except for additional
borrowings of (and the additional current portions, net of discounts, payable
on) $2.5 million under our secured convertible note and $250,000 under our loan
and security agreement -34-




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with Franklin Funding, decreases in our current notes
payable and lease obligations. Changes negatively impacting our working
capital since June 30, 2003 include decreases in our accounts receivable, and
$200,000 note receivable from Saigene (through receipt of payment in the form
of our common stock), decreased inventories since June 30, 2003, and increases
in accrued liabilities, and the current portion of our $2.5 million secured
convertible note and $250,000 under our loan and security agreement with
Franklin Funding. In addition, our working capital position at June 30, 2004
gives effect to approximately $304,000 of discounts recorded on the current
portion of our secured convertible note with Laurus, as required by U.S.
generally accepted accounting principles. If this discount were disregarded,
we would have working capital of approximately $1,111,000 at June 30, 2004. Net cash used in operating activities was approximately $1,293,000 for the
fiscal year ended June 30, 2004, primarily to fund our net loss and changes in
our working capital. Net cash used in operations included the effect of
approximately $477,000 in write off of our technology assets, $116,000 in
depreciation and amortization, $25,000 in Board compensation settled in stock
options (rather than cash), $35,000 in income recognized in fiscal 2004 in
accordance with accounting options under variable pricing rules as it relates
to our May 2002 repricing of stock options, and $16,000 in interest income on,
and $72,000 in loss on settlement of, a note receivable from Saigene that was
paid to us using our common stock. Our investing activities used approximately
$91,000 for the fiscal year ended June 30, 2004 primarily for the purchase of
capital equipment. Cash flows provided by financing activities was
approximately $3,885,000 for the fiscal year ended June 30, 2004, consisting
primarily of approximately $2,500,000 in borrowings under our secured
convertible note with Laurus (net of approximately $193,000 in deferred finance
charges), approximately $1,711,000 in net proceeds from our private placement
of unregistered common stock in March 2004, approximately $250,000 in proceeds
of borrowings under our loan and security agreement with Franklin Funding and
approximately $3,000 in proceeds from exercise of stock options and
warrants, offset by
approximately $379,000 in payments on notes payable, notes payable to related
parties, and payments on capital lease obligations, and payment of
approximately $6,000 in cash dividends on our Series B preferred stock. During fiscal 2004, within the quarter ended September 30, 2003, we redeemed
72,072 shares of our common stock as payment on a $200,000 note receivable and
accrued interest from Saigene. The payment on the Saigene note in common stock
was made in accordance with the terms of the note, and resulted in elimination
of the note receivable but without a corresponding increase in our cash
position. During the fiscal year ended June 30, 2004, we also reversed
approximately $1,000 previously recorded to our common stock and prepaid
financing expense accounts, reflecting the return and cancellation of 83,333
shares of our common stock that had been held in escrow under an agreement with
our prior landlord. Under the terms of the escrow agreement, 583,333 shares of
our common stock remain in escrow. As described above, we experienced a significant decrease in revenues, and
incurred significant net losses, as well as significant losses and (except for
the proceeds from our $2.5 million secured convertible note) degradation of our
cash and working capital position from operations, throughout fiscal 2004. We
expect these trends will continue into fiscal 2005. To improve our cash
position, we are actively seeking to increase revenues, raise additional debt
or
equity financing and cut certain expenses significantly. In an effort to
become more competitive and to increase our revenues, we are also currently
actively planning to make additional investments in our business development
activities, our technology infrastructure, operations and other areas of our
business. These efforts will use significant amounts of time, effort and
funding. There can be no assurance that our efforts to control expenses,
generate revenue and raise sufficient capital will be successful. In the current market conditions, raising capital from equity financing has
been, and will continue to be difficult. We did not raise sufficient financing
from our Series B preferred stock private placement in the spring / summer of
2003. Beginning in November 2003, we initiated a best efforts private
placement through the sale of unregistered shares of common stock at $0.50 per
share. Through the closing of the private placement in March 2004, we sold
3,846,000 shares of common stock and received approximately $1,711,000 in net
proceeds. In connection with that private placement, as of March 31, 2004, we
had recorded cash commissions to the broker dealer of $192,300 and incurred
$20,101 of legal expenses. On August 5, 2003, we entered into a loan and security agreement with our
lender, Franklin Funding, Inc. Under this agreement, we borrowed $250,000
during the first and second quarters of fiscal 2004. Amounts borrowed under
the loan agreement bear interest at 17.64% and are amortized over 36 months,
with monthly payments beginning September 2003 and a final balloon payment due
at maturity on August 5, 2006, and are secured by specific -35-




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equipment. In the
event of default, among other remedies, the lender may declare the entire
amount under the loan agreement to be immediately due and payable, and may take
possession of the equipment provided as security. No additional amounts are
available to us under this credit facility, and we do not have any other credit
facility in place. Effective May 28, 2004, we closed on a $2.5 million debt financing with Laurus
Master Funds Ltd., and issued a three year term note, with monthly payments of
interest only that commenced July 1, 2004, and monthly principal payments
commencing December 1, 2004. See BUSINESS  Laurus Debt Investment. The term
note bears interest at an initial rate equal to the prime rate plus two percent
(2%), and is subject to reduction on a month by month basis if specified
conditions are met. For any cash payments we make on the note, we are required
to pay an amount equal to 102% of the principal amount due. Based on current
interest rates, our monthly cash payments of interest only would be
approximately $13,542 and our monthly cash payments of principal and interest
beginning December 1, 2004 would be approximately $98,542. Our actual required
cash payments on the note could be less if amounts under the note are converted
into our common stock. We can prepay the note at any time upon payment of an
amount equal to 130% of the outstanding principal balance plus accrued and
unpaid interest. From the $2.5 million in gross proceeds, we paid a closing fee
equal to $87,500 to the manager of Laurus, $29,500 for Laurus legal and due
diligence expenses and $1,500 to the escrow agent. At closing, we paid cash
commissions of $75,000 to our broker, Source Capital Group, Inc.. In addition,
for any amounts of the outstanding principal and accrued and unpaid interest
owing on the note that are converted into shares of our common stock, we are
also obligated to pay our broker additional placement agent fees of 4% of the
amount being converted, for maximum additional fees of up to $100,000. In
addition, we issued to our broker a five-year warrant, exercisable as and to
the extent that amounts owing under the Laurus note are converted into common
stock, for up to 181,818 shares of common stock at an exercise price of $1.25
per share. We also incurred approximately $34,500 in legal fees related to the
Laurus transaction. The impact of these transactions, including recording the
value allocated to the warrants and beneficial conversion feature, are being
recorded beginning in the quarter ended June 30, 2004. See Note 8 to Notes to
Consolidated Financial Statements. With these recent cash infusions from the Laurus debt investment and our
private placement in March 2004, we currently expect that our current cash,
current assets and any cash flows from operations will be sufficient to fund
operations through July 1, 2005. However, any further decreases in revenue
would adversely affect our financial condition, and we may need to seek
additional capital during the latter part of fiscal 2005. We may not be able
to raise sufficient financing. For instance, under the terms of our financing
with Laurus, we had the right to seek an additional $1.0 million in pari passu
debt from an investor acceptable to Laurus within 30 days of closing of the
initial financing; however, we were not successful in closing on additional
funds within such time frame. Accordingly, management continues to contemplate
other alternatives to enable us to fund continuing operations, including loans
from management or employees, salary deferrals and reductions and other cost
cutting mechanisms, and raising additional capital by private placements of
equity or debt securities or through the establishment of other funding
facilities. In addition, we are exploring strategic alternatives, which may
include a merger, asset sale, joint venture or another comparable transaction.
None of these potential alternatives may be available to us, or may only
be available on unfavorable terms. If we are unable to obtain sufficient cash
to continue to fund operations or if we are unable to locate a strategic
partner, we may be forced to seek protection from creditors under the
bankruptcy laws or cease operations. Any inability to obtain additional cash as
needed could have a material adverse effect on our financial position, results
of operations and our ability to continue in existence. Our auditors added an
explanatory paragraph to their opinion on our fiscal 2004 financial statements
stating that there was substantial doubt about our ability to continue as a
going concern. Our efforts to reduce expenses and generate revenue may not be
successful. With respect to our research and development activities, Saigene has informed
us that in order to develop and commercialize the technology that we acquired
from Saigene in August 2002, we would likely require in the near term a capital
infusion in excess of $5 million. Moreover, management believes that an
additional $15 million over the next two years would be required to achieve
regulatory approval and commercialization of the technologies acquired from
Saigene in August 2002, as well as the additional technologies that may be
acquired under the option agreement with Saigene. Due to our current working
capital position, we are not actively pursuing these research and development
efforts. Although, in the future we do intend to seek suitable financing to
continue research and development efforts, commence the regulatory approval
process and commercialization of the technologies, but there can be no
assurance that we will be able to obtain such financing, on favorable terms or
at all. We also intend to continue to explore strategic alternatives for our
technology assets, which, in addition to further development, -36-




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may include sale,
partnership, joint venture, licensing or other means of developing or otherwise
realizing the value of these assets. As of June 30, 2004, our periodic assessment of the possible impairment of our
technology assets led us to conclude that the $476,874 of technology assets on
our balance sheet should be written off. See MANAGEMENTS DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS  Impairment of
Technology Assets. Reversal of Technology License Payable in Fiscal 2003 In December 1997, we entered into an exclusive license agreement and supply
agreement with Sudormed, Inc. The technology licensed from Sudormed was the
basis for our development of our sweat and saliva products. Due to a lack of
funding and the failure to obtain FDA approval for the products, all
development efforts relating to the products were suspended in August 1998.
The license agreement required us to make a $1.6 million license payment in
December 1998, which was subsequently extended to March 1999. In May 1999,
Sudormed terminated the license agreement and the supply agreement due to our
failure to make the $1.6 million license payment. The Minnesota Mining and Manufacturing Company (3M) manufactured certain of
the products that Sudormed supplied to us pursuant to the supply agreement. As
described above, Sudormed terminated both the license agreement and the supply
agreement in May 1999 due to our failure to make required payments. 3M
subsequently foreclosed upon certain assets of Sudormed and became a party in
possession of secured property of Sudormed. In May 2000, 3M notified us that,
in its capacity as a secured party in possession of the Sudormed assets, it
demanded payment in full of the $1.6 million plus accrued interest and fees due
under the Sudormed license agreement. We dispute 3Ms demand, and will
vigorously defend any action that 3M may bring. We have not had any
correspondence or communication with 3M since 2000, and to our knowledge no
action has been filed. During fiscal 2003, we reassessed our potential liability to 3M. We believe
based on advice from legal counsel that any claims by 3M under the license
agreement are now barred by the applicable statute of limitations (having
expired in the third and fourth quarters of fiscal 2003), and accordingly that
the likelihood of liability to 3M is remote. We previously reserved on our
balance sheet a contingent liability in the amount of $2,240,040, representing
the full potential amount owing under the technology license plus accrued
interest and fees. At June 30, 2003, we reversed the reserve and removed the
contingent liability from the balance sheet. 
 ITEM 7. FINANCIAL STATEMENTS. Financial Statements are listed in the Index to Financial Statements and filed
and included elsewhere herein as a part of this Annual Report on Form 10-KSB,
beginning at page F-1. 
 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE. None 
 ITEM 8A. CONTROLS AND PROCEDURE We maintain disclosure controls and procedures designed to ensure that
information required to be disclosed in our reports filed or submitted under
the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commissions rules and forms. As of the end of the period covered by this
Annual Report on Form 10-KSB, we carried out an evaluation, under the
supervision and with the participation of management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures pursuant to -37-




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Exchange Act Rule 13a-15. Based upon that evaluation, management and our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective. A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Because of the inherent limitations in all control systems no
evaluation of controls can provide absolute assurance that all control issues
if any, within a company have been detected. On September 20, 2004, our independent registered public accounting firm orally
notified our management and audit committee that they had identified a
significant deficiency regarding our internal controls. The deficiency noted
was the lack of segregation of duties within the accounting department. This
significant deficiency was not believed to be a material weakness. To correct
such deficiency, we are in the process of making changes in assigned roles and
responsibilities, as well as formalizing in writing some of our established
internal policies that we have been complying with but had not previously been
reduced to writing. Other than the actions we are taking to correct the significant deficiency as
described above, during and subsequent to the fourth quarter of fiscal 2004,
there have been no changes in our internal controls over financial reporting or
in other factors that could significantly affect internal controls over
financial reporting. In response to the Sarbanes-Oxley Act of 2002, we are
continuing a comprehensive review of our disclosure procedures and internal
controls and expect to make minor modifications and enhancements to these
controls and procedures. 
 ITEM 8B. OTHER INFORMATION Not applicable 
 PART III 
 ITEM 9. OUR DIRECTORS AND EXECUTIVE OFFICERS We have a Code of Ethics that applies to our principal executive officer,
principal financial officer, controller and other employees performing similar
functions. A copy of the Code of Ethics is included with this Report as
Exhibit 14. The other information called for by Part III, Item 9, will be included in our
proxy statement relating to our 2004 annual meeting of shareholders, and is
incorporated herein by reference. The proxy statement will be filed within 120
days of June 30, 2004, our fiscal year end. 
 ITEM 10. EXECUTIVE COMPENSATION Information called for by Part III, Item 10, will be included in our proxy
statement relating to our 2004 annual meeting of shareholders, and is
incorporated herein by reference. 
 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Certain information called for by Part III, Item 11, will be included in our
proxy statement relating to our 2004 annual meeting of shareholders, and is
incorporated herein by reference. -38-




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Equity Compensation Plan Information The following table gives information as of June 30, 2004, regarding our
common stock that may be issued upon the exercise of options, warrants and
other rights under our equity compensation plans. See also Notes 11 and 12 to
Consolidated Financial Statements included in this Report. (a)No. of Shares
    
    (b)
    
    (c)to be Issued
    
    Weighted Average
    
    No. of Shares AvailableUpon Exercise of
    
    Exercise Price of
    
    for Future Issuance,Outstanding Options,
    
    Outstanding Options,
    
    excluding securitiesPlan Category
    
    Warrants and Rights
    
    Warrants and Rights
    
    reflected in Column (a)Equity Compensation
Plans Approved by
Stockholders (1)
    
    
    1,281,396
    
    
    $
    0.77
    
    
    
    486,940Equity Compensation
Plans Not Approved
by Stockholders
    
    
    1,457,728
    
    
    
    0.97
    
    
    
    TOTAL
    
    
    2,739,124
    
    
    $
    0.88
    
    
    
    486,940
   (1)
    
    Consists solely of the Pacific Biometrics, Inc. 1996 Stock Incentive
Plan. 
 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information called for by Part III, Item 12, will be included in our proxy
statement relating to our 2004 annual meeting of shareholders, and is
incorporated herein by reference. 
 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. ExhibitNo.
    
    
    
    
    
    Description3.1
    
    
    (1)
    
    
    Amended and Restated Certificate of Incorporation of the Company, as amended  includes (a) Amended and Restated Certificate of Incorporation dated July 9, 1996, (b) Certificate of Amendment to Certificate of Designation for Series A Convertible Preferred Stock, dated as of August 28, 2002, (c) Certificate of Amendment to Restated Certificate of Incorporation, dated February 14, 2003, and (d) Certificate of Designation for Series B Convertible Preferred Stock, dated as of March 6, 20033.2
    
    
    (2)
    
    
    Amended and Restated By-Laws of the Company4.1
    
    
    (2)
    
    
    Specimen Stock Certificate10.1A
    
    
    (3)
    
    
    1996 Stock Incentive Plan, as amended10.1B
    
    
    **
    
    
    Form of stock option agreement (for employees and officers) under 1996 Stock Incentive Plan10.1C
    
    
    **
    
    
    Form of stock option agreement (for directors) under 1996 Stock Incentive Plan10.2
    
    
    (3)
    
    
    Part Time Employment Agreement, dated April 1, 2001, by and between the Company and Elizabeth Teng Leary, Ph.D.10.3
    
    
    (4)
    
    
    Office Lease, dated April 23, 1997, by and between Tom Kane and Elsa Kane and Pacific Biometrics, Inc.10.4
    
    
    (5)
    
    
    Asset Purchase Agreement, dated as of June 27, 2002, by and among the Company, PBI-WA and Saigene Corporation10.5
    
    
    (6)
    
    
    Amendment Number One to Asset Purchase Agreement, dated as of August 28, 2002, by and among the Company, Saigene, and PBI-WA10.6
    
    
    (10)
    
    
    Common Stock Purchase Warrant issued by the Company in favor of Source Capital Group, Inc.10.7
    
    
    (6)
    
    
    Consulting Agreement, dated as of August 28, 2002, between Terry M. Giles and the Company
 -39-




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ExhibitNo.
    
    
    
    
    
    Description10.8
    
    
    (7)
    
    
    Amended and Restated Financing Agreement, dated as of October 1, 2002, by and among the Company, Transamerica Technology Finance Corporation, successor in interest to Transamerica Business Credit Corporation, and Saigene Corporation10.9
    
    
    (7)
    
    
    Restructure Agreement, dated as of October 1, 2002, by and among the Company, Transamerica Technology Finance Corporation, successor in interest to Transamerica Business Credit Corporation, and Saigene Corporation10.10
    
    
    (7)
    
    
    Amendment to Warrant Agreements, dated as of October 1, 2002, by and among the Company, Transamerica Technology Finance Corporation, successor in interest to Transamerica Business Credit Corporation, and Saigene Corporation10.11
    
    
    (7)
    
    
    Promissory Note, dated as of October 1, 2002, in the principal amount of $245,000 in favor of Transamerica Technology Finance Corporation10.12
    
    
    (7)
    
    
    Investment Agreement, dated as of December 19, 2002, by and between Saigene Corporation and the Company10.13
    
    
    (3)
    
    
    Settlement Agreement, dated May 31, 2003, by and between Makena Commercentre II, LLC, Makena Partners, the Company, PBI-WA, and Saigene Corporation10.14
    
    
    (3)
    
    
    Promissory Note, dated May 31, 2003, in favor of Makena Commercentre II, LLC, by and between the Company, PBI-WA, and Saigene Corporation10.15
    
    
    (3)
    
    
    Escrow Agreement, dated May 2003, by and between U.S. Bank Trust National Association, the Company, Makena Commercentre II, LLC, and Makena Partners10.16
    
    
    (3)
    
    
    Loan and Security Agreement, dated August 5, 2003, by and between the Company and Franklin Funding, Inc.10.17
    
    
    (3)
    
    
    Option Agreement, dated August 28, 2002, by and between the Company and Saigene Corporation10.18
    
    
    (8)
    
    
    Securities Purchase Agreement, dated May 28, 2004 between the Company and Laurus Master Fund, Ltd.10.19
    
    
    (8)
    
    
    Secured Convertible Term Note, dated May 28, 2004, made by the Company in favor of Laurus Master Fund, Ltd.10.20
    
    
    (8)
    
    
    Master Security Agreement dated May 28, 2004, among the Company, BioQuant, Inc., Pacific Biometrics, Inc., a Washington corporation, PBI Technology, Inc., and Laurus Master Fund, Ltd.10.21
    
    
    (8)
    
    
    Registration Rights Agreement, dated May 28, 2004, between the Company and Laurus Master Fund, Ltd.10.22
    
    
    (8)
    
    
    Common Stock Purchase Warrant, dated May 28, 2004, issued by the Company in favor of Laurus Master Fund, Ltd.10.23
    
    
    (8)
    
    
    Subsidiary Guaranty dated May 28, 2004, among Pacific Biometrics, Inc., a Washington corporation, BioQuant, Inc., and PBI Technology, Inc.10.24
    
    
    (8)
    
    
    Stock Pledge Agreement dated May 28, 2004, between the Company and Laurus Master Fund, Ltd.14.1
    
    
    **
    
    
    Code of Ethics for Financial Officers21.1
    
    
    (9)
    
    
    Subsidiaries of Pacific Biometrics, Inc.23.1
    
    
    **
    
    
    Consent of Grant Thornton LLP31.1
    
    
    **
    
    
    Certification by Ronald R. Helm, Chief Executive Officer31.2
    
    
    **
    
    
    Certification by Michael Carrosino, Chief Financial Officer32.1
    
    
    **
    
    
    Certification by Ronald R. Helm, Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    
    **
    
    
    Certification by Michael Carrosino, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 **
    
    Filed herewith(1)
    
    Incorporated by reference to Exhibits of Registrants Quarterly Report on
Form 10-QSB for the quarter ended March 31, 2003, filed on May 15, 2003.(2)
    
    Incorporated by reference to Exhibits of Registrants Registration
Statement on Form SB-2, Registration No. 333-11551, filed on September 6,
1996.(3)
    
    Incorporated by reference to Exhibits of Registrants Annual Report on
Form 10-KSB for the fiscal year ended June 30, 2003, filed on September
29, 2003.
 -40-




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##### Table of Contents



(4)
    
    Incorporated by reference to Exhibits of Registrants Annual Report on
Form 10-KSB for the fiscal year ended June 30, 1997, filed on September
29, 1997.(5)
    
    Incorporated by reference to Exhibits of Registrants Current Report on
Form 8-K filed on July 3, 2002.(6)
    
    Incorporated by reference to Exhibits of Registrants Current Report on
Form 8-K filed on September 6, 2002.(7)
    
    Incorporated by reference to Exhibits of Registrants Quarterly Report on
Form 10-QSB for the quarter ended December 31, 2002, filed on February 14,
2003.(8)
    
    Incorporated by reference to Exhibits of Registrants Current Report on
Form 8-K filed on June 7, 2004.(9)
    
    Incorporated by reference to Exhibits of Registrants Quarterly Report on
Form 10-QSB for the quarter ended March 31, 2004, filed on May 17, 2004.(10)
    
    Incorporated by reference to Exhibits of Registrants Registration
Statement on Form SB-2, Registration No. 333-116968, filed on June 29,
2004.
  (b)
    
    Reports on Form 8-K  
    
    We filed a Current Report on Form 8-K on June 7, 2004,
reporting our entering into a $2.5 million secured debt financing
with Laurus Master Fund, Ltd.  
    
    We filed a Current Report on Form 8-K on September 2, 2004,
reporting the termination of our management agreement with Saigene. 
 ITEM 14      PRINCIPAL ACCOUNTANT FEES AND SERVICES Information called for by Part III, Item 14, will be included in our proxy
statement relating to our 2004 annual meeting of shareholders, and is
incorporated herein by reference. -41-




---



##### Table of Contents



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, on September 22, 2004. PACIFIC BIOMETRICS, INC.By:
    
    /s/ Ronald R. HelmRonald R. HelmPresident 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 on
the dates indicated. Signature
    
    Capacities
    
    Date/s/ Ronald R. Helm

Ronald R. Helm
    
    Chief Executive Officer, President, and Director
(Principal Executive Officer)
    
    September 22, 2004/s/ Michael Carrosino

Michael Carrosino
    
    Chief Financial Officer and Treasurer
(Principal Financial Officer and
Principal Accounting Officer)
    
    September 21, 2004/s/ Michael L. Hartzmark

Michael L. Hartzmark
    
    Director
    
    September 21, 2004/s/ Terry M. Giles

Terry M. Giles
    
    Director
    
    September 21, 2004/s/ Paul G. Kanan

Paul G. Kanan
    
    Director
    
    September 21, 2004/s/ Richard W.
Palfreyman

Richard W. Palfreyman
    
    Director
    
    September 22, 2004Timothy A. Wudi
    
    Director
 -42-




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##### Table of Contents



PACIFIC BIOMETRICS, INC. Form 10-KSB Annual Report Index to Financial Statements PageReport of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Financial Statements:Consolidated Balance Sheets as of June 30, 2004 and 2003
    
    
    F-3Consolidated Statements of Operations for the years ended June 30, 2004 and 2003
    
    
    F-4Consolidated Statements of Cash Flows for the years ended June 30, 2004 and 2003
    
    
    F-5Consolidated Statement of Stockholders Equity (Deficit) for the years ended
June 30, 2004 and 2003
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7
 F-1




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors
Pacific Biometrics, Inc.
Seattle, Washington We have audited the accompanying consolidated balance sheets of Pacific
Biometrics, Inc. as of June 30, 2004 and 2003 and the related consolidated
statements of operations, cash flows and stockholders equity (deficit) for the
years then ended. 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 standards of the Public Company Accounting Oversight
Board (United States). 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, 2004 and 2003, and the consolidated
results of its operations and its consolidated cash flows for the years then
ended, in conformity with accounting principles generally accepted in the
United States of America. The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 3 to
the financial statements, the Company has experienced significant losses from
operations and has experienced cash flow shortages.
Additionally, the Company has reported deficiencies in working capital and
stockholders equity. These matters, among others, as discussed
in Note 3 to the financial statements, 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 not include any adjustments that might result from the
outcome of this uncertainty. /s/ Grant Thornton LLP Seattle, Washington
September 10, 2004 F-2




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##### Table of Contents



PACIFIC BIOMETRICS, INC.
CONSOLIDATED BALANCE SHEETS
As of June 30, 2004
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    2,941,014
    
    
    $
    440,326Accounts receivable, net of allowance for doubtful
accounts of $22,100 and $23,965, respectively
    
    
    367,449
    
    
    
    466,608Note receivable from related party
    
    
    
    
    
    
    200,000Inventories
    
    
    
    
    
    
    158,104Prepaid expenses and other assets
    
    
    78,999
    
    
    
    73,176Deferred financing cost on secured convertible note  current portion
    
    
    64,500
    
    
    
    Total current assets
    
    
    3,451,962
    
    
    
    1,338,214Property and equipment, net
    
    
    407,548
    
    
    
    433,060Other assets:Deferred financing cost on secured convertible note  long-term portion
    
    
    123,625
    
    
    
    Restricted cash
    
    
    71,395
    
    
    
    71,074Technology assets
    
    
    
    
    
    
    476,874Total assets
    
    $
    4,054,530
    
    
    $
    2,319,222LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    479,446
    
    
    $
    792,420Accrued liabilities
    
    
    647,986
    
    
    
    563,778Dividends payable
    
    
    
    
    
    
    1,558Advances from customers
    
    
    210,922
    
    
    
    310,948Capital lease obligations - current portion
    
    
    48,253
    
    
    
    58,239Note payable to related party - current portion
    
    
    22,183
    
    
    
    123,576Secured convertible note - current portion, net of unamortized fair value
assigned to beneficial conversion feature and warrants of $304,349
    
    
    278,982
    
    
    
    Other notes payable - current portion
    
    
    349,002
    
    
    
    172,392Total current liabilities
    
    
    2,036,774
    
    
    
    2,022,911Capital lease obligations - long term portion
    
    
    160,487
    
    
    
    208,717Note payable to related party - long term portion
    
    
    
    
    
    
    11,775Secured convertible note - long term portion, net of unamortized fair value
assigned to beneficial conversion feature and warrants of $931,133
    
    
    985,536
    
    
    
    Other notes payable - long term portion
    
    
    336,510
    
    
    
    470,696Total liabilities
    
    
    3,519,307
    
    
    
    2,714,099Commitments and contingencies
    
    
    
    
    
    
    Stockholders equity (deficit):Preferred stock, Series A $0.01 par value, 5,000,000 shares
authorized, 1,550,000 shares issued and outstanding, liquidation
preference of $2.00 per share, aggregating $3,100,000
    
    
    15,500
    
    
    
    15,500Preferred stock, Series B $0.01 par value, 5,000,000 shares
authorized, 0 and 33,666.66 shares issued and outstanding
at June 30, 2004 and 2003, respectively, liquidation preference
of $3.00 per share, aggregating $101,000 at June 30, 2003
    
    
    
    
    
    
    337Common stock, $0.01 par value, 30,000,000 shares authorized,
13,048,820 shares issued and outstanding at June 30, 2004
and 9,218,458 issued and outstanding at June 30, 2003
    
    
    302,214
    
    
    
    263,189Additional paid-in capital
    
    
    23,338,016
    
    
    
    20,421,642Accumulated deficit
    
    
    (23,119,084
    )
    
    
    (21,094,843
    )Treasury stock
    
    
    (1,423
    )
    
    
    (702
    )Total stockholders equity (deficit)
    
    
    535,223
    
    
    
    (394,877
    )Total liabilities and stockholders equity (deficit)
    
    $
    4,054,530
    
    
    $
    2,319,222
 The accompanying notes are an integral part of these consolidated financial statements. F-3




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##### Table of Contents



PACIFIC BIOMETRICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended June 30, 2004
    
    2003Revenues
    
    $
    4,801,248
    
    
    $
    5,764,932Laboratory expense and cost of goods sold
    
    
    2,762,849
    
    
    
    2,801,188Gross Margin
    
    
    2,038,399
    
    
    
    2,963,744Operating expenses:Research and product development
    
    
    128,677
    
    
    
    213,635Impairment of technology assets
    
    
    476,874
    
    
    
    Selling, general and administrative
    
    
    3,150,101
    
    
    
    3,837,273Operating loss
    
    
    (1,717,253
    )
    
    
    (1,087,164
    )Other income (expense):Interest expense
    
    
    (155,497
    )
    
    
    (118,399
    )Interest income
    
    
    16,670
    
    
    
    760Other income
    
    
    44,437
    
    
    
    248,723Loss on settlement of note receivable from related party
    
    
    (72,072
    )
    
    
    Gain on troubled debt restructuring
    
    
    
    
    
    
    169,384Reversal of technology license payable
    
    
    
    
    
    
    2,244,040(166,462
    )
    
    
    2,544,508Net earnings (loss) before tax expense
    
    
    (1,883,715
    )
    
    
    1,457,344Tax expense
    
    
    
    
    
    
    Net earnings (loss)
    
    $
    (1,883,715
    )
    
    $
    1,457,344Preferred stock dividend
    
    
    (7,421
    )
    
    
    (1,558
    )Net earnings (loss) applicable to common stockholders
    
    $
    (1,891,136
    )
    
    $
    1,455,786Net earnings (loss) per share:Basic earnings (loss) per share
    
    $
    (0.19
    )
    
    $
    0.20Diluted earnings (loss) per share
    
    $
    (0.19
    )
    
    $
    0.17Weighted average common shares outstanding:Basic
    
    
    10,149,127
    
    
    
    7,315,103Diluted
    
    
    10,149,127
    
    
    
    8,333,313
 The accompanying notes are an integral part of these consolidated financial statements. F-4




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##### Table of Contents



PACIFIC BIOMETRICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended
June 30,
 2004
    
    2003Cash flows from operating activities:Net earnings (loss)
    
    $
    (1,883,715
    )
    
    $
    1,457,344Adjustment to reconcile net earnings to net cash provided by operating activities:Depreciation and amortization
    
    
    121,846
    
    
    
    89,640Interest income on note receivable from related party settled by common stock
    
    
    (16,218
    )
    
    
    Amortization of fair value assigned to beneficial conversion feature and warrants
    
    
    21,746
    
    
    
    Loss on settlement of note receivable from related party
    
    
    72,072
    
    
    
    Gain recognized on troubled debt restructuring
    
    
    
    
    
    
    (169,384
    )Reversal of technology license payable
    
    
    
    
    
    
    (2,244,040
    )Gain on restructuring of capital leases
    
    
    
    
    
    
    (22,018
    )Compensation (income) expense from fair value adjustment to options
    
    
    (35,294
    )
    
    
    181,169Stock options granted at less than fair market value
    
    
    2,584
    
    
    
    Impairment of technology assets
    
    
    476,874
    
    
    
    Changes in assets and liabilities:Accounts receivable, net
    
    
    99,160
    
    
    
    523,702Inventories
    
    
    158,104
    
    
    
    (158,104
    )Prepaid expenses and other assets
    
    
    (6,657
    )
    
    
    24,806Advances from customers
    
    
    (100,026
    )
    
    
    107,530Accounts payable
    
    
    (312,974
    )
    
    
    358,621Accrued liabilities
    
    
    109,049
    
    
    
    287,987Net cash provided by (used in) operating activities
    
    
    (1,293,449
    )
    
    
    437,253Cash flows from investing activities:Purchases of capital equipment
    
    
    (90,959
    )
    
    
    (72,092
    )Net cash used in investing activities
    
    
    (90,959
    )
    
    
    (72,092
    )Cash flows from financing activities:Payments on notes payable
    
    
    (207,576
    )
    
    
    (175,265
    )Payments on notes payable to related parties
    
    
    (113,168
    )
    
    
    (88,346
    )Transfer to restricted cash
    
    
    (321
    )
    
    
    (728
    )Net proceeds from Series B preferred stock
    
    
    
    
    
    
    72,920Net proceeds loan and security agreement
    
    
    250,000
    
    
    
    Payments on capital lease obligation
    
    
    (58,216
    )
    
    
    (8,602
    )Payment of cash dividends
    
    
    (5,685
    )
    
    
    Stock split - fractional share payout
    
    
    
    
    
    
    (6
    )Proceeds
from exercise of stock options and warrants
    
    
    2,963
    
    
    
    4,241Net proceeds from private placement of common stock
    
    
    1,710,599
    
    
    
    Proceeds from secured convertible note payable, net of financing cost
    
    
    2,306,500
    
    
    
    Net cash provided by (used in) financing activities
    
    
    3,885,096
    
    
    
    (195,786
    )Net increase in cash and cash equivalents
    
    
    2,500,688
    
    
    
    169,375Cash and cash equivalents, beginning of year
    
    
    440,326
    
    
    
    270,951Cash and cash equivalents, end of year
    
    $
    2,941,014
    
    
    $
    440,326Cash paid during the year for interest
    
    $
    143,611
    
    
    $
    35,634Non-Cash Activities:Assets purchased under capital lease
    
    $
    
    
    
    $
    253,500Donated equipment
    
    $
    
    
    
    $
    70,766Note payable issued in exchange for capital lease obligation
    
    $
    
    
    
    $
    245,000Common stock issued in exchange for accrued preferred dividends
    
    $
    
    
    
    $
    909,828Warrants and options issued in exchange for deferred compensation and notes payable
    
    $
    
    
    
    $
    933,472Notes payable issued in exchange for accounts payable
    
    $
    
    
    
    $
    75,169Purchase of technology assets and equipment in exchange for common stock (See Note 14)
    
    $
    
    
    
    $
    490,698Preferred stock dividends
    
    $
    7,421
    
    
    $
    1,558Common stock issued and held in trust as security for note payable
    
    $
    
    
    
    $
    6,667Stock issued in conjunction with restructure agreement with prior landlord
    
    $
    
    
    
    $
    16,001Value of common stock received in settlement of note receivable from related party
    
    $
    144,144
    
    
    $
    Shares released from escrow under restructure agreement with prior landlord
    
    $
    833
    
    
    $
    Warrants issued in consideration of issuance costs for private placement
    
    $
    191,477
    
    
    $
    Common stock issued in exchange for Series B preferred stock and accrued dividends
    
    $
    3,294
    
    
    $
    Value allocated to beneficial conversion feature and warrants issued in conjunction with secured
convertible note
    
    $
    1,257,228
    
    
    $
    
 The accompanying notes are an integral part of these consolidated financial statements. F-5




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##### Table of Contents



PACIFIC BIOMETRICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
Years ended June 30, 2004 and June 30, 2003 Series A Preferred
    
    Series B PreferredStock
    

    Stock
    
    Common StockShares
    
    Amount
    
    Shares
    
    Amount
    
    Shares
    
    AmountBalance, July 1, 2002
    
    
    1,550,000
    
    
    $
    15,500
    
    
    
    
    
    
    
    
    
    
    
    1,270,057
    
    
    $
    38,102Net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of common stock for purchase of assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,000,000
    
    
    
    210,000Common stock contributed towards development of
purchased assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,000
    )
    
    
    Issuance of common stock in exchange for accrued preferred
dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150,000
    
    
    
    4,500Issuance of common stock warrants in exchange for deferred
compensation and notes payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Fair value adjustment to options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock issued in conjunction with troubled debt
restructure
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    50,000
    
    
    
    1,500Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    75,141
    
    
    
    2,255Donated equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1 for 3 reverse stock split of common stock and payment
of fractional shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (73
    )
    
    
    (2
    )Proceeds from Series B preferred stock, net of issuance
costs of $28,417
    
    
    
    
    
    
    
    
    
    
    33,666
    
    
    
    337
    
    
    
    
    
    
    
    Common stock issued and held in trust as security for
note payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    666,666
    
    
    
    6,667Common stock issued in conjunction with prior landlord
restructure agreement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,667
    
    
    
    167Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance June 30, 2003
    
    
    1,550,000
    
    
    $
    15,500
    
    
    
    33,666
    
    
    $
    337
    
    
    
    9,218,458
    
    
    $
    263,189Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Fair value adjustment to options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cancellation of common stock released from escrow,
previously held in trust as security for note payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (83,333
    )
    
    
    (833
    )Common stock received from related party in settlement

of note receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (72,072
    )
    
    
    Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31,664
    
    
    
    317Exercise of stock warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,809
    
    
    
    38Stock options granted at less than fair market value
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Board compensation paid by stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Proceeds from common stock, net of issuance costs
of $21,102 and broker commissions of $192,300
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,846,000
    
    
    
    38,460Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of common stock and $0.84 in cash in exchange for
Series B preferred stock and accrued dividends payable
    
    
    
    
    
    
    
    
    
    
    (33,666
    )
    
    
    (337
    )
    
    
    104,294
    
    
    
    1,043Fair value of warrants issued to lender in conjunction with
secured convertible note payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Fair value of beneficial conversion feature on secured
convertible note payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance June 30, 2004
    
    
    1,550,000
    
    
    $
    15,500
    
    
    
    
    
    
    $
    
    
    
    
    13,048,820
    
    
    $
    302,214
   [Continued from above table, first column(s) repeated] Additional
    
    
    
    
    
    TotalTreasury
    
    Paid-in
    
    Accumulated
    
    StockholdersStock
    
    Capital
    
    Deficit
    
    Equity (Deficit)Balance, July 1, 2002
    
    
    
    
    
    $
    17,939,666
    
    
    $
    (22,552,187
    )
    
    $
    (4,558,919
    )Net earnings
    
    
    
    
    
    
    
    
    
    
    1,457,344
    
    
    
    1,457,344Issuance of common stock for purchase of assets
    
    
    
    
    
    
    281,400
    
    
    
    
    
    
    
    491,400Common stock contributed towards development of
purchased assets
    
    
    (702
    )
    
    
    
    
    
    
    
    
    
    
    (702
    )Issuance of common stock in exchange for accrued preferred
dividends
    
    
    
    
    
    
    905,328
    
    
    
    
    
    
    
    909,828Issuance of common stock warrants in exchange for deferred
compensation and notes payable
    
    
    
    
    
    
    933,472
    
    
    
    
    
    
    
    933,472Fair value adjustment to options
    
    
    
    
    
    
    181,169
    
    
    
    
    
    
    
    181,169Common stock issued in conjunction with troubled debt
restructure
    
    
    
    
    
    
    21,000
    
    
    
    
    
    
    
    22,500Exercise of stock options
    
    
    
    
    
    
    1,986
    
    
    
    
    
    
    
    4,241Donated equipment
    
    
    
    
    
    
    70,766
    
    
    
    
    
    
    
    70,7661 for 3 reverse stock split of common stock and payment
of fractional shares
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    (6
    )Proceeds from Series B preferred stock, net of issuance
costs of $28,417
    
    
    
    
    
    
    72,583
    
    
    
    
    
    
    
    72,920Common stock issued and held in trust as security for
note payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,667Common stock issued in conjunction with prior landlord
restructure agreement
    
    
    
    
    
    
    15,834
    
    
    
    
    
    
    
    16,001Preferred stock dividends
    
    
    
    
    
    
    (1,558
    )
    
    
    
    
    
    
    (1,558
    )Balance June 30, 2003
    
    $
    (702
    )
    
    $
    20,421,642
    
    
    $
    (21,094,843
    )
    
    $
    (394,877
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (1,883,715
    )
    
    
    (1,883,715
    )Fair value adjustment to options
    
    
    
    
    
    
    (35,294
    )
    
    
    
    
    
    
    (35,294
    )Cancellation of common stock released from escrow,
previously held in trust as security for note payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (833
    )Common stock received from related party in settlement
of note receivable
    
    
    (721
    )
    
    
    (2,897
    )
    
    
    (140,526
    )
    
    
    (144,144
    )Exercise of stock options
    
    
    
    
    
    
    1,583
    
    
    
    
    
    
    
    1,900Exercise of stock warrants
    
    
    
    
    
    
    1,025
    
    
    
    
    
    
    
    1,063Stock options granted at less than fair market value
    
    
    
    
    
    
    2,583
    
    
    
    
    
    
    
    2,583Board compensation paid by stock options
    
    
    
    
    
    
    24,840
    
    
    
    
    
    
    
    24,840Proceeds from common stock, net of issuance costs
of $21,101 and broker commissions of $192,300
    
    
    
    
    
    
    1,672,139
    
    
    
    
    
    
    
    1,710,599Preferred stock dividends
    
    
    
    
    
    
    (7,421
    )
    
    
    
    
    
    
    (7,421
    )Issuance of common stock and $0.84 in cash in exchange for
Series B preferred stock and accrued dividends payable
    
    
    
    
    
    
    2,588
    
    
    
    
    
    
    
    3,294Fair value of warrants issued to lender in conjunction with
secured convertible note payable
    
    
    
    
    
    
    573,266
    
    
    
    
    
    
    
    573,266Fair value of beneficial conversion feature on secured
convertible note payable
    
    
    
    
    
    
    683,962
    
    
    
    
    
    
    
    683,962Balance June 30, 2004
    
    $
    (1,423
    )
    
    $
    23,338,016
    

    
    $
    (23,119,084
    )
    
    $
    535,223
 The accompanying notes are an integral part of these consolidated financial statements. F-6




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PACIFIC BIOMETRICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Basis of Presentation Pacific Biometrics, Inc., a Delaware corporation (PBI or the Company),
provides specialty reference laboratory services to the pharmaceutical and
diagnostics industries. The Company was incorporated in Delaware in May 1996.
The Company conducts its business primarily through its wholly owned
subsidiary, Pacific Biometrics, Inc., a Washington corporation (PBI-WA). The
Companys other wholly owned subsidiaries include PBI Technology, Inc., a
Washington corporation, and BioQuant, Inc., a Michigan corporation. On August 28, 2002, the Company, and its wholly-owned subsidiary, PBI-WA,
consummated an asset purchase transaction pursuant to an Asset Purchase
Agreement, dated as of June 27, 2002, as amended (collectively, the Asset
Purchase Agreement), with Saigene Corporation, a Delaware corporation
(Saigene), providing for the purchase by PBI-WA of certain technology,
intellectual property and equipment in connection with certain DNA
amplification and cell viability and related technologies and processes.
Pursuant to the Asset Purchase Agreement, as consideration for the purchased
assets, the Company issued to Saigene 6,541,430 shares, and to certain of
Saigenes designees an additional 458,570 shares, of the Companys common
stock, par value $.01 per share (the Common Stock). See
Note 14-Related Party Transactions for further details. The Company had previously been engaged in the development and
commercialization of non-invasive diagnostics to improve the detection and
management of chronic diseases. Due to a lack of significant resources, the
Company has suspended such activities for the foreseeable future. The Company
has developed two patented platform technologies that permit the use of sweat
and saliva as diagnostic fluids. Except for the revenues from laboratory
services, nominal revenues have been generated from the Companys products. In
prior years, the Company was considered to be a development stage enterprise,
but since the laboratory services now constitute the majority of the Companys
commercial efforts, the Company is no longer considered to be in the
development stage. 2. Summary of Significant Accounting Policies Principles of Consolidation These consolidated financial statements include consolidated financial
position, results of operations, and statement of stockholders equity and cash
flows of Pacific Biometrics, Inc. and its wholly-owned subsidiaries Pacific
Biometrics, Inc., a Washington corporation (PBI-WA), PBI Technology, Inc., a
Washington corporation, and BioQuant, Inc., a Michigan corporation. All
material intercompany balances and transactions have been eliminated in the
accompanying consolidated financial statements.. Cash and Cash Equivalents Cash and cash equivalents consist of highly liquid investments with an original
maturity of three months or less when purchased. Accounts Receivable Accounts receivable are stated at amounts due from and billed to customers net
of an allowance for doubtful accounts. Credit is extended based on evaluation
of a customers financial condition, and collateral is not required. In
determining the adequacy of the allowance, management identifies specific
receivables for which collection is not certain and estimates the potentially
uncollectible amount based on the most recently available information. The
Company writes off accounts receivable when they are determined to be
uncollectible, and payments subsequently received on such receivables are
credited to the allowance for doubtful accounts. For the years ended June 30,
2004 and 2003, respectively, the Company wrote off $1,865 and $1,578 of
accounts receivable deemed uncollectible. Inventories Inventories consist of supplies purchased in advance of being used for the
related laboratory services they support. The laboratory services, and the
related supplies used in performing those services, are recognized as revenue
and F-7




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##### Table of Contents



expense, respectively, in the period that the laboratory services are
performed. Inventories are stated at lower of cost or market; cost is
determined using the first-in, first-out method. Restricted Cash During 1997, in connection with the signing of an operating lease for
laboratory and office facilities in Seattle, Washington, the Company was
required to set aside $100,000 as a security deposit, throughout the term of
the lease. This amount has been reduced to $71,395 as of June 30, 2004 and is
recorded as restricted cash on the accompanying consolidated balance sheet. Long Lived Assets Property and equipment are recorded at cost. Depreciation is provided using
the straight-line method over the useful lives of the related assets, which
range from three to five years. Leasehold improvements are amortized over the
shorter of the estimated useful life of the improvements or the remaining term
of the lease. 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. In accordance with the Financial Accounting Standards Boards Statements of
Financial Accounting Standards Statement No. 144  Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS 144),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. Technology Assets PBI Technology, Inc., a wholly owned subsidiary of the Company, has been
established to hold certain technologies and intellectual property, including
isothermal DNA amplification method (LIDA), Cell Viability technology, and
Saliva Sac®. In connection with the Asset Purchase Agreement, (see Note 14), the Company
acquired from Saigene a DNA technology platform called LIDA (Logarithmic
Isothermal DNA Amplification). LIDA is a chemistry designed to rapidly
replicate DNA. The Company also acquired from Saigene another technology
relating to Cell Viability, a chemistry platform that can distinguish a live
cell from a dead cell. Applications for this Cell Viability technology could
include antibiotic susceptibility testing, sterility testing and environmental
monitoring in the water and beverage industries. The Companys technology assets currently still require additional development
prior to commercialization and their future value as well as the timing of
their ongoing development is dependent upon additional capital being available
to fund continuing research and development. (See Note 3.) The SalivaSac® is a proprietary patented product of the Company that collects
and processes saliva for medical diagnostic purposes. As of June 30, 2004, the Companys periodic assessment of the impairment issues
on the technology assets led the Company to conclude that the assets should be
written off. The Company considered its ability to recover the asset from
undiscounted cash flows of the related operations in light of reductions in
both its general as well as research and development workforce in the second
and third fiscal quarters (which was then considered to be temporary, but which
has since become more extended), an inability to secure a licensing or other
partnership arrangement to date for the intangible assets, combined with the
inability to obtain financing specifically for further development of the
intangible assets to date. While the Company obtained equity and debt funding
for its general operations in May 2004 and its private placement in March 2004,
and while the Company intends to continue to pursue development efforts,
partnership, licensing or other means to realize the value of the intangible
assets, management believes that current conditions have changed such that the
value of these assets should now be considered less likely to be recovered in
the near term, and should be written off in accordance with SFAS 144.
Accordingly, the Company wrote off the entire balance of $476,874 of technology
assets to operations as Impairment of technology assets as of June 30, 2004. F-8




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##### Table of Contents



Beneficial Conversion Feature In accordance with Financial Accounting Standards Board (FASB) Emerging Issues
Task Force Issue (EITF) No. 98-5 and FASB EITF No. 00-27, using the relative
fair value method of Accounting Principles Board Opinion 14 (APB 14), the
Company recorded a beneficial conversion feature (BCF) related to the issuance
of convertible debt that has conversion features at fixed rates that are
in-the-money when issued and recorded the value allocated to warrants issued
with those instruments. The BCF for the convertible instrument and value
allocated to warrants are measured and recognized by allocating a
portion of the proceeds to additional paid-in capital with an offset to
discount on the convertible instrument. For convertible debt and
related warrants, the recorded discount is amortized
as interest expense using the effective interest method over the life of the
debt. 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 The Company recognizes deferred tax assets and liabilities based on differences
between the financial reporting and tax bases of assets and liabilities using
the enacted tax laws and rates that are expected to be in effect when the
differences are expected to be recovered. The Company provides a valuation
allowance for deferred tax assets due to the uncertainty of realization. Financial Instruments The carrying amounts of cash and cash equivalents approximate fair value due to
the short-term maturities of these instruments. The carrying value of the
Companys secured convertible note is recorded net of the unamortized fair
value assigned to beneficial conversion feature and warrants, representing its
estimated fair value. (See Note 8.) The carrying value of the Companys other
debt approximates their estimated fair values because the rates of interest on
the debt approximate current interest rates for similar obligations with like
maturities. Stock-Based Compensation The Company has a stock-based employee compensation plan, which is described
more fully in Note 11. The Company applies APB Opinion 25, Accounting for
Stock Issued to Employees, and related interpretations in accounting for its
plan. The Company has adopted the disclosure-only provisions of SFAS No. 123 
Accounting for Stock-Based Compensation. In August 2002, in conjunction with
deferred compensation agreements with senior executives, the Company granted
183,917 stock options and 117,624 warrants to purchase common stock at $0.51
per share which expire in August 2012. (See Note 14  Related Party
Transactions - Deferred Compensation Agreements with Senior Executives.) These
stock options and warrants were granted in exchange for amounts otherwise due
the senior executives. During the years ended June 30, 2004 and 2003,
respectively, the Company granted 996,400 and 0 incentive-based stock options
under incentive compensation plans. Had compensation cost been determined
based on the fair value of stock options granted in a manner consistent with
the method promulgated by SFAS No. 123, the Companys net earnings and earnings
per share would have been changed to the pro forma amounts below: F-9




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##### Table of Contents



Years Ended June 30,2004
    
    2003Net earnings (loss), as reported
    
    $
    (1,883,715
    )
    
    $
    1,457,344Adjust: Total stock-based employee compensation expense
determined under fair value based method for all awards, net
of related tax effects
    
    
    260,304
    
    
    
    93,798Pro forma net earnings (loss)
    
    $
    (2,144,019
    )
    
    $
    1,363,546Net earnings (loss) per share:Basic-as reported
    
    $
    (0.19
    )
    
    $
    0.20Diluted  as reported
    
    $
    (0.19
    )
    
    $
    0.17Basic-pro forma
    
    $
    (0.21
    )
    
    $
    0.19Diluted-pro forma
    
    $
    (0.21
    )
    
    $
    0.16
 To estimate compensation expense, the Company uses the Black-Scholes
option-pricing model and assumptions deemed reasonable by management. The
following assumptions were used to compute the fair value of option grants for
the year ended June 30: 2004
    
    2003Expected volatility
    
    
    186
    %
    
    
    304
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %Risk-free interest rate
    
    
    3.83
    %
    
    
    3.83
    %Expected life
    
    10 years
    
    10 years
 Stock Split On January 10, 2003, the Companys Board of Directors approved a one-for-three
reverse stock split of the Companys common stock. The reverse split was
subsequently approved by the stockholders of the Company and became effective
on March 14, 2003. All shares and per share calculations set forth herein
reflect the one-for-three reverse stock split. Revenue Recognition The Company recognizes revenue in the period that the related services are
performed and collectibility is reasonably assured. Currently, the Company
derives substantially all of its revenues from laboratory services. Service
contracts generally take the form of fixed-price contracts. Under fixed-price
contracts, revenue is recognized as services are performed, with performance
generally assessed using output measures, such as units-of-work performed to
date as compared to the total units-of-work contracted. Changes in the scope
of work generally result in a renegotiation of contract pricing terms.
Renegotiated amounts are not included in net revenues until earned, and
realization is assured. Advance payments on service contracts are deferred and
recognized as revenue in the period the related services are performed.
Estimates of costs to complete are made, as appropriate, to provide for losses
expected on contracts. Costs are not deferred in anticipation of contracts
being awarded, but instead are expensed as incurred. All out-of-pocket costs
are included in total revenues and expenses. Research and Development Expenses Expenditures for research and development are expensed as incurred. Earnings Per Share Basic earnings per share is based upon the weighted average number of common
shares outstanding. Diluted earnings per share is computed on the basis of the
weighted average number of common shares outstanding plus the effect of
outstanding stock options and warrants using the treasury stock method and
the effect of preferred stock on an as-converted basis. All per share
calculations exclude treasury shares, and shares held in trust as security for
a note payable. Net earnings applicable to common stockholders includes
cumulative dividends on the convertible F-10




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##### Table of Contents



preferred stock of $7,421 for the year
ended June 30, 2004 (through conversion of the Series B preferred stock into
common stock, effective May 31, 2004) and $1,558 for the year ended June 30,
2003. The components of basic and diluted earnings per share were as follows for the
years ended June 30: 2004
    
    2003Net earnings (loss) (A)
    
    $
    (1,883,715
    )
    
    $
    1,457,344Preferred stock dividend
    
    
    (7,421
    )
    
    
    (1,558
    )Net earnings (loss) applicable to common shareholders (B)
    
    $
    (1,891,136
    )
    
    $
    1,455,786Weighted average number of outstanding shares of common
stock (C)
    
    
    10,149,127
    
    
    
    7,315,103Diluted, weighted average number of outstanding shares of
common stock and common stock equivalents (D)
    
    
    10,149,127
    
    
    
    8,333,313Earnings (loss) per share:Basic (B/C)
    
    $
    (0.19
    )
    
    $
    0.20Diluted (A/D)
    
    $
    (0.19
    )
    
    $
    0.17
 As of June 30, 2004, options to purchase 1,281,396 shares of common stock and
warrants to purchase 1,457,729 shares of common stock were outstanding, but
were not included in the computation of diluted earnings (loss) per share
because the effect would be anti-dilutive. In addition, 1,550,000 shares of
Series A Preferred Stock convertible into 516,667 shares of common stock, were
also not included in the computation of diluted earnings (loss) per share
because the effect would be anti-dilutive. In June 2004, the holders of the
Series B Preferred Stock exchanged their Series B Preferred Stock and accrued
dividends into 104,294 shares of common stock, effective May 31, 2004. Prior
to that date, the Series B Preferred Stock was convertible into 33,666 shares
of common stock. Accordingly, as of June 30, 2004, there were no
outstanding shares of Series B Preferred Stock, and no further
shares of common stock into which it would be convertible. As of June 30, 2003, options to purchase 281,111 shares of common stock and
warrants to purchase 339,472 shares of common stock were outstanding, of which
209,947 and 257,929, respectively, were included in the computation of diluted
earnings per share after giving effect to the treasury stock method. In
addition, 1,550,000 shares of Series A Preferred Stock and 33,666.66 shares of
Series B Preferred Stock convertible into 516,667 and 33,666 shares of common
stock, respectively, were included in the computation of diluted earnings per
share. Use of Estimates In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America (U.S. GAAP), management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. Risks and Uncertainties The Companys securities were delisted from the Nasdaq Stock Market in 1999.
The stock currently is quoted on the OTC Bulletin Board in the over-the-counter
market under the symbol PBME. New Accounting Pronouncements In May 2003, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 150 (SFAS No. 150), Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity, which establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. SFAS No. 150 requires that an issuer classify a financial instrument
that is within the scope of SFAS No. 150 as a liability (or an asset in some
circumstances), many of which were previously classified as equity. On October
29, 2003, the FASB voted to defer the provisions of paragraphs 9 and 10 of SFAS
No. 150 as they apply to mandatorily redeemable noncontrolling interests. We
adopted the non-deferred provisions of SFAS No. 150 effective July 1, 2003
which had no material impact on our financial F-11




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##### Table of Contents



position or results of
operations. We do not anticipate that the adoption of these provisions will
have a material impact on our financial position or results of operations. 3. Managements Plans The Company had a net loss in 2004. Although the Company had net earnings in
2003, it experienced a net loss from operations. The Company has historically
experienced recurring losses from operations and has had cash flow shortages.
While the Company currently has a positive working capital position, it has
significant amounts of notes payable and other liabilities, and minimal
stockholders equity. Historically, the Company has had deficiencies in
working capital and stockholders equity and has had significant amounts of
current and past due debt. These matters raise substantial doubt about the
Companys ability to continue as a going concern. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty. Management has taken steps to revise its operating and financial requirements,
which it believes are sufficient to provide the Company with the ability to
continue in existence for the near term. These steps include expansion of
business development efforts, and raising $2.5 million in gross proceeds from a
secured debt financing effective May 2004 and approximately $1.9 million in
gross proceeds from a private placement of common stock that closed in March
2004. Prior, the Company also renegotiated contractual commitments with
Transamerica Business Corporation and entered into a Loan and Security
Agreement whereby the Company borrowed $250,000 through November 2003 (See Note
16). Even after the aforementioned steps, the Company still has significant debts
and claims that need to be settled. The Company will continue to review its
operating and financial requirements and attempt to settle outstanding debts
with cash generated from its operations, with stock, and/or with technology
assets. There can be no assurance that the Company will be successful in these
negotiations and may have to seek protection from creditors under the
bankruptcy laws. These financial statements have been prepared on a going concern basis and no
potential adjustments that may be required as a result of a potential inability
to continue as a going concern have been recorded. 4. Concentration of Credit Risk One customer, Pfizer, Inc., individually accounted for approximately 36% and
76% of the Companys total revenues in fiscal 2004 and 2003, respectively, and
another customer, Procter & Gamble Pharmaceuticals, Inc., accounted for
approximately 40% and 2%, respectively. Revenues from the Companys five
largest customers represented approximately 86% and 88% of total revenues in
fiscal 2004 and fiscal 2003, respectively. As of June 30, 2004 and 2003,
respectively, approximately 39% and 80% of the Companys accounts receivable
balance was from the two customers that collectively represented approximately
76% and 78% of the Companys total revenues during fiscal 2004 and fiscal 2003. 5. Property and Equipment Property and equipment consists of the following at June 30: 2004
    
    2003Laboratory equipment
    
    $
    714,027
    
    
    $
    648,407Computer equipment
    
    
    169,938
    
    
    
    156,609Office furniture and equipment
    
    
    63,539
    
    
    
    63,539Leasehold improvements
    
    
    73,541
    
    
    
    61,531Total property and equipment
    
    
    1,021,045
    
    
    
    930,086Less: accumulated depreciation and amortization
    
    
    613,497
    
    
    
    497,026Net property and equipment
    
    $
    407,548
    
    
    $
    433,060
 At June 30, 2004 and 2003, respectively, these amounts included assets under
capital leases of $358,856 and $358,856, and related accumulated amortization
of $179,727 and $119,030. In December 2002, the Company wrote-off approximately $497,000 of
fully-depreciated equipment. F-12




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##### Table of Contents



6.
    
    Accounts Payable and Accrued Liabilities Accrued liabilities consist of the following at June 30: 2004
    
    2003Accrued payroll and related payroll taxes
    
    $
    86,974
    
    
    $
    137,490Accrued consulting expense (See Note 14)
    
    
    95,000
    
    
    
    100,000Accrued vacation
    
    
    78,884
    
    
    
    74,650Accrued commissions
    
    
    91,902
    
    
    
    55,313Accrued board of directors fees
    
    
    92,785
    
    
    
    50,000Accrued professional services
    
    
    83,877
    
    
    
    47,500Accrued supply expense reimbursement under
Saigene Management Agreement (See Note 14)
    
    
    17,996
    
    
    
    30,941Accrued fees due to PBRF (See Note 14)
    
    
    7,835
    
    
    
    9,602Other
    
    
    92,733
    
    
    
    58,282$
    647,986
    
    
    $
    563,778
 During fiscal 2003, the Company reassessed certain then existing liabilities
which had been recorded in prior years. As a result of this review, for
amounts that were believed to no longer be valid liabilities, the Company wrote
off certain old accounts payable and accruals of approximately $206,000 and an
old lease obligation of approximately $22,000. The write off of the accounts
payable and lease obligation resulted in, and was recorded as, approximately
$228,000 of other income in the year ended June 30, 2003.  7.
    
    Capital Lease Obligations The Company leases laboratory and other equipment under capital lease
arrangements. The obligations under capital leases have interest rates ranging
from approximately 7.5% to 11% and mature at various dates through 2008.
Annual future minimum lease payments for years subsequent to June 30, 2003 are
as follows: 2005
    
    $
    62,2532006
    
    
    62,2532007
    
    
    62,2532008
    
    
    47,5092009
    
    
    7,112Total minimum payments
    
    
    241,380Less: amount representing interest
    
    
    (32,640
    )Obligations under capital leases
    
    
    208,740Less: current portion
    
    
    48,253Long term portion
    
    $
    160,487
 In December 2002, the Company restructured a capital lease obligation of
approximately $470,000 with Transamerica Business Credit Corporation
(Transamerica), exchanging it for 50,000 shares of restricted common stock
and a promissory note for $245,000. Title to the previously leased assets,
subject to security interest retained by Transamerica, was conveyed to the
Company as part of the restructuring. Saigene and the Company are co-makers on
the promissory note. A gain of $169,384 was recognized on this debt
restructure during fiscal 2003.  8.
    
    Notes Payable Laurus Debt Investment Effective May 28, 2004, the Company entered into a financing arrangement with
Laurus Master Fund, Ltd., a New York City based investment fund (Laurus). The
financing consisted of a $2.5 million secured convertible note with a term of
three years. In connection with the financing, the Company also issued Laurus a
warrant to purchase up to 681,818 shares of common stock at an exercise price
of $1.25, exercisable at any time prior to May 28, 2011. The note bears
interest at an initial rate equal to the prime rate (which was four percent
(4%) as of June 30, 2004) plus two percent (2%) for a total of six percent
(6%), subject to reduction on a month to month basis if certain specified
conditions are met. Under the terms of the note, the Company is obligated to make monthly payments
of accrued interest beginning July 1, 2004 and, commencing December 1, 2004,
monthly payments of principal in the amount of $83,333.33. F-13




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##### Table of Contents



For any cash payments made on the note, the Company is required to pay an
amount equal to 102% of the principal amount due. In addition, the Company can
prepay the note at any time upon payment of an amount equal to 130% of the
then-outstanding principal balance, plus accrued and unpaid interest. Laurus has the option at any time to convert any or all of the outstanding
principal and accrued and unpaid interest on the note into shares of common
stock at an initial conversion price of $1.06 per share. In addition, for each
monthly payment under the note, Laurus will be obligated to convert a portion
of the monthly payment into common stock at the applicable conversion price, if
certain specified conditions are met. The initial note conversion price ($1.06 per share) is subject to certain
anti-dilution adjustments, including full ratchet anti-dilution if the Company
issues convertible or equity securities at a price per share less than the
conversion price. As security for the obligations to Laurus, the Company and each of its
subsidiaries granted a blanket security interest in all of their respective
assets to Laurus, and the Company entered into a stock pledge with Laurus for
the capital stock in each of its subsidiaries. If an event of default occurs,
as specified in the agreement, 130% of the unpaid principal balance on the
note, plus accrued interest, shall become immediately due and Laurus shall be
entitled to payment of a default interest rate of 1.5% per month on all amounts
due under the note. In addition, Laurus will be entitled to specified
remedies, including remedies under the Uniform Commercial Code. The Company is obligated to register with the SEC for resale the shares of
common stock that are issuable upon conversion of the note and upon exercise of
the warrant. Under the registration rights agreement, the Company is obligated
to (a) file a registration statement with the SEC on or before July 3, 2004
(which the Company did on June 29, 2004), and (b) use best efforts to have the
registration statement declared effective not later than October 1, 2004. The
Company will be required to maintain the effectiveness of the registration
statement for up to three years from the closing date. If the Company fails to
comply with the registration obligations, Laurus will be entitled to certain
specified remedies, including monetary liquidated damages. In particular, for
each 30 days (or such pro rated number of days) that the Company is out of
compliance with the registration obligations, the Company will be subject to a
liquidated damage assessment of 2% of the outstanding principal amount of the
note. In conjunction with the financing, the Company paid fees of $87,500 to the
manager of Laurus, $29,500 for Laurus legal and due diligence expenses and
$1,500 to the escrow agent. In addition, the Company paid placement agent fees
of $75,000 to its broker, Source Capital Group, Inc. The Company recorded the
aggregate of these fees of $193,500 as deferred financing costs, which is being
amortized to general and administrative expenses over the life of the note. At
June 30, 2004, the unamortized balance of the deferred financing costs was
$188,125. The Company also recorded discounts to the secured convertible note
of $683,962 and $573,266, respectively, representing the value of the
beneficial conversion feature and value allocated to the 681,818 warrants. At
June 30, 2004, of the total $1,257,228 initially recorded discounts, $21,746
had been amortized as interest expense, and $1,235,482 remained unamortized and
will be amortized over the remaining life of the secured convertible note or
upon earlier conversion, using the effective interest method. The balance due
under the secured convertible note is shown net of the remaining unamortized
discount on the accompanying balance sheet. The Company estimated the
valuation of the beneficial conversion feature and the warrant for 681,818
shares in accordance with EITF 00-27, Application of Issue No. 98-5 to Certain
Convertible Instruments, using the Black-Scholes pricing model and other
assumptions deemed reasonable by management. For any amounts of outstanding principal and accrued and unpaid interest owing
on the note that are converted into shares of the Companys common stock, the
Company is also obligated to pay its broker additional placement agent fees of
4% of the amount converted, for maximum additional fees of up to $100,000. In
addition, upon conversion of any amounts owing under the note, the Company is
obligated to issue warrants for up to a maximum of 181,818 shares of common
stock to its broker, in the amount of 8% of amounts converted, at an exercise
price of $1.25 per share, exercisable for five years. Accordingly, as of May
28, 2004, the Company granted its broker such a warrant for 181,818 shares of
common stock, to be exercisable only as and to the extent that principal and
accrued interest under the note is converted into common stock. The warrant
shall become vested and exercisable in the amount of 8% of the dollar amount of
any principal and interest under the note that is converted into common stock,
divided by $1.10. F-14




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##### Table of Contents



Loan and Security Agreement with Franklin Funding On August 5, 2003, the Company entered into a Loan and Security Agreement (the
Loan Agreement) under which the Company borrowed $250,000 during the first
and second quarters of fiscal 2004. Amounts borrowed under the Loan Agreement
bear interest at 17.64% and are amortized over 36 months, with monthly payments
beginning September 2003 and a final balloon payment due at maturity on August
5, 2006, and are secured by specific equipment. In the event of default, among
other remedies, the lender may declare the entire amount under the Loan
Agreement to be immediately due and payable, and may take possession of the
equipment provided as security. Pursuant to the terms of the Loan Agreement,
the Company granted to the lender warrants to purchase 25,000 shares of common
stock (at the rate of 5,000 per $50,000 borrowed, with exercise prices as of
the date of borrowing), consisting of warrants for 5,000 shares at $1.10 per
share, 5,000 shares at $1.00 per share, 10,000 shares at $0.95 per share, and
5,000 shares at $0.85 per share. Note Payable to Related Party The Company had the following note payable to a related party as of June 30: 2004
    
    2003Promissory note to Saigene, original
principle of $223,697, dated August 28,
2002, 8% interest, monthly payments of
$10,000 including interest until paid in
full
    
    $
    22,183
    
    
    $
    135,351Less: Current Portion
    
    
    22,183
    
    
    
    123,576$
    
    
    
    $
    11,775
 Other Notes Payable The Company had the following other notes payable as of June 30: 2004
    
    2003Secured Convertible Note Payable:Secured convertible note to Laurus,
secured by all assets, interest at prime
plus 2% (subject to reduction upon
specified conditions), monthly payments of
$83,333 plus interest beginning December
1,2004, due May 1, 2007
    
    $
    2,500,000
    
    
    $
    Less: Unamortized fair value assigned to
beneficial conversion feature and warrants
    
    
    (1,235,482
    )
    
    
    1,264,518
    
    
    
    Less: Current Portion
    
    
    (278,982
    )
    
    
    $
    985,536
    
    
    $
    Other Notes Payable:Loan and security agreement, secured by
specific equipment, 17.64% interest,
monthly payments of $8,709, balloon
payment of $30,000 due August 2006
    
    $
    201,925
    
    
    $
    Promissory note to prior landlord, secured
by common stock held in escrow, 10%
interest, quarterly payments of $25,000,
due July 31, 2005 (See Note 13)
    
    
    240,624
    
    
    
    311,404Promissory note to creditor, 9% interest,
monthly payments of $4,000, balloon
payment of $7,912 due December 2004
    
    
    27,416
    
    
    
    71,484Note payable to Transamerica, secured by
security interest in previously leased
assets, 8% interest October 1, 2003 to
February 28, 2004, 14.123% beginning March
1, 2004, monthly payments including
interest of $2,000 through February 28,
2004 and $14,500 thereafter, due October
1, 2005
    
    
    202,547
    
    
    
    241,265Demand notes payable, 18% interest,
current monthly payments of interest only
    
    
    13,000
    
    
    
    18,935685,512
    
    
    
    643,088Less: Current Portion
    
    
    349,002
    
    
    
    172,392$
    336,510
    
    
    $
    470,696
 F-15




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##### Table of Contents



Aggregate maturities of notes payable (at face value, gross of the unamortized
fair value assigned to beneficial conversion feature and warrants related to
the secured convertible note financing with Laurus) are approximately as
follows for the years ending June 30: 2005
    
    $
    954,5162006
    
    
    1,298,3622007
    
    
    954,817Thereafter
    
    
    $
    3,207,695
  9.
    
    Preferred and Common Stock Series A Preferred Stock The Companys Series A Convertible Preferred Stock (the Series A Preferred
Stock) is convertible into shares of the Companys Common Stock at the option
of the holders at any time on a three-for-one basis, subject to adjustment for
stock splits, dividends and the like. Initially, the Series A Preferred Stock
provided for a cumulative cash dividend payable quarterly in arrears at an
annual rate of 8%; however, the Series A Preferred Stock no longer carries a
mandatory dividend. On August 28, 2002, in connection with the Asset Purchase
Agreement (see Note 15  Related Party Transactions), the holders of Series A
Preferred Stock consented to an amendment of the Certificate of Designation
with respect to the rights and preferences of the Series A Preferred Stock,
which included elimination of future dividends and converted approximately
$910,000 in accrued dividends thereon into an aggregate of 150,000 shares of
Common Stock. The Company has the right to force conversion of the Series A
Preferred Stock in the event the price per share of the Common Stock is $6.00
or more for 20 consecutive trading days. The Series A Preferred Stock has a
liquidation preference of $2.00 per share along with full participation as a
common stockholder on an as-converted basis. The Company has agreed to use
commercially reasonable efforts to effect the registration of the Common Stock
into which the Series A Preferred Stock is convertible. Series B Preferred Stock In March through July 2003, the Company sold 33,666.66 shares of Series B, 8%
convertible, cumulative redeemable $0.01 par value preferred stock at $3.00 per
share (the Series B Preferred Stock or Series B) for total net proceeds of
$72,920. The Series B Preferred Stock was convertible at the holders
discretion on a one for one basis into Common Stock, and at the Companys
discretion beginning March 11, 2004 if the Companys Common Stock were to trade
for at least $5.00 per share for at least 10 trading days. In conjunction with
the Series B offering, the placement agent received a $20,000 non-refundable
advance against a non-accountable expense allowance of 2% of Series B Preferred
Stock sold and a sales commission of 8% totaling $8,080. Pursuant to the terms
of the offering, the placement agent received 3,366 warrants to purchase common
stock at $3.00 per share, expiring January 31, 2005. In May 2004, the Company offered to the holders of Series B preferred stock the
opportunity to voluntarily convert all of their shares of Series B preferred
stock, and all accrued and unpaid dividends thereon through May 31, 2004
(approximately $3,295), into shares of common stock. The conversion ratio was
3 shares of common stock for one share of Series B preferred stock, plus 1
share of common stock for each $1 in accrued and unpaid dividends. In June
2004, the holders of the Series B preferred stock accepted the Companys
conversion offer and canceled their Series B preferred stock and accrued and
unpaid dividends in exchange for 104,294 shares of common stock, and
approximately $1 in cash for payment of fractional shares. As of June 30,
2004, there were no shares of Series B preferred stock issued and outstanding. Common Stock In November 2003, the Company initiated a best efforts private placement of
unregistered common stock through registered broker-dealers. Through the
closing of the private placement in March 2004, the Company sold 3,846,000
shares of unregistered common stock and received gross proceeds of $1,923,000.
In accordance with the terms of the private placement, the broker dealers
receive a commission of 10% of the gross proceeds. Also, for every 10 shares of
unregistered common stock sold, the broker dealers received a warrant covering
one share of unregistered common stock at $0.60 per share expiring on December
31, 2006. Accordingly, the Company recorded broker F-16




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##### Table of Contents



dealer commissions of $192,300 and issued warrants covering 384,600 shares of
unregistered common stock exercisable at $0.60 per share, and incurred $20,101
of legal expenses related to the private placement, which have been netted
against gross proceeds of the private placement.  10.
    
    Income Taxes The income tax expense reconciled to the tax expense computed at the statutory
rate were approximately as follows during the years ended June 30: 2004
    
    2003Tax expense (benefit) computed at federal statutory rate
    
    $
    (640,000
    )
    
    $
    495,000Permanent differences
    
    
    2,000
    
    
    
    2,000Valuation
allowance (tax benefit of recognizing prior year net operating loss
carryforward)
    
    
    638,000
    
    
    
    (497,000
    )$
    
    
    
    $
    
 Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Companys net deferred tax assets are approximately as follows at June
30: 2004
    
    2003Net deferred tax asset:Net operating loss carryforward
    
    $
    4,624,000
    
    
    $
    4,183,000Research and experimentation credit
    
    
    324,000
    
    
    
    324,000Impairment of technology assets
    
    
    162,000
    
    
    
    Effect of stock option variable pricing
    
    
    50,000
    
    
    
    62,000Accrued liabilities
    
    
    55,000
    
    
    
    44,000Allowance for bad debts
    
    
    8,000
    
    
    
    8,000Depreciation and amortization
    
    
    67,000
    
    
    
    31,0005,290,000
    
    
    
    4,652,000Less valuation allowance
    
    
    (5,290,000
    )
    
    
    (4,652,000
    )$
    
    
    
    $
    
 The net operating loss
carryforward and valuation allowance for the year ended June 30,
2003 have been changed to properly reflect the effect of book to tax
differences, primarily related to the reversal of technology license
payable in fiscal 2003. Accordingly, as of June 30, 2003, both
the net operating loss carryforward and valuation allowance were each
increased by approximately $872,000 to approximately $4,183,000 and
$4,652,000, respectively. The aforementioned change had no effect on
the consolidated financial statements as of, and for the years ended
June 30, 2004 and 2003. At June 30, 2004, operating loss carryforwards of approximately $14 million
expiring through 2024 are available to offset future taxable income. For
financial reporting purposes, a valuation allowance of approximately $5,290,000
has been recognized to offset the deferred tax asset due to the uncertainty of
future utilization of net operating loss carryforwards and realization of other
deferred tax assets. For the year ended June 30, 2004, the valuation allowance
was increased by approximately $638,000. Internal Revenue Code Section 382 places a limitation on the amount of taxable
income that can be offset by carryforwards after a change in control (generally
greater than 50% change in ownership). As a result of these provisions,
utilization of the NOL and credit carryforwards may be limited.  11.
    
    Stock Option Plan 1996 Stock Incentive Plan In July 1996, the Company adopted a Stock Incentive Plan (the Plan) with
333,333 shares of common stock reserved for issuance under this Plan. In
November 1997, the stockholders approved that the number of shares reserved for
issuance would be increased to 666,667. On September 17, 2003, the Companys
Board of Directors approved an amendment to the Plan to increase the number of
shares of common stock authorized for issuance under the Plan to 1,800,000
shares (the Amendment), subject to stockholder approval. On September 25,
2003, the holder of a majority of the voting rights represented by the
Companys outstanding common stock executed a written consent approving the
Amendment. F-17




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##### Table of Contents



Options granted under the 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 a range of immediately to five years. As of June 30, 2004,
486,940 shares of common stock remained available for future grant under the
Plan. In November 2003, the Compensation Committee of the Board of Directors
recommended and the Board of Directors ratified a compensation program for
outside Directors of the Company (the Director Compensation Program) covering
the period from August 2002 to September 30, 2003. In conjunction with the
Director Compensation Program, on November 12, 2003, the Board of Directors
granted to each of the Companys three outside directors stock options for
10,000 shares of common stock at an exercise price of $0.8075 per share, and
one Director elected to receive payment of 30,761 shares of common stock at
$0.8075 per share in lieu of cash. As of November 12, 2003, the closing market
value of the Companys common stock was $0.85 per share, while the strike price
of the options granted of $0.8075 was determined in consideration of the market
value of the common stock over the prior service period. The Company recorded
$2,582 of expense related to the granting of the 60,761 options at $0.0425 per
share below market value. On May 3, 2002, the Board of Directors voted to reduce the exercise price of
all then outstanding options to $0.06 per share. No initial expense was
recognized on this repricing, as the new exercise price equaled the market
value of the Companys stock on that date. For the periods ended June 30, 2004
and 2003, in accordance with accounting for options under variable pricing
rules, the Company recognized approximately $35,000 and $(181,000),
respectively, in compensation income (expense) representing the decrease
(increase) in the market price of the Companys common shares to $1.03 and
$1.40 per share. The Company will recognize compensation expense in the future
for all outstanding repriced stock options if the market value of the common
stock increases, and will recognize income if the market value decreases. The following is a summary of the activity in the Plan for the years ended June
30, 2004 and 2003: Shares Under OptionNumber
    
    Weighted Average
    
    Weighted AverageOf
    
    Exercise Price per
    
    Fair Value ofShares
    
    share
    
    Options GrantedOptions outstanding
at June 30, 2002
    
    
    203,529
    
    
    $
    0.06Granted
    
    
    183,917
    
    
    
    0.51
    
    
    $
    0.51Exercised
    
    
    (75,139
    )
    
    
    0.06Terminated
    
    
    (31,196
    )
    
    
    0.06Options outstanding
at June 30, 2003
    
    
    281,111
    
    
    
    0.35Granted
    
    
    1,086,340
    
    
    
    0.81
    
    
    $
    0.81Exercised
    
    
    (31,664
    )
    
    
    0.06Terminated
    
    
    (54,391
    )
    
    
    0.06Options outstanding
at June 30, 2004
    
    
    1,281,396
    
    
    $
    0.77
 The weighted average contractual life remaining of options outstanding at June
30, 2004 is approximately 9.3 years. In August 2003, in conjunction with
deferred compensation agreements with senior executives, the Company granted
183,917 stock options and 117,624 warrants to purchase common stock at $0.51
per share which expire in August 2012. As of June 30, 2004, outstanding options had exercise periods which expired
over the following time periods: F-18




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##### Table of Contents



Weighted AverageRemaining LifeExercise Price
    
    Number Outstanding
    
    (in years)
    
    Number Exercisable$    0.06
    
    
    11,139
    
    
    
    1.1
    
    
    
    11,139$    0.51
    
    
    183,917
    
    
    
    8.4
    
    
    
    183,917$0.8075
    
    
    60,761
    
    
    
    9.6
    
    
    
    60,761$    0.81
    
    
    1,010,579
    
    
    
    9.8
    
    
    
    318,622$    0.90
    
    
    6,000
    
    
    
    9.6
    
    
    
    6,000$    1.01
    
    
    3,000
    
    
    
    9.8
    
    
    
    3,000$    1.75
    
    
    6,000
    
    
    
    9.6
    
    
    
    6,0001,281,396
    
    
    
    9.5
    
    
    
    589,439
 12. Stock Purchase Warrants During 1997, the Company issued 17,143 warrants to an institutional lender in
conjunction with a capital equipment leasing facility. Each warrant entitled
the holder to purchase one share of the Companys common stock at an exercise
price of $7.89. In December of 1998 the Company reduced the exercise price to
$1.50 as part of a debt forbearance agreement. In August 1999, the Company
reduced the exercise price of these warrants to $0.27 per share. In February
2000, the Company further reduced the exercise price of 13,333 of these
warrants to $0.1875 per share. The warrants expire on December 31, 2007. No
discount was recorded for the value of the warrants because the amount was not
material. In January 1999, the principals of the landlord of the Companys previously
occupied Lake Forest facility advanced the Company $15,000 and received 15,000
warrants related to the advance. Each warrant entitled the holder to purchase
one share of the Companys common stock at an exercise price of $1.005. The
warrants expired on March 13, 2004. A discount of approximately $23,400 was
recorded for the value of the warrants. In March 1999, a bank lender was issued 31,008 warrants in conjunction with a
previous credit agreement. Each warrant entitled the holder to purchase one
share of the Companys common stock at an exercise price of $0.8062. In
conjunction with anti-dilution provisions of the warrants (as triggered by the
November 1999 repricing of warrants to an institutional lender discussed
below), these warrants were replaced with like warrants to purchase 139,536
shares of common stock at $0.1875 per share. The warrants expired on March 13,
2004. A discount of $26,047 was recorded for the value of the warrants. In August 1999, the Company issued 50,169 warrants to an institutional lender
as part of a debt forbearance agreement. Each warrant entitles the holder to
purchase one share of the Companys common stock at an exercise price of $0.27.
Also, as noted above, in August of 1999 the Company reduced the exercise price
to $0.27 on 13,333 of the 17,142 previously issued warrants as part of the debt
forbearance agreement. The warrants expire on December 31, 2007. No discount
was recorded for the value of the warrants because the amount was not material. In November 1999, the Company reduced the exercise price from $0.27 to $0.1875
on the 50,169 warrants and 13,333 of the 17,142 warrants referred to above. The
reduced price was in excess of the fair value of the Companys per share stock
price at that time. In August 2002, in connection with the Asset Purchase Agreement, the Company
converted deferred compensation notes, deferred compensation liabilities and
other accrued compensation due to senior executives and other current and
former employees into 117,624 warrants and 183,917 options to purchase shares
of Common Stock (see Note 14  Related Party Transactions  Deferred
Compensation Agreements with Senior Executives). Each warrant and option
entitled the holder to purchase one share of the Companys common stock at an
exercise price of $0.51. The warrants expired on March 13, 2004. In July 31, 2003, in connection with the sale and issuance of our Series B
preferred stock (see Note 9  Preferred and Common Stock  Series B Preferred
Stock) the Company granted our placement agent warrants to purchase 3,366
shares of common stock at an exercise price of $3.00 per share, expiring
January 31, 2005. No discount was recorded for the value of the warrants
because the amount was not material. In August 2003, in connection with a Loan and Security Agreement, the Company
granted warrants to Franklin Funding to purchase 25,000 shares of common stock,
consisting of warrants for 5,000 shares at $1.10 per share, 5,000 shares at
$1.00 per share, 10,000 shares at $0.95 per share, and 5,000 shares at $0.85
per share (see Note 8  F-19




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##### Table of Contents



Notes Payable  Loan and Security Agreement). No discount was recorded for the
value of the warrants because the estimated fair value would not have been
material to the financial statements taken as a whole. The warrants expire at
the rate of 5,000 shares on each of August 13, August 18, September 2, November
1 and November 14, 2013. In March 2004, in connection with a private placement of common stock, the
Company granted warrants to the placement agents covering 384,600 shares of
unregistered common stock at $0.60 per share (see Note 9  Preferred and Common
Stock  Common Stock). The warrants expire on December 31, 2006. In June 2004, in connection with a $2.5 million secured convertible note, the
Company granted the lender a warrant to purchase up to 681,818 shares of common
stock at an exercise price of $1.25 per share, exercisable at any time prior to
May 28, 2011. In addition, we issued to our broker a five-year warrant,
exercisable as and to the extent that any amounts owing under the convertible
note are converted into common stock, for up to 181,818 shares of common stock
at an exercise price of $1.25 per share (see Note 8  Notes Payable  Laurus
Debt Investment). The following is a summary of outstanding warrants as of June 30, 2004 and
2003: Weighted AverageExercise Price
    
    Exercise Priceper Share
    
    per Share
    
    NumberWarrants outstanding at June 30, 2003
    
    $
    0.1875 - $1.005
    
    
    $
    0.34
    
    
    
    339,472Warrants outstanding at June 30, 2004
    
    $
    0.1875 - $3.00
    
    
    $
    0.97
    
    
    
    1,457,728
 Included in the 1,457,728 outstanding warrants at June 30, 2004 are warrants to
purchase 181,818 shares of common stock which have been issued, but are not
currently exercisable as described above. 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 $256,997 and $253,292 for the years ended June 30,
2004 and 2003, respectively. Future minimum lease payments are as follows: Year Ended June 30,2005
    
    
    
    240,5752006
    
    
    
    225,2642007
    
    
    
    231,1922008
    
    
    
    78,052$
    775,083
 Promissory Note to Prior Landlord In May 2003, the Companys prior landlord, the Company, and Saigene entered
into a settlement agreement confirming amounts due the prior landlord
(including attorneys fees of $20,541) of $320,315 as of May 31, 2003, and
granting the landlord 16,667 shares of Common Stock. Under the terms of the
settlement agreement, the Company and Saigene jointly and severally entered
into a promissory note dated May 31, 2003 to the landlord for $320,315,
providing for an initial payment of $10,000 by June 30, 2003, and quarterly
payments of $25,000 thereafter until the promissory note is paid in full. The
promissory note bears interest at 10% and provides that all amounts due under
the promissory note shall be paid no later than the first to occur of: an
equity funding by either Saigene or the Company of at least $4 million; sale of
the Companys laboratory; sale of PBI-WA; or, July 31, 2005. In conjunction
with the promissory note and settlement agreement, and to secure performance
thereunder, the Company also entered into an escrow agreement, providing for
666,666 shares of the Companys common stock to be held in escrow for the
benefit of the landlord. The shares held in escrow will be released to the
Company for cancellation at the rate of 83,333 for each calendar quarter that
the landlord receives at least $50,000 in payment under the terms of the
promissory note. Upon payment of the promissory note in full, all remaining
shares will be F-20




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returned to the Company. As of June 30, 2004, the balance of the promissory
note was $240,624 and the Company had made payments sufficient to release
83,333 of escrow shares to the Company, which shares have been cancelled and
are no longer outstanding. Reversal of Technology License Payable in Fiscal 2003 In December 1997, the Company entered into an exclusive license agreement and
supply agreement with Sudormed, Inc. The technology licensed from Sudormed was
the basis for the Companys development of its sweat and saliva products. Due
to a lack of funding and the Companys failure to obtain FDA approval for the
products, all development efforts relating to the products were suspended in
August 1998. The license agreement required the Company to make a $1.6 million
license payment in December 1998, which was subsequently extended to March
1999. In May 1999, Sudormed terminated the license agreement and the supply
agreement due to the Companys failure to make the $1.6 million license
payment. The Minnesota Mining and Manufacturing Company (3M) manufactured certain of
the products that Sudormed supplied to the Company pursuant to the supply
agreement. As described above, Sudormed terminated both the license agreement
and the supply agreement in May 1999 due to the Companys failure to make
required payments. 3M subsequently foreclosed upon certain assets of Sudormed
and became a party in possession of secured property of Sudormed. In May 2000,
3M notified the Company that, in its capacity as a secured party in possession
of the Sudormed assets, it demanded payment in full of the $1.6 million plus
accrued interest and fees due under the Sudormed license agreement. The
Company disputes 3Ms demand, and will vigorously defend any action that 3M may
bring. The Company has not had any correspondence or communication with 3M
since 2000, and to managements knowledge no action has been filed. During fiscal 2003, the Company reassessed its potential liability to 3M.
Management believes based on advice from legal counsel that any claims by 3M
under the license agreement are now barred by the applicable statute of
limitations (having expired in the third and fourth quarters of fiscal 2003),
and accordingly that the likelihood of liability to 3M is remote. The Company
previously reserved on its balance sheet a contingent liability in the amount
of $2,240,040, representing the full potential amount owing under the
technology license plus accrued interest and fees. At June 30, 2003, the
Company reversed the reserve and removed the contingent liability from the
balance sheet. 14. Related Party Transactions Asset Purchase Transaction On June 27, 2002, the Company, and its wholly-owned subsidiary, PBI-WA, entered
into an Asset Purchase Agreement, as amended by Amendment Number One to Asset
Purchase Agreement, dated as of August 28, 2002 (collectively, the Asset
Purchase Agreement) with Saigene Corporation, a Delaware corporation
(Saigene), providing for the purchase by PBI-WA of certain technology,
intellectual property and equipment assets in connection with certain DNA
amplification and cell viability and related technologies and processes. On
August 28, 2002, pursuant to the Asset Purchase Agreement, as consideration for
the purchased assets, the Company issued to Saigene 6,541,430 shares, and to
certain of Saigenes designees an additional 458,570 shares, of the Companys
common stock, par value $.01 per share. Of the shares issued to Saigene,
333,333 shares were held in escrow in the event that the Company was required
to satisfy certain anti-dilution protections granted to one of Saigenes
designees (the Anti-Dilution shares), and 333,333 shares were held in escrow
in the event that the Company incurred any liabilities with respect to any of
Saigenes creditors that had not consented to the purchase transaction (the
Saigene Creditor shares). In accordance with the terms of the respective
escrow agreements, the Anti-Dilution shares were released back to Saigene as of
August 28, 2003, as the anti-dilution provisions were not triggered, and the
Saigene Creditor shares were released back to Saigene as of August 28, 2004,
without any such creditor liabilities having been incurred by the Company.
Additionally, PBI-WA issued two promissory notes in favor of Saigene (and
guaranteed by the Company) in the principal amounts of $223,697 and $219,109,
respectively. The first note, which has a remaining principal balance of
$22,183 at June 30, 2004, is payable at the rate of $10,000 per month and bears
interest at the rate of 8% per annum until fully paid; provided, however, that
in the event the Company obtains equity financing in the minimum amount of $6
million, then this note will become immediately due and payable. The second
note matured in 12 months and bore interest at the annual rate of 12% per
annum, however, this second note, along with $9,721 of accrued interest, was
subsequently forgiven by Saigene as part of a F-21




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December 2002 contribution toward the development and commercialization of
certain technologies discussed below. Upon consummation of the transactions
contemplated in the Asset Purchase Agreement, Saigene owned approximately 77%
of the Common Stock of the Company. In connection with the asset purchase transaction, PBI-WA and Saigene executed
an Option Agreement whereby PBI-WA may purchase certain additional assets of
Saigene (the Option Assets) in exchange for, at PBI-WAs election, either
$5,147,118 in cash or the issuance by the Company of an additional 1,715,706
shares of Common Stock and the assumption of certain additional liabilities
associated with such transferred assets. The Companys option under the Option
Agreement expires on August 28, 2003, extended by one day for each day that
Saigene allows certain encumbrances to remain on the Option Assets subsequent
to October 31, 2002. As of September 2004, the encumbrances were still on the
Option Assets. Further, in connection with the consummation of the transactions contemplated
by the Asset Purchase Agreement, (1) the parties executed an amendment to the
Management Agreement dated September 15, 1999 (the Management Agreement),
whereby Saigene will continue to operate the PBI-WA laboratory in exchange for
monthly payments by the Company to Saigene equal to $90,000, which arrangement
may be terminated by either the Company or Saigene upon 30 days prior written
notice, and which arrangement was amended as of June 18, 2003 to reduce the
management fee to $70,000 per month effective July 1, 2003, amended February 1,
2004 to reduce the management fee to $40,000 per month effective February 1,
2004, amended as of May 11, 2004 to reduce the management fee to $20,000 per
month effective June 15, 2004, and amended subsequent to yearend (as of July
22, 2004) to terminate the management agreement effective August 31, 2004; (2)
the Purchase Agreement dated June 22, 2000, relating to the purchase by Saigene
of the laboratory operations of PBI-WA was terminated; (3) the holders of the
Companys Series A Convertible Preferred Stock, par value $0.01 per share,
consented to an amendment of the Certificate of Designation with respect to the
rights and preferences of the Preferred Stock and converted all accrued
dividends thereon into an aggregate of 150,000 shares of Common Stock; (4) the
Company entered into consulting arrangements with Paul Kanan and Terry Giles;
(5) the Company converted $933,472 of deferred compensation and notes payable
to warrants and options to purchase an aggregate of 301,541 shares of Common
Stock; and (6) each of Saigene, Paul Kanan, Terry Giles and Burkhalter,
Michaels, Kessler & George, LLP, agreed, for a period of one year, not to sell
any Company securities, except at a price per share equal to or greater than
$3.00, in a private transaction, in a transaction solely for estate planning,
or, in the event the Company completes a private financing, at a per share
price equal to or greater than the per share price set forth in such private
financing. On December 19, 2002, toward the development and commercialization of certain
technologies acquired by the Company from Saigene in connection with the Asset
Purchase Agreement, Saigene entered into an agreement with the Company in which
Saigene: (i) executed a promissory note in the principal amount of $200,000 in
favor of the Company payable on or before September 30, 2003, at Saigenes
election, either in cash or by the tender of shares of common stock of the
Company currently held in Saigenes name at an attributed value equal to the
greater of $3.00 per share or the average trading price of our common stock
over a five day period (which promissory note and accrued interest was repaid
in September 2003 by tender of 72,072 shares of the Companys common stock and
$2 in cash), (ii) forgave a creditor obligation assumed by the Company from
Saigene pursuant to the Asset Purchase Agreement in the aggregate amount of
approximately $229,000, (iii) settled a credit obligation in the aggregate
amount of approximately $150,000, and (iv) surrendered to the Company for
cancellation 10,000 shares of Company common stock that had been held in
Saigenes name. As a result of the December 19, 2002 agreement, an adjustment
to decrease the value of the acquired technology assets in the approximate
amount of $430,000 was recorded. On September 30, 2003, the Companys $200,000 note receivable from Saigene,
along with accrued interest of $16,218, was settled by tender of 72,072 shares
of the Companys common stock and $2 in cash. The Company recorded a $72,072
loss on settlement of the note plus accrued interest, representing the
difference between the carrying value as based on the attributed $3.00 per
share value of the stock at the December 19, 2002 date of the note, and the
$2.00 per share trading price of the stock at September 30, 2003. In accordance
with the par value method, additional paid-in capital was reduced by $2,897,
the original amount recorded for the shares, and treasury stock was valued at
the par value of $.01 per share or $721 for the 72,072 shares. The excess
amount of $140,526 was recorded against accumulated deficit as required by the
par value method. F-22




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Consulting Agreements On August 28, 2002, in connection with the Asset Purchase Agreement, the
Company entered into a consulting agreement with Terry M. Giles, a former
director of the Company and greater than 5% stockholder. Pursuant to the
consulting agreement, the Company agreed to engage Mr. Giles as a consultant
and to pay Mr. Giles compensation of $10,000 per month until the conversion of
Mr. Giles shares of Series A Preferred Stock into Common Stock, and until such
shares are either (a) registered pursuant to an effective registration
statement, or (b) deemed tradable pursuant to Rule 144. Pursuant to the
consulting agreement, the first years payments (totaling $120,000) will be
accrued, and paid over the following four years (i.e., an additional $2,500 per
month over 48 months beginning September 2003), with any accrued amounts due
being payable upon termination of the consulting agreement, if terminated
earlier than 60 months. As of June 30, 2004, accrued expenses and accounts
payable included $132,154 related to this consulting agreement. On August 28, 2002, in connection with the Asset Purchase Agreement, the
Company entered into a consulting agreement with Paul G. Kanan, a director and
former officer of the Company. Pursuant to the consulting agreement, the
Company agreed to engage Mr. Kanan as a consultant for a period of 12 months
beginning September 1, 2002, and to pay Mr. Kanan $3,000 per month. The
consulting arrangement was extended on a month-to-month basis for up to 12
additional months until such time as the shares of Common Stock held by Mr.
Kanan have been registered for resale pursuant to an effective registration
statement filed with the SEC. The consulting agreement was not extended beyond
the additional 12 months, and expired on August 31, 2004. As of June 30, 2004,
$27,000 was included in accounts payable as owing to Mr. Kanan under this
consulting arrangement. Co-Maker Notes Payable In September 2001 and November 2001, respectively, the Company was named as a
co-maker with Saigene on promissory notes for $150,000 and $100,000. In
December 2002, in conjunction the Investment Agreement between Saigene and the
Company, Saigene assumed all liabilities of the Company under these notes.
These notes payable are not recorded on the Companys financial statements as
of June 30, 2004, however, the Company may have a contingent liability on these
notes should Saigene not make required payments thereunder. (See Note 14 
Related Party Transactions  Asset Purchase Transaction) Deferred Compensation Agreements with Senior Executives The Company had entered into deferred compensation agreements with four of its
senior executives. The agreements provided that a specified portion of their
salaries (from prior to fiscal 2002) be deferred until they elected to receive
the deferred amount. During prior years, certain deferred compensation amounts
had been converted to promissory notes bearing annual interest at 7% and
payable on demand. These notes were included with Notes Payable to Related
Parties in prior years on the accompanying consolidated balance sheet and, with
accrued interest totaled $552,171 as of June 30, 2002. The Company made no
interest payments on these amounts since September of 1998. Additional
deferred compensation, not converted to notes, of $295,368 to senior executives
and other current and former employees was also due as of June 30, 2002. On
August 28, 2002, in connection with the Asset Purchase Agreement, the Company
converted all deferred compensation notes, deferred compensation liabilities,
and $85,933 of other accrued compensation into warrants and options to purchase
an aggregate of 301,541 shares of Common Stock. (see Note 14  Related Party
Transactions  Asset Purchase Transaction). Pacific Biometrics Research Foundation The Company is affiliated with Pacific Biometrics Research Foundation (PBRF),
one of five laboratories in the CDC (Centers for Disease Control) /NHLBI
sponsored Cholesterol Reference Method Laboratory Network. PBRF is organized
as a non-profit organization corporation under Section 501(c)(3) of the
Internal Revenue Code. The Company provides laboratory testing services,
invoicing and collection services in connection with PBRFs service offerings.
In consideration for this arrangement, the Company receives 85% of the revenues
generated through the testing services offered by PBRF. For the fiscal years
ended June 30, 2004 and 2003, the Company recorded approximately $37,000 and
$60,000, respectively, in revenues related to services provided for PBRF. As
of June 30, 2004 and 2003, the Company had approximately $9,600 and $40,000,
respectively, in accounts receivable from PBRF. F-23




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15. Retirement Plan The Company has a 401(k) Plan, which had fallen out of compliance with the
Internal Revenue Service (the IRS) due to prior year filing delinquencies.
During fiscal 2004, the Company engaged a consultant to assist in regaining
compliance through the IRS Delinquent Filer Voluntary Compliance Program (the
DFVCP) and filed the returns which had been delinquent. The Company believes
that it is now in compliance with the IRS reporting regulations, and, under the
DFVCP, will incur no additional material expenses associated with late filings.
The Company made no matching contributions to the 401(k) Plan during fiscal
2004 or 2003. F-24