UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   Form 10-QSB

           (Mark One)
               |X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934

               For the quarterly period ended September 30, 2004

               |_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
                                THE EXCHANGE ACT

           For the transition period from _________ to ____________.

                          Commission File number 0-935

                           MOLECULAR DIAGNOSTICS, INC.
        (Exact Name of Small Business Issuer as Specified in Its Charter)

         Delaware                                               36-4296006
-------------------------------                            ------------------
(State or Other Jurisdiction of                             (I.R.S. Employer
 Incorporation or Organization)                            Identification No.)

                       414 North Orleans Street, Suite 502
                                Chicago, IL 60610
                    (Address of Principal Executive Offices)

                                 (312) 222-9550
                (Issuer's Telephone Number, including Area Code)

                                       N/A
         (Former Name, Former Address and Former Fiscal Year, if Changed
                               Since Last Report)

      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 issuer was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes |X| No |_|

      The number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:

Common Stock, $0.001 par value, AT OCTOBER 31, 2004: 101,178,125
                                                    ------------

Transitional Small Business Disclosure Format (Check One): Yes |_|   No |X|

<PAGE>

                           Molecular Diagnostics, Inc.
                         Quarterly Report on Form 10-Qsb
                               September 30, 2004

                                Table of contents

<TABLE>
<CAPTION>
                                                                                  Page
                                                                                  ----
<S>                                                                                <C>
Part I. -- Financial Information

Item 1.  Financial Statements

        a) Consolidated Balance Sheets -- September 30, 2004 (unaudited) and
           December 31, 2003......................................................  3

        b) Consolidated Statements of Operations - Three and nine months ended
           September 30, 2004 and 2003 (unaudited)................................  4

        c) Consolidated Statements of Cash Flows -- Nine months ended
           September 30, 2004 and 2003 (unaudited)................................  5

        d) Notes to Consolidated Financial Statements (unaudited).................  6

Item 2.  Management's Discussion and Analysis or Plan of
         Operation................................................................  20

Item 3.  Controls and Procedures..................................................  26

Part II. -- Other Information

Item 1.  Legal Proceedings........................................................  26

Item 2.  Unregistered Sales of Securities and Use of Proceeds.....................  26

Item 3.  Defaults upon Senior Securities..........................................  28

Item 4.  Submission of Matters to a Vote of Security Holders......................  28

Item 5.  Other Information........................................................  29

Item 6.  Exhibits.................................................................  29

SIGNATURES........................................................................  29

EXHIBIT INDEX.....................................................................  30
</TABLE>


                                       2
<PAGE>

Part I. -- Financial Information

Item 1.  Financial Statements

                  MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                                           September 30,    December 31,
                                                                                               2004            2003
                                                                                             --------        --------
                                                                                           (Unaudited)
<S>                                                                                          <C>             <C>
      Assets
Current Assets:
   Cash and cash equivalents .............................................................   $      2        $     --
   Accounts receivables, net of allowance for doubtful accounts of $50 at September 30
      2004 and December 31, 2003 .........................................................         14              26
   Inventories ...........................................................................         75              94
   Prepaid financing costs ...............................................................        108             307
   Prepaid expenses and other current assets .............................................         11               7
                                                                                             --------        --------
      Total current assets ...............................................................        210             434
   Fixed assets, net .....................................................................        363             374
   Licenses, patents and technology, net of amortization .................................      6,533           6,907
                                                                                             --------        --------
      Total assets .......................................................................   $  7,106        $  7,715
                                                                                             ========        ========

      Liabilities and Stockholders' Equity (Deficit)
Current Liabilities:
   Checks issued in excess of amounts on deposit .........................................   $     --        $      5
   Accounts payable ......................................................................      4,219           5,540
   Accrued payroll costs .................................................................      1,320           1,745
   Accrued expenses ......................................................................      1,773           1,401
   Deferred revenue ......................................................................         --              50
   Due to stockholder ....................................................................         38              53
   Lease obligation ......................................................................         96             279
   Notes payable--related parties ........................................................         70           1,092
   Notes payable .........................................................................      4,524           6,099
                                                                                             --------        --------
      Total current liabilities ..........................................................     12,040          16,264
                                                                                             --------        --------

Stockholders' Equity (Deficit):
Preferred stock; $0.001 par value; 10,000,000 shares authorized; 1,132,735 and 2,511,108
   shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively
   (Liquidation value of all classes of preferred stock $9,582,968 at September 30, 2004)       7,840          12,894
Common stock; $0.001 par value; 300,000,000 shares authorized; 89,335,213 and
   45,830,928 shares issued and 89,143,125 and 45,638,840 shares outstanding
   at September 30, 2004 and December 31, 2003, respectively .............................         89              46
Additional paid-in-capital ...............................................................     44,868          29,553
Treasury stock; 192,088 shares at September 30, 2004 and December 31, 2003 ...............       (327)           (327)
Accumulated deficit ......................................................................    (57,358)        (50,673)
Accumulated comprehensive loss--
   Cumulative translation adjustment .....................................................        (46)            (42)
                                                                                             --------        --------
      Total stockholders' equity (deficit) ...............................................     (4,934)         (8,549)
                                                                                             --------        --------
      Total liabilities and stockholders' equity (deficit) ...............................   $  7,106        $  7,715
                                                                                             ========        ========
</TABLE>

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


                                       3
<PAGE>

                           MOLECULAR DIAGNOSTICS, INC.
                      Consolidated Statements of Operations
                    (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                            For the nine months            For the three months
                                                            ended September 30,            ended September 30,
                                                       ----------------------------    ----------------------------
                                                           2004            2003            2004            2003
                                                       ------------    ------------    ------------    ------------
                                                                (Unaudited)                     (Unaudited)
<S>                                                    <C>             <C>             <C>             <C>
Net revenues .......................................   $        195    $        291    $         41    $         59
Operating expenses
Cost of revenues ...................................             25              91              --               2
Research  and development ..........................            716             378             231             112
Selling, general, and administrative expenses ......          4,274           5,224           1,204           2,417
                                                       ------------    ------------    ------------    ------------
         Total operating expenses ..................          5,015           5,693           1,435           2,531
                                                       ------------    ------------    ------------    ------------

Operating loss .....................................         (4,820)         (5,402)         (1,394)         (2,472)

Other income (expense):
Interest expense -related party ....................            (50)            (67)             (2)            (32)
Interest expense ...................................         (1,546)         (2,563)           (409)         (1,309)
Restructuring settlements ..........................            921              --              88              --
Gain on sale of fixed assets .......................             99              --              --              --
Other, net .........................................             10              45              --              38
                                                       ------------    ------------    ------------    ------------
         Total other income (expense) ..............           (566)         (2,585)           (323)         (1,303)
                                                       ------------    ------------    ------------    ------------
Loss from continuing operations before income taxes          (5,386)         (7,987)         (1,717)         (3,775)
Income tax expense .................................             --              --              --              --
                                                       ------------    ------------    ------------    ------------
Loss from continuing operations ....................         (5,386)         (7,987)         (1,717)         (3,775)
Results from discontinued operations ...............             --            (135)             --             (42)
                                                       ------------    ------------    ------------    ------------
 Net loss ..........................................         (5,386)         (8,122)         (1,717)         (3,817)

Preferred stock dividend ...........................           (802)         (1,113)           (232)           (361)
                                                       ------------    ------------    ------------    ------------

Net loss applicable to common stockholders .........   $     (6,188)   $     (9,235)   $     (1,949)   $     (4,178)
                                                       ============    ============    ============    ============

Basic and fully diluted net loss per common share ..   $      (0.09)   $      (0.23)   $      (0.02)   $      (0.11)
                                                       ============    ============    ============    ============

Weighted average number of common shares outstanding     71,054,095      40,191,128      83,374,666      38,858,622
                                                       ============    ============    ============    ============
</TABLE>

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


                                       4
<PAGE>

                           MOLECULAR DIAGNOSTICS, INC.
                      Consolidated Statements of Cash Flows
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                                   Nine months ended
                                                                                     September 30,
                                                                                  ------------------
                                                                                   2004       2003
                                                                                  -------    -------
                                                                                      (Unaudited)
<S>                                                                               <C>        <C>
Operating Activities:
   Net loss ...................................................................   $(5,386)   $(8,122)
   Adjustments to reconcile net loss to net cash used for operating activities:
      Amortization of debt discount ...........................................       905      2,139
      Depreciation and amortization ...........................................       514        683
      Amortization of fees ....................................................       319        350
      (Gain)/loss on sale of fixed assets .....................................       (99)         1
      Fixed assets exchanged for services .....................................        --          8
      Return of fixed assets in exchange for relief of indebtedness ...........       149         --
      Stocks, warrants and options issued to non-employees for services .......     1,158      1,984
      Compensation expense related to stock appreciation rights ...............        --         12
      Changes in assets and liabilities:
         Accounts receivable, net .............................................        12          1
         Inventories ..........................................................        19        262
         Refundable taxes .....................................................        --         11
         Due to stockholder ...................................................       (15)        13
         Prepaid expenses and other current assets ............................      (124)      (468)
         Checks issued in excess of amounts on deposit ........................        (5)        --
         Accounts payable .....................................................    (1,100)       122
         Deposits .............................................................        --        (24)
         Lease obligation .....................................................      (183)        --
         Deferred revenue .....................................................       (50)      (153)
         Accrued expenses .....................................................       343        401
                                                                                  -------    -------
   Net cash used for operating activities .....................................    (3,543)    (2,780)
                                                                                  -------    -------

Investing activities:
   Expenditures in licenses, patents and technology ...........................       (20)        --
   Purchases of fixed assets ..................................................      (187)       (18)
                                                                                  -------    -------
   Net cash used for investing activities .....................................      (207)       (18)
                                                                                  -------    -------

Financing activities:
   Proceeds from issuance of convertible notes ................................     4,236      1,843
   Proceeds from issuance of convertible notes, related parties ...............        --      1,015
   Proceeds from issuance of common stock .....................................       275         --
   Note issued in payment of an expense .......................................       103        339
   Payment of notes payable ...................................................      (890)      (373)
   Proceeds of revolving line-of-credit, net ..................................        --         49
   Proceeds from sale of fixed assets .........................................        28         --
                                                                                  -------    -------
   Net cash provided by financing activities ..................................     3,752      2,873
                                                                                  -------    -------

Effect of exchange rate changes on cash and cash equivalents ..................        --          7
                                                                                  -------    -------

Net increase in cash and cash equivalents .....................................         2         82

Cash and cash equivalents at beginning of period ..............................        --         42
                                                                                  -------    -------

Cash and cash equivalents at end of period ....................................   $     2    $   124
                                                                                  =======    =======

Supplemental disclosure of cash flow information:
Cash paid during the period for:
   Interest ...................................................................   $   135    $    18
Non-cash transactions during the period for:
   Financing costs ............................................................   $ 1,067    $ 1,652
   Preferred stock and cumulative dividends converted into common stock .......   $ 6,353    $ 4,495
</TABLE>

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


                                       5
<PAGE>

                           MOLECULAR DIAGNOSTICS, INC.
                   Notes to Consolidated Financial Statements
                               September 30, 2004
                                   (Unaudited)

Note 1. Organization

      Molecular Diagnostics, Inc. ("MDI" or the "Company") was incorporated as
Ampersand Medical Corporation in Delaware in December 1998 as the successor to
Bell National Corporation ("Bell National"). Bell National was incorporated in
California in 1958, and was the continuing legal entity following its
acquisition of InPath, LLC, a development-stage company engaged in the design
and development of medical instruments and related tests, in December 1998. Bell
National then merged into the Company, which was then operating under the
Ampersand name, in 1999.

      On September 25, 2001, following the Company's acquisition of AccuMed
International, Inc. ("AccuMed") via the merger of AccuMed into a wholly-owned
subsidiary of MDI, the Company changed its corporate name to Molecular
Diagnostics, Inc. in order to better represent its operations and products. The
name change was effected through a merger with a separate wholly-owned
subsidiary. MDI retained its Certificate of Incorporation in the merger, except
as amended to reflect its new name, bylaws and capitalization.

      MDI is a biomolecular diagnostics company engaged in the design,
development and commercialization of cost-effective screening systems to assist
in the early detection of cancer for use around the world. MDI is currently
focused on the design, development and marketing of its InPath(TM) System, and
related image analysis systems. The InPath System and related products are
intended to detect cancer and cancer-related diseases. These products may be
used in a laboratory, clinic, or doctor's office.

      In addition to AccuMed and Oncometrics Imaging Corp., a wholly-owned
subsidiary of AccuMed, MDI had another wholly-owned subsidiary, Samba
Technologies, Sarl ("Samba"). MDI acquired all of the assets of Samba in January
1999 from Unilog Regions, SA for approximately $500,000 in cash. Samba designed,
developed, and marketed web-enabled, software-based systems for image analysis,
image capture, and image transmission and management for clinical and industrial
applications. A majority of reported revenues since inception of MDI were
generated by Samba. Commencing December 20, 2002, Samba operated under the
protection of the French Commercial Court in compliance with the bankruptcy laws
of France. During 2003, MDI was unable to raise sufficient capital to enable it
to provide funds to Samba to meet its obligations. On December 19, 2003, the
French Commercial Court finalized the liquidation sale of Samba's assets. Upon
completion of the bankruptcy liquidation sale, MDI lost all rights and title to
the Samba assets, including Samba software. MDI has reflected the involuntary
liquidation of Samba's assets by the French Commercial Court in its December 31,
2003 financial statements and subsequent financial statements as discontinued
operations.

      The Company has incurred significant operating losses since its inception.
Management expects that significant on-going operating expenditures will be
necessary to successfully implement MDI's business plan and develop, manufacture
and market its products. These circumstances raise substantial doubt about MDI's
ability to continue as a going concern. Implementation of the Company's plans
and its ability to continue as a going concern depend upon its securing
substantial additional financing. During the first nine months of 2004, MDI
raised $4,236,000 and $275,000 through the sale of convertible debt and common
stock, respectively. Management's plans include substantial efforts to obtain
additional capital. Management can give no assurances that funding will be
available to the company on terms acceptable to the company, or at all,
particularly in light of MDI's current financial condition. In addition, the
Company cannot rely on internal sources of liquidity given the current cash flow
from operations. If the Company is unable to obtain adequate additional
financing or generate profitable sales revenues, it may be required to curtail
its product development and other activities and may be forced to cease
operations.

Note 2. Basis of Presentation

      The consolidated financial statements for the periods ended September 30,
2004 and 2003 included herein are unaudited. Such financial statements reflect,
in the opinion of management, all adjustments necessary to present fairly the
financial position and results of operations as of and for the periods indicated
and in order to make the financial statements not misleading. All such
adjustments are of a normal recurring nature, except for the Monsun judgment for
legal fees in the amount of $438,000 as discussed below. These interim results
are not necessarily indicative of the results to be expected for the fiscal year
ending December 31, 2004 or for any other period.


                                       6
<PAGE>

      Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission. These financial
statements should be read in conjunction with the audited financial statements
and the notes thereto included in our Annual Report on Form 10-KSB for the
fiscal year ended December 31, 2003, as filed with the SEC.

Note 3. Summary of Significant Accounting Principles

      The accounting policies and principles management believes are most
critical to aid in understanding and evaluating the Company's reported financial
results include the following:

      Basis of Presentation. The accompanying consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries. All
inter-company balances and transactions have been eliminated in consolidation.

      Use of Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates.

      Revenue Recognition. MDI recognizes revenue in accordance with Staff
Accounting Bulletin No. 104, "Revenue Recognition," when the following criteria
are met: shipment of a product or license to customers has occurred and there
are no remaining Company obligations or contingencies; persuasive evidence of an
arrangement exists; sufficient vendor-specific, objective evidence exists to
support allocating the total fee to all elements of the arrangement; the fee is
fixed or determinable; and collection is probable.

      Revenue from ongoing client maintenance is recognized ratably over the
post-contract support term, which is generally 12 months. Revenue from
prepayments under licenses is recognized over the license period. Revenue from
training services and professional services is recognized when the service is
completed. Revenue from implementation and installation services is recognized
using the percentage of completion method. Implementation and installation
services are generally completed within 120 days. Samba calculated percentage of
completion based on the estimated total number of hours of service required to
complete an implementation project and the number of actual hours of service
rendered. All revenue recognition related to Samba ceased on December 19, 2003
in accordance with the liquidation sale of Samba's assets by the French
Commercial Court.

      Research and Development Costs. Research and development costs are charged
to operations as incurred. MDI conducts a portion of its research activities
under contractual arrangements with scientists, researchers, universities, and
other independent third parties.

      Foreign Currency Translation. The functional currency of MDI's foreign
operations is the local currency. Accordingly, all assets and liabilities are
translated into U.S. dollars using period-end exchange rates, and all revenues
and expenses are translated using average exchange rates during the period. The
amount of foreign currency translation is not material to the results of
operations and the financial position of the Company.

      Other Comprehensive Income (Loss). Translation adjustments related to
MDI's foreign operations are included in other comprehensive loss and reported
separately in stockholders' equity (deficit).

      Loss Per Share. Basic loss per share is calculated based on the
weighted-average number of outstanding common shares. Diluted loss per share is
calculated based on the weighted-average number of outstanding common shares
plus the effect of dilutive common shares. Molecular Diagnostics, Inc.
calculation of dilutive net loss per share excludes potential common shares as
the effect would be antidilutive.


                                       7
<PAGE>

      Restructuring Settlements. Restructuring settlements reflect the
difference between the actual settlement amounts for various litigation and
creditor payment matters and the amounts recorded on the Company's financial
statement as the amount due. For the nine months ended September 30, 2004, MDI
recorded $921,000 in net restructuring settlements.

Note 4. Licenses, Patents, Technology and Goodwill; Impairment

      Licenses, patents, and purchased technology are recorded at their
acquisition cost. Costs to prepare patent filings are expensed when incurred.
Costs related to abandoned patents are written off at the time of abandonment.
Amortization is begun as of the date of acquisition or upon the grant of the
final patent. Costs are amortized over the asset's useful life, which ranges
from two to 17 years.

      The Company has adopted SFAS No. 142, "Goodwill and Other Intangibles,"
which sets forth guidelines for discontinuing periodic goodwill amortization
costs in results of operations and for establishing an annual (or more frequent)
goodwill impairment review and related net realizable value asset write-down
methodology.

      At each annual balance sheet date or whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable, management of the Company evaluates recoverability of such assets.

      Licenses, patents, and technology were as follows (in thousands):

                                                     September 30,  December 31,
                                                         2004           2003
                                                       -------        -------
                                                     (unaudited)

Licenses .....................................         $ 1,033        $ 1,013
Patent costs .................................             133            133
MDI Technology Agreement .....................           7,230          7,230
Dianon Technology Agreement ..................             260            260
                                                       -------        -------
Subtotal .....................................           8,656          8,636
Less accumulated amortization ................          (2,123)        (1,729)
                                                       -------        -------
      Total ..................................         $ 6,533        $ 6,907
                                                       =======        =======

      In 2003, MDI recorded an impairment loss of $283,000. This loss was the
write-off of the full amount of MDI's goodwill recorded on the acquisition of
AccuMed. At December 31, 2003, management evaluated several factors, principally
that contracts and sales relating to the AccuMed products had failed to
materialize, which evaluation indicated that the carrying value of goodwill from
the AccuMed acquisition was impaired and no future cash flows would be realized
relating to the goodwill.

      For the nine months ended September 30, 2004 and 2003, amortization
expense was $394,000 and $484,000, respectively.

Note 5.Accrued Expenses

      Accrued expenses included the following (in thousands):

                                                     September 30,  December 31,
                                                         2004          2003
                                                       ------        ------
                                                     (unaudited)

         Accrued interest ...........................  $  827        $  704
         Accrued interest--related parties ..........      22           115
         Accrued franchise taxes ....................     476           476
         Accrued settlement costs ...................     438            --
         Other accrued expenses .....................      10           106
                                                       ------        ------
         Total ......................................  $1,773        $1,401
                                                       ======        ======


                                       8
<PAGE>

      MDI was delinquent in filing certain federal and state income tax returns
for 2003, 2002 and 2001 and intends to complete the filing requirements as soon
as practicable. The Company does not anticipate a tax liability with respect to
these delinquent corporate tax returns.

      MDI is also delinquent in paying a portion of federal and state employee
and employer payroll taxes for 2001. The Company owed $330,000 and $686,000 as
of September 30, 2004 and December 31, 2003, respectively, including $85,000 and
$258,000, respectively, in assessed and estimated statutory penalties and
interest related to such delinquent payroll taxes. MDI is currently in the
process of communicating with the Internal Revenue Service regarding payment of
the balance due and made a payment of approximately $117,000 on October 20,
2004. The Company has lost all rights of appeal regarding the outstanding
payroll tax liability and could be subject to the seizure of its tangible and
intellectual property in the event a final resolution is not reached with the
Internal Revenue Service or the remaining balance of $213,000 is not paid in
accordance with the schedule agreed upon with the IRS. These amounts were
included in accrued payroll costs in the accompanying balance sheet.

Note 6. Notes Payable--Related Parties

      Notes payable to related parties consisted of (in thousands):

<TABLE>
<CAPTION>
                                                                             September 30,  December 31,
                                                                                  2004          2003
                                                                                  ----          ----
                                                                              (unaudited)

<S>                                                                              <C>           <C>
Northlea Partners, Ltd., $25,000 Promissory Note issued August 6, 2001;
   interest rate 15% per annum ...............................................   $   25        $   25
Northlea Partners, Ltd., $15,000 Promissory Note issued September 20, 2001;
   interest rate 9% per annum ................................................       15            15
Northlea Partners, Ltd., $15,000 Bridge II Convertible Promissory Note issued
   May 1, 2003; interest rate 12% per annum (see description under Bridge II
   Notes in Note 7-Notes Payable for other terms and conditions) .............       15            15
Peter P. Gombrich, $305,667 Bridge II Convertible Promissory Note
   issued December 5, 2003; interest rate 12% per annum (see description under
   Bridge II Notes in Note 7-Notes Payable for other terms and conditions) ...       --           251
Robert Shaw, $25,000 Promissory Note issued September 20, 2001; interest rate
   9% per annum ..............................................................       15            25
Suzanne M. Gombrich, $1,000,000 Convertible Promissory Note issued
   April 2, 2003; interest rate 12% per annum; Due April 2, 2004 (see
   description below for other terms and conditions) .........................       --           761
                                                                                 ------        ------
      Total: .................................................................   $   70        $1,092
                                                                                 ======        ======
</TABLE>

      Suzanne Gombrich Note. On April 2, 2004, the Company repaid the $1,000,000
Convertible Promissory Note due Suzanne M. Gombrich in full and her first
priority security interest in all the Company's assets was released. The Company
paid $936,114 in cash towards principal and accrued interest of $126,114 on the
note. In addition, Mrs. Gombrich agreed to convert the remaining $190,000 into
1,900,000 shares of common stock of the Company upon stockholder approval of an
increase in the number of authorized shares of common stock of the Company. On
July 29, 2004, the Company's stockholders approved such increase and the
1,900,000 shares were issued to Mrs. Gombrich on August 31, 2004 in satisfaction
of her remaining debt.

      Peter Gombrich Bridge II Note and Other Amounts Due. On March 5, 2004, the
Bridge II Convertible Promissory Note (and accrued interest thereon) issued to
Peter Gombrich in December 2003 was converted into 2,113,987 common shares.

      Further, Peter Gombrich was owed $37,847 and $52,953 at September 30, 2004
and December 31, 2003, respectively. MDI has classified the amount due to Mr.
Gombrich under the current liabilities heading "Due to stockholder."

      Carrying Amounts. The carrying amounts of Notes Payable - Related Parties
approximated fair value at September 30, 2004 and December 31, 2003.


                                       9
<PAGE>

Note 7. Notes Payable

      Notes payable to unrelated parties consisted of (in thousands):

<TABLE>
<CAPTION>
                                                                                      September 30,  December 31,
                                                                                           2004         2003
                                                                                           ----         ----
                                                                                        (unaudited)
<S>                                                                                       <C>         <C>
Bridge I Convertible Promissory Notes; due December 31, 2002; interest
   rate 7% per annum; convertible into common stock at 75% of the market price on
   date of conversion; beneficial conversion feature valued at $1,042,000 at June
   30, 2002; Bridge I warrants at an exercise price of $0.25 per share; additional
   warrants at an exercise price equal to 150% of note conversion price ...............   $  850      $2,075
Bridge II Convertible Promissory Notes; due July 31, 2003; interest rate
   12%/15% per annum; convertible into common stock at $0.10 or $0.15 per share;
   beneficial conversion feature valued at $1,777,000 and $330,000 at December 31,
   2003 and December 31, 2002, respectively;
   warrants at an exercise price of $0.15 or $0.20 per share ..........................    1,285       2,845
Bridge III Convertible Promissory Notes; due December 31, 2008; interest rate 10%
   per annum; convertible into common stock at $.10 per share; beneficial
   conversion feature valued at $1,604,000 at June 30, 2004; warrants at an
   exercise price of $.15 per share ...................................................      182          --
Bridge IV Convertible Promissory Notes; due December 31, 2008; interest rate 10%
   per annum; convertible into common stock at $.10 per share; beneficial
   conversion feature valued at $1,791,000 at June 30, 2004; warrants at an
   exercise price of $.15 per share ...................................................      991          --
Monsun, AS $500,000 Promissory Note issued November 1, 2000; due July 31, 2002;
   interest rate 20% per annum, compounded into principal amount;
   beneficial conversion feature valued at $125,000 at November 1, 2000 ...............      744         641
Trek Diagnostic Systems $80,000 Promissory Note issued July 31, 2002; due in equal
   installments on September 1, 2002 and December 1, 2002 .............................       --          15
O.P., LLC $29,390 Promissory Note issued May 12, 2003; interest at 7% per annum;
   monthly principal payments of $1,316 plus interest commencing June 1, 2003;
   due April 2005 .....................................................................       10          24
Ungaretti and Harris $211,368 Secured Promissory Note issued May 8, 2003; interest
   at 12% per annum; due September 30, 2003 ...........................................      149         149
Ernst & Young $30,800 Promissory Note issued July 17, 2003; interest at 12% per annum
   commencing January 1, 2003; due December 31, 2003 ..................................       31          31
Ventana Medical Systems, Inc. $62,946 Promissory Note issued November 30, 2003;
   due December 31, 2003; interest at 8% per annum payable after December 31, 2003 ....       21          63
Xillix Technologies Corporation $361,000 Promissory Note issued June 26, 1998; interest
   rate Canadian Prime plus 6% per annum; represents a debt of AccuMed ................       34          34
Western Economic Diversification $221,000 Promissory Note issued June 1989;
   no interest; represents a debt of Oncometrics ......................................      227         222
                                                                                          ------      ------
         Total: .......................................................................   $4,524      $6,099
                                                                                          ======      ======
</TABLE>

      Bridge I. In 2002, MDI issued an aggregate $3,185,000 in Bridge I
Convertible Promissory Notes to accredited investors. The notes bear interest at
the rate of 7% per annum and are convertible at any time into the common stock
of MDI at a conversion price equal to 75% of the market price of the Company's
common stock on the date of conversion. In addition, MDI issued to each holder a
warrant that entitled each such holder to purchase one share of common stock at
an exercise price of $0.25 per share, for each dollar principal amount of notes.
MDI calculated a fair value of $99,950 for these warrants using the fair value
interest rate method and recorded this amount as additional interest expense
during 2002. In addition, at the time of conversion of the note, each holder is
entitled to receive a warrant to purchase one share of common stock for each
four shares of common stock into which the note converts at an exercise price
equal to 150% of the conversion price of the note. MDI has not determined a
value for the warrants as of September 30, 2004. Since the conversion price of
the note is at a 25% discount to the market price of the common stock of MDI,
the holder is considered to have a beneficial conversion feature. MDI determined
the value of the beneficial conversion feature to be $1,041,666 and recorded
this amount as additional interest expense during 2002.


                                       10
<PAGE>

      In February 2003, a note holder, NeoMed Innovations III, converted
$1,060,000 in principal amount of Bridge I notes into Bridge II notes. In
November 2003, two Bridge I note holders converted $50,000 in principal amount
of notes and $5,287 in accrued interest into 368,579 shares of unregistered
common stock. Management extended a written offer, dated October 10, 2003, to
the Bridge I noteholders to convert their notes and accrued interest into common
shares at a conversion rate of $0.15 per share. In addition, the Bridge I
holders were also offered warrants to purchase one new share for every four
shares acquired by the Bridge noteholder upon exercise of such holder's
conversion rights under the notes. This offer continues to remain outstanding as
of September 30, 2004.

      During the nine months ended September 30, 2004, holders of $1,225,000
principal amount of Bridge I Convertible Promissory Notes elected to convert
their notes and related accrued interest of $155,000 into 9,199,218 shares of
unregistered common stock. The remaining $850,000 in principal Bridge I notes
remained unconverted and outstanding at September 30, 2004.

      Bridge II. Beginning in October 2002, MDI began an issue of up to
$4,000,000 in Bridge II Convertible Promissory Notes to accredited investors.
MDI issued $550,000 in Bridge II notes as of December 31, 2002. From January 1,
2003 through the closing of the offering on December 5, 2003, MDI issued Bridge
II notes in the principal amount of: $1,980,200 in exchange for cash, $1,060,000
as a conversion of a Bridge I Convertible Promissory Note (see discussion above)
and $305,667 in exchange for a note payable to Peter P. Gombrich, the Company's
Chairman, for a total issuance during fiscal year 2003 of $3,345,867. The notes
bear interest at a rate of 12% per annum payable at the maturity date in kind in
the form of shares of common stock of MDI. The Company granted the holders a
junior security position in all of its assets. The notes are convertible at any
time into the common stock of MDI. The note conversion price and the value of
common shares paid in kind as interest for the first $1,000,000 in principal
amount of cash subscriptions, determined on a "first come - first served basis,"
is $0.10 per share. The note conversion price and the value of common shares
paid in kind as interest for the remaining $3,000,000 of principal amount of
notes in the series is $0.15 per share. The conversion prices of the notes
issued during 2002 and 2003 were less than the market price of the common stock
when the notes were issued; therefore, the holders are considered to have a
beneficial conversion feature. MDI determined the value of the beneficial
conversion feature to be $1,777,200 and $330,000 at December 31, 2003 and
December 31, 2002, respectively. The value was recorded as a reduction of the
debt and will be amortized as additional interest over the life of the notes.
MDI recorded additional interest expense of $334,909 and $1,826,743 to reflect
amortization of the discount during the nine months ended September 30, 2004 and
year ended December 31, 2003, respectively.

      At the time MDI completes significant additional funding plans, as
outlined in the subscription agreement, each holder of Bridge II notes is
entitled to receive a warrant to purchase one share of the common stock of the
Company for each four shares of common stock into which the note is convertible
at an exercise price of $0.15 per share for notes in the class pertaining to the
first $1,000,000 in subscriptions and $0.20 for the remaining $3,000,000 in note
principal subscriptions. In September 2003, an amendment to the Bridge II
Convertible Promissory Notes was sent to holders requesting an extension of the
notes to July 31, 2004. As additional consideration for the extension, holders
were offered an increase in the interest rate from 12% to 15%. In addition, an
amendment to the indenture also offered an increase in the warrant coverage
ratio from 25% to 33%. The Bridge II offering was closed as of December 5, 2003.

      For the nine months ended September 30, 2004, holders of $2,146,000
principal amount of Bridge II Convertible Promissory Notes elected to convert
their notes and related accrued interest of $251,000 into 17,619,242 shares of
unregistered common stock. Included in the above conversion amounts are amounts
due Peter P. Gombrich, the Company's Chairman, of $305,667 in Bridge II
principal and $11,431 in accrued interest thereon, which were converted into
2,113,987 shares of unregistered common stock. The remaining $1,300,000 in
principal Bridge II notes remained unconverted and outstanding at September 30,
2004.

      Bathgate Capital Partners, LLC - Bridge III. Beginning in January 2004,
Bathgate Capital Partners, LLC began an offering of a maximum of $4,000,000 and
a minimum of $1,500,000 in Bridge III Convertible Promissory Notes to accredited
investors on behalf of the Company. The notes bear interest at 10% per annum
payable, on a semi-annual basis, in kind in the form of shares of common stock
for the first two years and then in cash for the remaining three years until due
December 31, 2008. The note conversion price and the value of common shares paid
in kind as interest is $0.10 per share. The notes are convertible at any time
into the common stock of MDI, although the notes will automatically convert if
the last sales price of the stock is $0.30 or higher for twenty consecutive
trading days, the daily average trading volume is 250,000 shares, the underlying
shares are registered for sale, and the Convertible Promissory Note to an
affiliate, Suzanne M. Gombrich, has been paid or converted into common shares.
The holders were also granted a security interest in all of the Company's
assets. MDI granted each note holder the right to receive 25% warrant coverage
on all money invested; therefore, for every $100,000 invested, an investor will
receive warrants to purchase 25,000 shares of common stock at an exercise price
of $0.15. The warrants expire on December 31, 2008.


                                       11
<PAGE>

         The Bridge III offering documents provided that funds raised would not
be released from escrow until the following requirements were met:

      o     A minimum investment of $1,500,000 had been reached;

      o     The $190,000 Convertible Promissory Note held by Suzanne Gombrich
            was converted into common shares;

      o     A portion of the Bridge II Convertible Promissory Note holders
            converted their notes into common shares; and

      o     Peter P. Gombrich, MDI's Chairman and then-current CEO, would resign
            his position as CEO of the Company.

With the exception of the conversion of Suzanne Gombrich's note, which was
converted following stockholder approval of an increase in the number of
authorized shares of its common stock in July 2004, these requirements were
satisfied on April 2, 2004 and the Company issued $1,500,000 in convertible
promissory notes in exchange for cash. The funds were used for repayment of the
Suzanne Gombrich note, payment of IRS taxes, and working capital. On May 21,
2004, the Company issued an additional $162,500 in Bridge III notes in exchange
for cash. The conversion prices of the notes issued during 2004 were less than
the market price of the common stock when the notes were issued; therefore, the
holders are considered to have a beneficial conversion feature. MDI determined
the value of the beneficial conversion feature to be $1,604,000 at June 30,
2004. The value was recorded as a reduction of the debt and will be amortized as
additional interest over the life of the notes. MDI recorded additional interest
expense of $123,304 to reflect amortization of the discount during the nine
months ended September 30, 2004. Through September 30, 2004, the Company had
issued $1,662,500 in principal amount of Bridge III Convertible Promissory Notes
in exchange for cash.

      Bridge IV. Beginning in February 2004, MDI began a separate offering of
Bridge IV Convertible Promissory Notes to accredited investors. The notes bear
interest at 10% per annum payable, on a semi-annual basis, in kind in the form
of shares of common stock for the first two years and then in cash for the
remaining three years until the December 31, 2008 maturity date. The note
conversion price and the value of common shares paid in kind as interest is
$0.10 per share. The conversion price of the notes issued to date has been less
than the market price of the common stock when the notes were issued; therefore,
the holders are considered to have a beneficial conversion feature. MDI
determined the value of the beneficial conversion feature to be $499,000 and
$1,292,000 at June 30, 2004 and March 31, 2004, respectively. The value was
recorded as a reduction of the debt and will be amortized as additional interest
over the life of the notes. MDI recorded additional interest expense of $208,043
to reflect amortization of the discount during the nine months ended September
30, 2004. The notes are convertible at any time into the common stock of MDI,
although the notes will automatically convert if the last sales price of the
stock is $0.30 or higher for twenty consecutive trading days, the daily average
trading volume is 250,000 shares, the underlying shares are registered for sale,
and the Convertible Promissory Note to an affiliate, Suzanne M. Gombrich, has
been paid or converted into common shares. The holders were also granted a
security interest in all of the Company's assets. MDI granted each note holder
the right to receive 25% warrant coverage on all money invested; therefore, for
every $100,000 invested, an investor will receive warrants to purchase 25,000
shares of common stock at an exercise price of $0.15. The warrants expire on
December 31, 2008. Through September 30, 2004, the Company had issued $2,573,500
in principal amount of Bridge IV Convertible Promissory Notes in exchange for
cash.

      Monsun. On November 1, 2000, MDI issued a convertible promissory note to
Monsun, AS ("Monsun") in exchange for $500,000 in cash. The note bears interest
at the rate of 20% per year and was due 12 months from the date of issue. The
note is convertible into common stock, any time after the expiration of the
first 180 days of the loan term, at a conversion price of $1.00 per share.

      On October 31, 2001, Monsun and MDI agreed to the first extension of the
maturity date of the note until January 31, 2002. As consideration for the first
extension agreement, MDI issued a three-year warrant to Monsun, entitling the
holder to purchase 100,000 shares of common stock of MDI at an exercise price of
$0.60 per share. On January 31, 2002, Monsun and MDI agreed to the second
extension of the maturity date of the note until June 30, 2002. As consideration
for the second extension agreement, MDI issued a three-year warrant to Monsun,
entitling the holder to purchase 200,000 shares of common stock of MDI at an
exercise price of $0.30 per share. A fair value of $4,110 for the warrant was
calculated using the fair value interest rate method and was recorded as
additional interest expense during 2002. On April 1, 2002, Monsun and MDI agreed
to the third extension of the maturity date until July 31, 2002. As
consideration for the third extension agreement, MDI issued a five-year warrant
to Monsun, entitling the holder to purchase 200,000 shares of common stock of
MDI at an exercise price of $0.70 per share. A fair value of $8,287 for the
warrant was calculated using the fair value interest rate method and was
recorded as additional interest expense during 2002. In November 2002, MDI
issued 200,000 shares of common stock of MDI as a default penalty on the note. A
fair value of $42,000 for the shares was calculated using the market price of
the common stock on the date the shares were issued and was recorded as
financing expenses during 2002. MDI made payments against the principal of the
note amounting to $117,266 and recorded interest expense, in addition to the
amounts mentioned above, of $80,200 during 2002.


                                       12
<PAGE>

      Monsun initiated a legal action against Peter Gombrich, MDI's Chairman, as
a personal guarantor on the note, in an attempt to collect the unpaid principal
balance of the note. The Board of Directors of MDI agreed to pay Mr. Gombrich's
legal costs to defend and indemnify him against this action. Monsun was
successful in obtaining a legal judgment of $735,000 related to the note balance
and accrued interest against Peter Gombrich as the personal guarantor of the
note. In addition, Monsun was granted an award of $438,000 for attorneys' fees
against Peter Gombrich as the personal guarantor. The award for legal fees has
been recorded as an accrued expense. (See Note 5 - Accrued Expense) The Company
continues to negotiate the terms of a settlement of the outstanding balance due.
(See Note 11 - Legal Proceedings)

      Trek Diagnostic Systems. In July 2002, MDI agreed to settle a claim
brought by Trek Diagnostic Systems, Inc. against AccuMed regarding alleged
breaches of representations and warranties in a certain agreement under which
Trek purchased the microbiology business of AccuMed in 2000. MDI issued a
promissory note to Trek in the amount of $80,000, payable in two equal
installments on September 1, 2002 and December 1, 2002. MDI made the first
payment due on September 1, 2002 but did not make the second payment, causing a
default on the note. Through a court ordered action Trek was able to obtain
payments totaling $27,692 during the fourth quarter of 2003. In the first
quarter of 2004, a final settlement of $12,000 was reached for complete and
final settlement of the outstanding note balance.

      Defaults. Specific events of default have occurred on a significant
majority of the outstanding notes payable issued by MDI, including the Bridge I
and Bridge II convertible promissory notes, ranging from failure to make
principal payments when due to breach of certain warranties and representations.
The notes payable require the holder to notify MDI in writing of a declaration
of default at which time a cure period, as specified in each individual note,
would commence. There is no guarantee that MDI would be able to cure any event
of default if, or when, the holder provides the required written notice. Other
than the Monsun convertible promissory note and the Ungaretti and Harris note
payable, which are the subject of legal actions described in Note 11 - Legal
Proceedings, MDI has not received any written declarations of default from
holders of its outstanding notes payable.

      Carrying Amounts. The carrying amounts of Notes Payable approximated fair
value at September 30, 2004 and December 31, 2003.

Note 8. Stockholders' Equity

      The Company's preferred stock consisted of the following:

                                                 September 30,     December 31,
                                                     2004             2003
                                                     ----             ----
                                                Shares Issued &  Shares Issued &
Issue                                             Outstanding      Outstanding
-----                                             -----------      -----------
                                                   (unaudited)

Series A convertible ........................         82,655         82,655
Series B convertible, 10% cumulative dividend        377,606        799,856
Series C convertible, 10% cumulative dividend        262,833      1,192,833
Series D convertible, 10% cumulative dividend        175,000        175,000
Series E convertible, 10% cumulative dividend        234,641        260,764
                                                   ---------      ---------
   Total Preferred Stock ....................      1,132,735      2,511,108
                                                   =========      =========


                                       13
<PAGE>

      During the first nine months of 2004, several holders converted 930,000
shares of Series C convertible preferred stock, including cumulative dividends
due thereon, into 5,703,816 shares of common stock. In April 2004, holders of
Series B Convertible Preferred Stock elected to convert 422,250 of preferred
shares and accrued dividends into 2,211,401 shares of unregistered common stock.
In June 2004, holders of Series E Convertible Preferred Stock elected to convert
25,939 of preferred shares and accrued dividends into 892,154 shares of
unregistered common stock. During the third quarter of 2004, holders of Series E
Convertible Preferred Stock elected to convert 184 preferred shares and accrued
dividends into 6,363 shares of unregistered common stock.

      Summary of Preferred Stock Terms

<TABLE>
<S>                     <C>
Series A Convertible Preferred Stock
Liquidation Value:      $4.50 per share
Conversion Price:       $10.3034 per share
Conversion Rate:        0.4367--Liquidation Value divided by Conversion Price ($4.50/$10.3034)
Voting Rights:          None
Dividends:              None
Conversion Period:      Any time

Series B Convertible Preferred Stock
Liquidation Value:      $4.00 per share
Conversion Price:       $1.00 per share
Conversion Rate:        4.00--Liquidation Value divided by Conversion Price ($4.00/$1.00)
Voting Rights:          None
Dividends:              10%--Quarterly--Commencing June 30, 2001
Conversion Period:      Any time
Cumulative dividends in arrears at September 30, 2004 were $554,666

Series C Convertible Preferred Stock
Liquidation Value:      $3.00 per share
Conversion Price:       $0.60 per share
Conversion Rate:        5.00--Liquidation Value divided by Conversion Price ($3.00/$0.60)
Voting Rights:          None
Dividends:              10%--Quarterly--Commencing June 30, 2002
Conversion Period:      Any time
Cumulative dividends in arrears at September 30, 2004 were $229,907

Series D Convertible Preferred Stock
Liquidation Value:      $10.00 per share
Conversion Price:       $1.00 per share
Conversion Rate:        10.00--Liquidation Value divided by Conversion Price ($10.00/$1.00)
Voting Rights:          None
Dividends:              10%--Quarterly--Commencing April 30, 2002
Conversion Period:      Any time
Cumulative dividends in arrears at September 30, 2004 were $510,616

Series E Convertible Preferred Stock
Liquidation Value:      $22.00 per share
Conversion Price:       $0.80 per share
Conversion Rate:        27.50--Liquidation Value divided by Conversion Price
                        ($22.00/$0.80)
Voting Rights:          Equal in all respects to holders of common shares
Dividends:              10%--Quarterly--Commencing May 31, 2002 Conversion Period:Any time
Cumulative dividends in arrears at September 30, 2004 were $1,425,756
</TABLE>


                                       14
<PAGE>

      Issuance of Common Shares for Cash

      In August 2004, MDI offered common stock to accredited investors in
exchange for cash. Through September 30, 2004, the Company had received $275,000
and had issued 2,750,000 shares of restricted common stock.

      Issuance of Common Shares for Services

      In August 2004, MDI issued 924,333 shares of common stock in exchange for
services to a non-employee professional services firm for past services. MDI
calculated a fair value of $92,433 for these shares based on the value of the
shares on the date of issuance and recorded the amount as satisfaction of the
vendor's accounts payable balance as of September 30, 2004.

      In August 2004, MDI issued 1,200,000 shares of common stock in exchange
for services to a non-employee financial consultant for future services. MDI
calculated a fair value of $120,000 for these shares based on the value of the
shares on the date of issuance and is amortizing the amount over the remainder
of the service contract.

      In September 2004, MDI issued 572,748 shares of common stock to a
non-employee service vendor in lieu of payment for unpaid invoices. MDI
calculated a fair value of $57,275 for these shares based on the market value of
the shares on the date of issuance and recorded the amount as satisfaction of
the vendor's accounts payable balance as of September 30, 2004 based on a
settlement agreement.

      In September 2004, MDI issued 275,000 shares of common stock to a
non-employee financial consultant for past financial services. MDI calculated a
fair value of $27,500 for these shares based on the value of the shares on the
date of issuance and recorded the amount as an administrative expense as of
September 30, 2004.

      In September 2004, MDI issued 250,000 shares of common stock to a
non-employee professional services firm for past investor relations services.
MDI calculated a fair value of $25,000 for these shares based on the value of
the shares on the date of issuance and recorded the amount as an administrative
expense as of September 30, 2004.

      Issuance of Warrants for Services

      In March 2004, MDI issued warrants to purchase 67,000 shares of common
stock of the Company with an exercise price of $0.17 per share to a non-employee
financial consultant for past financial services. MDI valued the warrants at
$13,400 using the Black-Scholes valuation model and recorded the amount as an
administrative expense as of March 31, 2004.

      In March 2004, MDI issued warrants to purchase 500,000 shares of common
stock of the Company with an exercise price of $0.17 per share to a non-employee
financial consultant for past financial services. MDI valued the warrants at
$95,000 using the Black-Scholes valuation model and recorded the amount as an
administrative expense as of March 31, 2004.

      In May 2004, MDI issued warrants to purchase an aggregate 119,042 shares
of common stock of the Company with exercise prices ranging from $0.15 to $0.16
per share to non-employee service vendors in lieu of payment for unpaid service
invoices. MDI valued the warrants at $18,181 using the Black-Scholes valuation
model and recorded the amount as a reduction of the outstanding amount due.

      In June 2004, MDI issued warrants to purchase an aggregate 364,942 shares
of common stock of the Company with exercise prices ranging from $0.16 to $0.17
per share to non-employee service vendors in lieu of payment for unpaid service
invoices. MDI valued the warrants at $42,368 using the Black-Scholes valuation
model and recorded the amount as a reduction of the outstanding amount due.


                                       15
<PAGE>

      In May 2004, MDI issued warrants to purchase 500,000 shares of common
stock of the Company with an exercise price of $0.17 per share to a non-employee
financial consultant for past financial services. MDI valued the warrants at
$76,200 using the Black-Scholes valuation model and recorded the amount as a
current quarter administrative expense.

      In June 2004, MDI issued warrants to purchase 780,000 shares of common
stock of the Company with an exercise price of $0.17 per share to a non-employee
financial consultant for past financial services. MDI valued the warrants at
$73,320 using the Black-Scholes valuation model and recorded the amount as a
current quarter administrative expense.

      In June 2004, MDI issued warrants to purchase 681,625 shares of common
stock of the Company with an exercise price of $0.18 per share to a non-employee
broker-dealer for past financial services. MDI valued the warrants at $62,914
using the Black-Scholes valuation model and recorded the amount as a current
quarter administrative expense.

      In August 2004, MDI issued warrants to purchase 500,000 shares of common
stock of the Company with an exercise price of $0.17 per share to a non-employee
consultant for past services. MDI valued the warrants at $45,000 using the
Black-Scholes valuation model and recorded the amount as a current quarter
administrative expense.

      In September 2004, MDI issued warrants to purchase 200,000 shares of
common stock of the Company with an exercise price of $0.10 per share to a
non-employee professional services firm for past investor relations services.
MDI valued the warrants at $18,400 using the Black-Scholes valuation model and
recorded the amount as a current quarter administrative expense.

      In September 2004, MDI issued warrants to purchase 20,000 shares of common
stock of the Company with an exercise price of $0.20 per share to a non-employee
consultant for past services. MDI valued the warrants at $1,780 using the
Black-Scholes valuation model and recorded the amount as a current quarter
administrative expense.

      In September 2004, MDI issued warrants to purchase 25,000 shares of common
stock of the Company with an exercise price of $0.20 per share to a non-employee
service vendor in lieu of payment for unpaid services. MDI valued the warrants
at $2,250 using the Black-Scholes valuation model and recorded the amount as a
reduction of the outstanding amount due.

      Application of Black-Scholes Valuation Model

      In applying the Black-Scholes valuation model, the Company has used an
expected dividend yield of zero, a risk-free interest rate of 4.89% and 6% for
the September 30, 2004 and 2003 periods, respectively, volatility factors of
151% and 90%, respectively, and a fair value of the underlying common shares of
the closing market price on the date of the grant. The expected life equaled the
term of the warrants, options, or restricted shares.

Note 9. Equity Incentive Plan and Employee Stock Purchase Plan

      MDI applies APB No. 25, "Accounting for Stock Issued to Employees," and
related interpretations in accounting for options granted to employees under its
1999 Equity Incentive Plan. No compensation cost was recorded during the nine
months ended September 30, 2004 or during 2003 for options granted to employees,
as the exercise price approximated the fair value of the underlying common stock
on the date of the grant. Had stock options been accounted for under the fair
value method recommended by SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net loss allocated to common shareholders would
have been changed to the pro forma amounts indicated below:


                                       16
<PAGE>

<TABLE>
<CAPTION>
                                                For the nine months ended,   For the three months ended
                                                      September 30,               September 30,
                                                     2004       2003             2004       2003
                                                   -------    -------          -------    -------
                                                     (in thousands except for per share amounts)
                                                                     (unaudited)
<S>                                                <C>        <C>              <C>        <C>
Net loss applicable to common
   shareholders as reported ....................   $(6,188)   $(9,235)         $(1,949)   $(4,178)
Deduct: Total stock-based compensation
   expense determined under the fair value based
   method for all awards, net of related taxes .      (137)        33               34        (16)
                                                   -------    -------          -------    -------
Pro forma net loss applicable to
   common shareholders .........................   $(6,325)   $(9,202)         $(1,915)   $(4,194)
                                                   =======    =======          =======    =======

Basic loss per share applicable to common
   shareholders - as reported ..................   $  (.09)   $  (.23)         $  (.02)   $  (.11)
                                                   =======    =======          =======    =======
Basic loss per share applicable to
   common shareholders - pro forma .............   $  (.09)   $  (.23)         $  (.02)   $  (.11)
                                                              =======          =======    =======
</TABLE>

      The fair value for these options was estimated at the date of the grant
using a Black-Scholes option pricing model with the following weighted average
assumptions: risk-free interest rates of 4.89% and 6% for the September 30, 2004
and 2003 periods, respectively, volatility factors of the expected market price
of the Company's common stock of 151% and 90%, respectively, and a fair value of
the underlying common shares of the closing market price on the date of the
grant. The expected life equaled the term of the options or restricted shares.

      These pro forma amounts are not necessarily indicative of the future
effects of applying the fair value based method to, among other things, the
vesting period of the stock options and the fair value of the additional stock
options issued in future years. The Financial Accounting Standards Board has
indicated that it will likely require that companies expense employee options in
the future, but has not yet finalized the timing or methods for such a change.

      A summary of the Company's stock option activity and related information
follows:

                                                               Weighted Average
                                                    Options      Exercise Price
                                                    -------    ----------------

Outstanding at January 1, 2003 ...                 3,507,517
Granted ..........................                   600,000       $0.3144
Forfeited - assumed in acquisition                   (17,035)      $4.9169
Forfeited ........................                  (595,834)      $0.9385
                                                   ---------
Outstanding at December 31, 2003 .                 3,494,648
Granted ..........................                 2,500,000       $0.1540
Expired or Forfeited .............                  (901,921)      $1.0937
                                                   ---------
Outstanding at September 30, 2004                  5,092,727
                                                   =========
Exercisable at September 30, 2004                  3,382,727       $0.9282
                                                   =========

Note 10. Subsequent Events

      Common Stock Issuance

      In October 2004, MDI offered common stock to accredited investors in
exchange for cash. As of October 31, 2004, the Company had received $285,000 and
was obligated to issue 4,071,429 shares of restricted common stock in connection
with such offering.


                                       17
<PAGE>

Common Stock Equity Exchange Investment

         In October 2004, MDI entered into a stock purchase agreement with
Seaside Investments Plc, a private investment company, for the purchase by
Seaside of 11,000,000 shares of MDI's restricted common stock in exchange for
registered shares of the investment company.

         Seaside is a newly formed London-based company established to invest in
U.S. "micro cap" companies with long-term growth potential. The company has
agreed to apply for its shares to be admitted for trading on the London Stock
Exchange as an investment trust, and the closing of this transaction is subject
to certain contingencies, including approval of such listing. In the event
Seaside's shares are not listed on the London Stock Exchange before the agreed
deadline, the Company is not obligated to close and will be returned its shares
of common stock, which have been conditionally issued and are being held in
escrow pending closing.

         Seaside has entered into a "lock-up" agreement with MDI pursuant to
which it has agreed not to trade the MDI shares it receives upon consummation of
this transaction for a period of one year from the closing date. In full payment
for the shares of MDI, Seaside will issue to MDI shares of the investment
company valued at the purchase price of the MDI shares divided by the conversion
rate of the British Pound Sterling to purchase U.S. Dollars (subject to the
downside price protection described below), with each Seaside share having a
value of One Pound Sterling. The Company, upon issuance of such Seaside shares,
may thereafter sell such shares at a monthly rate of up to 10% of the total
number of shares issued, with any unused portion of allotted shares for a month
carried over to the next month.

         Thirty percent of the Seaside shares will be held in escrow for one
year following their issuance pursuant to an escrow agreement entered into by
the parties. In the event the per share market price of MDI's common stock at
the one year anniversary of the closing is less than the per share value of the
Company stock at the time of the closing, Seaside shall be entitled to receive
out of escrow a percentage of the shares equal to the percentage of such
decline. The remaining shares held in escrow will be released to MDI. The
parties also entered into a registration rights agreement pursuant to which the
Company is obligated to file a registration statement for the resale of its
shares with the SEC within eight months of the date of the agreement, subject to
certain conditions.

         The President and Chief Executive officer of MDI, Denis M. O'Donnell,
M.D., was a Managing Director of Seaside Advisors, LLC, an investment advisor to
Seaside Partners, L.P., a private equity limited partnership, from 1997 until
2003. William Ritger, a principal at Seaside Investments PLC, was also a
Managing Director of Seaside Advisors, LLC.

         Strategic Alliance

         In October 2004, the Company entered into a strategic alliance with the
biotechnology division of a Fortune 500 healthcare company. The alliance calls
for the manufacture and distribution of MDI's Automated Image Proteomic System
(AIPS). In addition, the two companies will collaborate and develop proprietary
antibodies to be used in the MDI proteomic cell-based assay systems, the first
of which is the CVX cervical screening system.

         Under the terms of the five-year agreement, the division will
manufacture the MDI-designed AIPS hardware and then distribute these systems
through its international sales organization. The complementary image analysis
software, running on the AIPS platform, was developed by MDI for the CVX system.

         MonoGen Settlement

         In October 2004, the Company and AccuMed entered into a settlement
agreement with MonoGen, Inc. relating to an arbitration proceeding brought by
MonoGen against the Company and its subsidiaries, AccuMed and Oncometrics
relating to certain license and related agreements among the parties. The
settlement agreement requires certain payments to be made by the Company and
AccuMed under a joint unsecured installment promissory note, the assignment of
certain patents, patent applications, copyrights, trademarks and other
intellectual property rights and certain FDA clearances, and the delivery of ten
AcCell units and spare parts. For a full discussion of the settlement, see Note
11 - Legal Proceedings.



                                       18
<PAGE>


Note 11. Legal Proceedings

         Garrett Realty. Prior to MDI's acquisition of AccuMed, Garrett Realty,
Inc. filed suit against AccuMed for unpaid rent and related expenses under a
lease for premises located at 900 and 920 N. Franklin in Chicago, Illinois
(Circuit Court of Cook County (Case No. 01 M1 725821)). Garrett originally
claimed amounts due of approximately $50,000. Following completion of MDI's
acquisition of AccuMed, management vacated AccuMed's leased facility and
consolidated its operations into MDI's headquarters facility. However, Garrett
continued to claim ongoing rent and amended its complaint in 2002 claiming
approximately $148,000 in unpaid rent and related legal costs through July 2002.
On July 18, 2002, judgment was entered in favor of Garrett and against AccuMed
in the amount of approximately $157,000. On December 20, 2002, pursuant to a
court order, Garrett seized approximately $12,500 from an MDI bank account as a
partial payment against the judgment amount. The unpaid remainder of the
judgment, approximately $136,000 including interest, will continue to accrue
interest until paid in full. Since AccuMed had a continuing obligation for the
minimum lease payments, MDI recorded a $290,000 lease obligation in accounting
for the AccuMed merger based on the present value of the future payments. MDI is
contesting the right of Garrett to pursue collection of the judgment against the
assets of MDI. Management believes that the amount of the accrued lease
obligation recorded as of December 31, 2003 is sufficient to cover any remaining
expenses of this litigation and the related judgment. During the first quarter
of 2004, MDI reached a preliminary settlement on the outstanding judgment, which
required six monthly payments of $13,724 each. MDI has made the first four
required monthly payments. MDI also agreed to issue 275,000 shares of its common
stock as part of the final settlement. The parties are currently at an impasse
concerning a dispute over the transfer of MDI shares, but it is expected that
this will be worked out amicably.

         Monsun. On January 9, 2003, Monsun, AS ("Monsun") filed suit against
Peter Gombrich, our Chairman and former CEO (United States District Court for
the Northern District of Illinois Eastern Division (Case No. 03 C 0184)),
claiming $500,000 plus consequential damages for failure to make payment in
compliance with the terms of a personal guaranty signed by Mr. Gombrich in
relation to Monsun's grant of an extension in the maturity date of a convertible
promissory note in the principal amount of $500,000 issued by MDI on November 1,
2000. The note had an original maturity date of November 1, 2001. The maturity
date of the note was initially extended until January 31, 2002 and subsequently
to April 1, 2002 and finally to July 31, 2002. Monsun granted the maturity date
extensions in exchange for various warrants issued by MDI entitling the holder
to purchase shares of common stock at various prices. In November 2002, the
Board of Directors approved the issuance of 200,000 shares of common stock to
Monsun to satisfy a default penalty clause in the guaranty. The terms of the
guaranty required that Monsun receive registered shares of our common stock;
however, in order to comply with securities laws, MDI issued the shares of
common stock to Monsun with a restrictive legend, which permits their sale only
in compliance with Rule 144 of the Securities Act of 1933, as amended. MDI
recorded the principal amount of the note plus accrued and unpaid interest to
December 31, 2003 as a note payable on its records. In March 2004, Monsun
obtained a judgment against Mr. Gombrich; $735,199 of that judgment remains
unsatisfied. In addition, Monsun has obtained a second judgment against Mr.
Gombrich in the amount of $438,419 for attorney fees and costs incurred in
enforcing the guaranty agreement. Since Mr. Gombrich's liability under the suit,
including the failure to deliver registered shares of our common stock, is the
result of the failure of MDI to pay the principal amount of its convertible
promissory note when due, the Board of Directors has agreed that MDI will assume
responsibility for Mr. Gombrich's obligations under the guaranty, including
legal costs.

         MonoGen. In July 2002, MonoGen, Inc. initiated an arbitration
proceeding against the Company and its subsidiaries, AccuMed and Oncometrics
Imaging Corp. (collectively, the "MDI Group"), alleging that the MDI Group had
violated MonoGen's rights under certain license agreements (the "License
Agreements") separately entered into by the subsidiaries with MonoGen prior to
the Company's acquisition of the subsidiaries. In December 2002, the parties to
the arbitration entered into an agreement (the "Technology Agreement") that
purported to settle the issues that had been raised in the arbitration
complaint. However, the Technology Agreement did not have the desired effect of
ending the dispute, and in May 2003 the MDI Group filed suit in the Circuit
Court of Cook County, Illinois (the "State Court Case") against MonoGen and two
individuals affiliated with MonoGen in an attempt to obtain a judicial
resolution of the issues that had been raised in the arbitration. The State
Court Case also sought to resolve certain allegations of breach of fiduciary
duties made by the Company against the President of MonoGen, Norman Pressman,
who had been the President of both AccuMed and Oncometrics at the time the
License Agreements had been entered into by the parties.

         MonoGen resisted the State Court Case by, among other things, insisting
that the dispute could only be settled in arbitration, as required in the
License Agreements. The claim as to MonoGen was dismissed on that basis. MonoGen
subsequently filed amended demands against the MDI Group in the arbitration
proceeding, which had never been dismissed. In order to avoid unnecessary
litigation expenses, the MDI Group subsequently, in February 2004, agreed to a
dismissal of the State Court Case, leaving the arbitration proceeding as the
principal venue for a resolution of the dispute over the license rights obtained
by MonoGen from the Company's subsidiaries.



                                       19
<PAGE>

         Effective as of October 14, 2004, the parties to the arbitration
settled most of the claims brought in that proceeding by virtue of a Settlement
Agreement that provided for the Company and AccuMed to, among other things,
transfer certain patents, patent applications and other intellectual property
rights, as well as certain identified AcCell units and spare parts, to MonoGen,
and to simultaneously issue to MonoGen a joint unsecured installment promissory
note in the principal amount of $305,000 (the "MonoGen Note"). The MonoGen Note
called for an initial payment of $25,000 to be made by the Company and AccuMed
to MonoGen on November 1, 2004, with subsequent monthly payments of $10,000 each
to be made until the full principal balance has been paid. The Settlement
Agreement also provided for the termination of the License Agreements and the
Technology Agreement, but reserved all rights of the parties in regard to any
matters that may continue to be disputed among them and the British Columbia
Cancer Agency ("BCCA") arising out of, or related to, the License Agreement
between Oncometrics Imaging Corp. and MonoGen.

         Inasmuch as the AcCell units and spare parts were not transferred to
MonoGen within the time period prescribed in the Settlement Agreement, and
because the initial $25,000 payment to be made under the MonoGen Note was not
paid by its due date, MonoGen delivered a notice of default to the Company and
AccuMed. If the defaults asserted in the latter notice are not timely cured,
there are a number of remedies that may be available to MonoGen under the
provisions of the Settlement Agreement and the MonoGen Note, one of which is the
possibility that the full principal amount of the MonoGen Note may be
accelerated and declared immediately due and payable.
         Employee Wage and Compensation Claims. On February 18, 2004, current
and former employees Daniel Kussworm, Jennifer Kawaguchi, and Susan Keesee filed
suit against MDI and one of its officers in the Circuit Court of Cook County,
Illinois (04 L 1941). These individuals are seeking to recover wages and other
compensation allegedly due them. Mr. Kussworm seeks approximately $68,600, Ms.
Kawaguchi seeks approximately $37,200, and Ms. Keesee seeks approximately
$124,800; all amounts exclude interest, court costs, and attorney fees. MDI and
these plaintiffs agreed to settlement terms, but MDI recently defaulted on the
settlement agreement and plaintiffs are now continuing with the litigation.

         Ungaretti & Harris. On May 31, 2004, the law firm Ungaretti & Harris
filed an amended complaint against MDI in the Circuit Court of Cook County,
Illinois (04 L 1101), to collect fees for services rendered prior to December
31, 2003. Ungaretti & Harris is seeking to collect approximately $182,000, plus
interest, attorney fees, and court costs. During the third quarter of 2004,
Ungaretti & Harris filed a motion for summary judgment.

         The Lash Group, Inc. On June 10, 2004, The Lash Group, Inc., a
healthcare consulting firm, filed a lawsuit against the Company in the General
Court of Justice, Superior Court Division, in Mecklenburg County, North Carolina
(04 CVS 10367). The Lash Group seeks approximately $94,000, plus interest,
attorney fees, and court costs, for the alleged breach of a promissory note. The
parties are currently attempting to resolve this dispute through settlement
negotiations.

         Creditors. MDI is a defendant in several lawsuits brought by current or
former unsecured creditors to collect past due amounts for goods and services.
MDI has recorded the amounts due in its records and is attempting to settle
these suits and unfiled claims.

         MDI is also currently negotiating the settlement of a wage claim
brought by a former employee seeking to collect for unpaid wages and severance
benefits. MDI has recorded the amount due in its records and is attempting to
settle this claim.

Item 2.  Management's Discussion and Analysis or Plan of Operation

         Forward-Looking Statements

         Certain statements contained in this discussion and analysis that are
not related to historical results are "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Statements that
are predictive, that depend upon or refer to future events or conditions, or
that include words such as "expects," "anticipates," "intends," "plans,"
"believes," "estimates," "hopes," or similar expressions constitute
forward-looking statements. In addition, any statements concerning future
financial performance (including future revenues, earnings or growth rates),
ongoing business strategies or prospects, or possible future actions by us are
also forward-looking statements.



                                       20
<PAGE>

         These forward-looking statements are based on beliefs of our management
as well as current expectations, projections and assumptions currently available
to the Company and are subject to certain risks and uncertainties that could
cause actual results to differ materially from historical results or those
anticipated or implied by such forward-looking statements. These risks are
described more fully in our most recent Annual Report on Form 10-KSB under the
caption "Risk Factors" and in subsequent reports filed with the Securities and
Exchange Commission. Should one or more of those risks or uncertainties
materialize or should underlying expectations, projections and assumptions prove
incorrect, actual results may vary materially from those described. Those events
and uncertainties are difficult to predict accurately and many are beyond our
control. We assume no obligation to update these forward-looking statements to
reflect events or circumstances that occur after the date of these statements
except as specifically required by law. Accordingly, past results and trends
should not be used to anticipate future results or trends.

Overview of Molecular Diagnostics, Inc.

         Molecular Diagnostics, Inc., formerly Ampersand Medical Corporation and
successor to Bell National Corporation, is a biomolecular diagnostics company
engaged in the design, development and commercialization of cost-effective
screening systems to assist in the early detection of cancer for use around the
world. MDI is currently focused on the design, development and marketing of the
InPath(TM) System, and related image analysis systems. The InPath System and
related products are intended to detect cancer and cancer-related diseases.
These products may be used in a laboratory, clinic, or doctor's office.

         The science of medical diagnostics has advanced significantly during
the past decade. Much of this advance has come as a result of new knowledge of
the human genome and related proteins, which form the foundation of cell biology
and the human body. Our goal is to utilize this research as a base to develop
screening and diagnostic testing products for cancer and cancer-related
diseases. We believe that the success of these products will improve patient
care through more accurate test performance, wider availability and
cost-effective service delivery. We are developing an initial series of products
to address these criteria including sample collection devices, chemical and
biological tests, and analysis instruments and related software.

         Our strategy is to develop products through internal development
processes, strategic partnerships, licenses and acquisitions of companies. This
strategy has required and will continue to require additional capital. As a
result, we will incur substantial operating losses until we are able to
successfully market some, or all, of our products.

         The Company has incurred significant operating losses since its
inception. Management expects that significant on-going operating expenditures
will be necessary to successfully implement MDI's business plan and develop,
manufacture and market its products. These circumstances raise substantial doubt
about MDI's ability to continue as a going concern. Implementation of the
Company's plans and its ability to continue as a going concern depend upon its
securing substantial additional financing. During the first nine months of 2004,
MDI raised $4,236,000 and $275,000 through the sale of convertible debt and
common stock, respectively. Management's plans include substantial efforts to
obtain additional capital. If the Company is unable to obtain adequate
additional financing or generate profitable sales revenues, it may be required
to curtail its product development and other activities and may be forced to
cease operations.

Critical Accounting Policies and Changes to Accounting Policies

         The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

     There have been no material changes in our critical accounting policies or
critical accounting estimates since December 31, 2003, nor have we adopted any
accounting policy that has or will have a material impact on our consolidated
financial statements. For further discussion of our accounting policies see Note
3 - Summary of Significant Accounting Policies in the Notes to Consolidated
Financial Statements included in this Quarterly Report on Form 10-QSB, as well
as our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2003.



                                       21
<PAGE>

Results of Operations

         The following discussion and analysis should be read in conjunction
with our consolidated financial statements presented in Part I, Item 1 of this
Quarterly Report and our consolidated financial statements and Management's
Discussion and Analysis contained in our Annual Report on Form 10-KSB for the
year ended December 31, 2003 and in our Quarterly Reports on Form 10-QSB for the
quarters ended March 31, 2004 and June 30, 2004.

         Three Months Ended September 30, 2004 as compared to Three Months Ended
September 30, 2003

Revenue

         Revenue of $41,000 for the three months ended September 30, 2004
represented a decrease of $18,000 or 30.5% over revenue of $59,000 for the same
period in 2003. This decrease was primarily the result of $17,000 in deferred
revenue recorded during 2003 from a previous maintenance fee agreement

Costs and Expenses

         Cost of Goods Sold

         Cost of goods sold for the three months ended September 30, 2004 was
zero, a decrease of $2,000 or 100% over the same period in 2003.

         Research and Development

         We devote a substantial amount of our resources to research and
development ("R&D") related to new products, including markers, tests,
instruments and software applications, as well as modifications and refinements
of our existing products.

         R&D expenses increased $119,000 to $231,000 for the three-month period
ended September 30, 2004, an increase of 106.3% over the comparable period in
2003. This increase was the result of planning and preparation for the clinical
trial for the Company's biochemical assay that is applied to a sample in order
to identify abnormal cells. Management expects to proceed with the trial as soon
as practicable after receipt of appropriate financing. This assay, in
conjunction with the Company's proprietary automated microscopy instrument and
custom-designed image analysis software, as well as the previously approved FDA
sample collection device, comprise the InPath System of products.

         R&D expenses typically consist of costs related to specific development
programs with scientists and researchers at universities and hospitals; full
scale device development contracts began during 1999 with industrial design and
manufacturing companies covering the disposable and instrument components of the
InPath System; payments to medical and engineering consultants for advice
related to the design and development of our products and their potential uses
in the medical technology marketplace; instrumentation, disposables, clinical
consumables, clinical supplies and regulatory costs to develop clinical trial
reference laboratories and to recruit and test patients in support of our
various FDA clinical trials; and payroll-related costs for in-house engineering,
scientific, laboratory, software development and research management staff.

         Selling, General and Administrative

         Selling, general and administrative expenses ("SG&A") decreased
$1,213,000 to $1,204,000 for the three-month period ended September 30, 2004, a
decrease of 50.2% over the period ended September 30, 2003. Decreases in
expenses included $1,254,000 in financing costs, $65,000 in legal and
professional fees, $135,000 in investor relations, and $196,000 in other general
and administrative costs for the period. This decrease was offset by an increase
in expenses of $438,000 relating to a legal judgment awarded to Monsun in a case
against Mr. Gombrich with respect to his personal guaranty of a Company note
payable. The Board of Directors has agreed that MDI will assume responsibility
for Mr. Gombrich's obligations under the guaranty, including legal costs. (See
Note 11 - Legal Proceedings for a discussion of the case.)



                                       22
<PAGE>

         Significant components of SG&A are compensation costs for executive,
sales and administrative personnel; financing costs; professional fees primarily
related to legal and accounting services; travel costs; fees for public and/or
investor relations services; insurance premiums; facilities and office expenses;
marketing-related costs; and amortization/depreciation charges.

Other Income and Expense

         Interest Expense

         Interest expense, including interest expense to related parties,
decreased $930,000 for the quarter ended September 30, 2004 to $411,000, a
decrease of 69.4% over the quarter ended September 30, 2003. Bridge I, II, III,
IV, and related party convertible promissory notes in principal amounts totaled
$6,386,000 and $6,593,000 for the periods ended September 30, 2004 and 2003,
respectively. The $930,000 decrease related primarily to the amortization of
debt discount arising from the beneficial conversion feature of such notes. The
amortized debt discount amount decreased due to an increase in the duration of
the new Bridge III and IV notes issued during the three-month period ended
September 30, 2004 in relation to the shorter maturity periods of the Bridge I
and II notes issued during the three-month period ended September 30, 2003.

         Restructuring Settlements

         For the three months ended September 30, 2004, MDI recorded $88,000 as
a gain from the settlement of various litigation and credit payment matters. For
the same three-month period ended September 30, 2003, the Company did not record
any restructuring settlement amounts.

Net Loss

         The net loss for the three-month period ended September 30, 2004 before
preferred dividends totaled $1,717,000, compared with $ 3,817,000 for the same
period in 2003, a decrease of $2,100,000 or 55.0%. The decrease was primarily
the result of reduced operating capacity due to capital and liquidity
constraints as well as a reduction in interest expense. In addition, cumulative
dividends on the outstanding Series B, Series C, Series D and Series E
convertible preferred stock totaled $232,000 for the quarter ended September 30,
2004, compared with $361,000 for the same period in 2003. The combined net loss
applicable to common stockholders for the three months ended September 30, 2004
of $1,949,000 or $0.02 per share, on 83,374,666 weighted average common shares
outstanding, compared with the net loss and net loss available to common
stockholders for the three-month period ended September 30, 2003 of $4,178,000
or $0.11 per share, on 38,858,622 weighted average common shares outstanding.

         The weighted average shares outstanding during the three months ended
September 30, 2004 include the shares issued or issuable upon conversion of
Series E convertible preferred stock during the period, and the conversion of
Bridge II convertible promissory notes. The Bridge II note conversions resulted
in the issuance of an aggregate 419,159 shares of common stock; the Series E
convertible preferred stock conversions resulted in the issuance of an aggregate
6,363 shares of common stock during the period.

         Nine Months Ended September 30, 2004 as compared to Nine Months Ended
September 30, 2003

Revenues

         Revenues for the nine months ended September 30, 2004 decreased
$96,000, or 33.0%, to $195,000 from revenues of $291,000 for the same period in
2003. This decrease primarily was the result of decreases in the sales of
AccuMed-related products and services. Revenues and related costs and expenses
have been adjusted to reflect the liquidation of MDI's French subsidiary, Samba,
and its reclassification as a discontinued operation.



                                       23
<PAGE>

Costs and Expenses

         Cost of Goods Sold

         Cost of goods sold for the nine months ended September 30, 2004 was
$25,000, a decrease of $66,000 or 72.5% over the same period in 2003. The cost
of goods sold amount for the nine months ended September 30, 2004 is related to
the shipment of the two automated microscopy systems during such period. The
overall decrease was due to the receipt of royalty-related income only for the
period based on an AccuMed system under a license agreement.

         Research and Development

         As noted above, we devote a substantial amount of our resources to R&D
related to new products, including markers, tests, instruments and software
applications, as well as modifications and refinements of our existing products.

         R&D expenses increased $338,000 to $716,000 for the nine-month period
ended September 30, 2004, an increase of 89.4% over the comparable period in
2003. This increase was the result of planning and preparation for the upcoming
clinical trial for the Company's biochemical assay that is applied to a sample
in order to identify abnormal cells. Management expects to proceed with the
trial as soon as practicable after receipt of appropriate financing. This assay,
in conjunction with the Company's proprietary automated microscopy instrument
and custom-designed image analysis software, as well as the previously approved
FDA sample collection device, comprise the InPath System of products.

         Selling, General and Administrative

         SG&A decreased $950,000 for the nine months ended September 30, 2004 to
$4,274,000, a decrease of 18.2% over the same period ended September 30, 2003.
Decreases in expenses included $982,000 in financing costs, $263,000 in investor
relations and $262,000 in other general and administrative costs, offset by an
increase of $119,000 in legal and professional fees for the period. This
decrease in SG&A was also offset by an increase in expenses of $438,000 relating
to a legal judgment awarded to Monsun in a case against Mr. Gombrich with
respect to his personal guaranty of a Company note payable. The Board of
Directors has agreed that MDI will assume responsibility for Mr. Gombrich's
obligations under the guaranty, including legal costs. (See Note 11 - Legal
Proceedings for a discussion of the case.)

Other Income and Expense

         Interest Expense

         Interest expense, including interest expense to related parties,
decreased $1,034,000 for the nine-month period ended September 30, 2004 to
$1,596,000, a decrease of 39.3% over the same period of 2003. Bridge I, II, III,
IV, and related party convertible promissory notes in principal amounts totaled
$6,386,000 and $6,593,000 for the nine-month periods ended September 30, 2004
and 2003, respectively. The change included an increase in interest expense of
$200,000 related to the increase in the notes and a decrease of $1,234,000
related to the amortization of debt discount arising from the beneficial
conversion feature of the notes. The amortized debt discount amount decreased
due to an increase in the duration of the new Bridge III and IV notes issued
during the period ended September 30, 2004 in relation to the shorter maturity
periods of the Bridge I and II notes issued during the period ended September
30, 2003.

         Restructuring Settlements

         For the nine months ended September 30, 2004, MDI recorded $921,000 as
a gain from the settlement of various litigation and credit payment matters. For
the same nine-month period ended September 30, 2003, the Company did not record
any restructuring settlement amounts.

Net Loss

         The net loss for the nine-month period ended September 30, 2004 before
preferred dividends totaled $5,386,000 compared with $8,122,000 for the same
period in 2003, a decrease of $2,736,000 or 33.7%. The decrease was primarily
the result of reduced operating capacity due to capital and liquidity
constraints. In addition, cumulative dividends on the outstanding Series B,
Series C, Series D and Series E convertible preferred stock totaled $802,000 for
the nine-month period ended September 30, 2004, compared with $1,113,000 for the
same period in 2003. The combined net loss applicable to common stockholders for
the nine months ended September 30, 2004 of $6,188,000 or $0.09 per share, on
71,054,095 weighted average common shares outstanding, compared with the net
loss and net loss available to common stockholders for the nine-month period
ended September 30, 2003 of $9,235,000 or $0.23 per share, on 40,191,128
weighted average common shares outstanding.



                                       24
<PAGE>

         The weighted average shares outstanding during the nine months ended
September 30, 2004 include the shares issued or issuable upon conversion of
Series B, Series C, and Series E convertible preferred stock during the period,
and the conversion of Bridge I and Bridge II convertible promissory notes. The
Bridge I and II note conversions resulted in the issuance of an aggregate
26,818,470 shares of common stock; the Series B, C and E convertible preferred
stock conversions resulted in the issuance of an aggregate 8,813,734 shares of
common stock.

Liquidity and Capital Resources

         Research and development, clinical trials and other studies of the
components of our InPath System, conversions from designs and prototypes into
product manufacturing, initial sales and marketing efforts, medical consultants
and advisors, and research, administrative, and executive personnel are and will
continue to be the principal basis for our cash requirements. In addition, the
company is going through a restructuring process and is working with its vendors
and creditors to settle outstanding indebtedness. We have provided operating
funds for the business since its inception through private offerings of debt and
equity to limited numbers of U.S. and foreign accredited investors. We will be
required to make additional offerings in the future to support the operations of
the business until some or all of our products are introduced into the market.
We used $3,543,000 and $2,780,000 for the first nine months ended September 30,
2004 and 2003, respectively, to support our operating activities.

         As of the nine months ended September 30, 2004, we had cash on hand of
$2,000, an increase of $2,000 over cash on hand at December 31, 2003 of zero.
This increase resulted from the receipt of common stock investment funds
received during the period, as discussed herein and in the Notes to the
Financial Statements included herewith.

         In August 2004, MDI offered common stock to accredited investors in
exchange for cash. Through September 30, 2004, the Company had received $275,000
and had issued 2,750,000 shares of restricted common stock. In October 2004, MDI
offered common stock to accredited investors in exchange for cash. The Company
received $285,000 and is obligated to issue 4,071,429 shares of restricted
common stock in connection with such offering.

         We incurred approximately $187,000 in capital expenditures during the
first nine months of 2004 as compared to capital expenditures of $18,000 for the
first nine months of 2003, an increase of 938.9%. The increase was due to
expenditures for design and tooling costs incurred for the e2 collector and the
Automated Image Proteomic System (AIPS). Capital expenditures are defined as
disbursements for laboratory equipment, leasehold improvements, software, and
furniture/fixtures with a purchase price in excess of $1,000 per item and a
useful life in excess of one year. MDI is striving to keep capital expenditures
to a minimum due to capital and liquidity constraints.

         Our operations have been, and will continue to be, dependent upon
management's ability to raise operating capital in the form of debt or equity.
Management can give no assurances that funding will be available to the company
on terms acceptable to the company, or at all, particularly in light of MDI's
current financial condition. In addition, the Company cannot rely on internal
sources of liquidity given the current cash flow from operations. We have
incurred significant operating losses since inception and expect that
significant on-going operating expenditures will be necessary to successfully
implement our business plan and develop, manufacture and market our products, as
well as fund operations, including the satisfaction of accounts payable and
repayment of debt. As a result of capital and liquidity constraints, we
significantly reduced our staff and all other operating expenditures during 2003
and through September 30, 2004.

         These circumstances raise substantial doubt about our ability to
continue as a going concern. As noted above, there can be no assurance that we
will be able to obtain additional capital or generate revenues to meet our
current operating needs or to complete pending or contemplated licenses or
acquisitions of technologies. If we are unable to raise sufficient adequate
additional capital or generate profitable sales revenues, we may be forced to
substantially curtail product research and development, clinical trials and
other activities, and may be forced to cease operations.



                                       25
<PAGE>

Item 3.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures

         Our principal executive officer and principal financial officer have
reviewed and evaluated the effectiveness of the Company's disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under
the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the
end of the period covered by this quarterly report. Our principal executive
officer and principal financial officer have concluded, based on that
evaluation, which included inquiries made to certain other employees of the
Company, that our disclosure controls and procedures are effective to ensure
that information required to be disclosed by MDI in the reports filed or
submitted by us under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified by the SEC's rules and forms. We
continue to make progress to improve our internal control systems and address
any deficiencies.

Changes in Internal Control over Financial Reporting

         During the quarter to which this report relates, there was no change in
our internal control over financial reporting that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.

Part II. Other Information

Item 1.  Legal Proceedings

         See Note 11 - Legal Proceedings for a discussion of the most recent
events regarding the Company's pending and threatened legal proceedings.

Item 2.  Unregistered Sales of Securities and Use of Proceeds

Issuance of Securities

         Common Stock. In August 2004, MDI offered common stock to accredited
investors in exchange for cash. The Company received $275,000 and issued
2,750,000 shares of restricted common stock.

         In August 2004, MDI issued 924,333 shares of common stock in exchange
for services to a non-employee professional services firm for past services. MDI
calculated a fair value of $92,433 for these shares based on the value of the
shares on the date of issuance and recorded the amount as satisfaction of the
vendor's accounts payable balance as of September 30, 2004.

         In August 2004, MDI issued 1,200,000 shares of common stock in exchange
for services to a non-employee financial consultant for future services. MDI
calculated a fair value of $120,000 for these shares based on the value of the
shares on the date of issuance and is amortizing the amount over the remainder
of the service contract.

         In September 2004, MDI issued 572,748 shares of common stock to a
non-employee service vendor in lieu of payment for unpaid invoices. MDI
calculated a fair value of $57,275 for these shares based on the market value of
the shares on the date of issuance and recorded the amount as satisfaction of
the vendor's accounts payable balance as of September 30, 2004 based on a
settlement agreement.

         In September 2004, MDI issued 275,000 shares of common stock to a
non-employee financial consultant for past financial services. MDI calculated a
fair value of $27,500 for these shares based on the value of the shares on the
date of issuance and recorded the amount as an administrative expense as of
September 30, 2004.

         In September 2004, MDI issued 250,000 shares of common stock to a
non-employee professional services firm for past investor relations services.
MDI calculated a fair value of $25,000 for these shares based on the value of
the shares on the date of the issuance and recorded the amount as an
administrative expense as of September 30, 2004.



                                       26
<PAGE>

         Warrants. In August 2004, MDI issued warrants to purchase 500,000
shares of common stock of the Company with an exercise price of $0.17 per share
to a non-employee consultant for past services. MDI valued the warrants at
$45,000 using the Black-Scholes valuation model and recorded the amount as a
current quarter administrative expense.

         In September 2004, MDI issued warrants to purchase an aggregate 200,000
shares of common stock of the Company with an exercise price of $0.10 per share
to a non-employee professional services firm for past investor relations
services. MDI valued the warrants at $18,400 using the Black-Scholes valuation
model and recorded the amount as a current quarter administrative expense.

         In September 2004, MDI issued warrants to purchase 20,000 shares of
common stock of the Company with an exercise price of $0.20 per share to a
non-employee consultant for past services. MDI valued the warrants at $1,780
using the Black-Scholes valuation model and recorded the amount as a current
quarter administrative expense.

         In September 2004, MDI issued warrants to purchase 25,000 shares of
common stock of the Company with an exercise price of $0.20 per share to a
non-employee service vendor in lieu of payment for unpaid services. MDI valued
the warrants at $2,250 using the Black-Scholes valuation model and recorded the
amount as a reduction of the outstanding amount due.

         Each of the above warrants expires five years from the date of issuance
and is exercisable immediately upon issuance. None of the warrants are subject
to any vesting schedules or conditions other than those imposed by applicable
securities laws. The exercise price and number of shares issuable upon exercise
of the warrants are subject to anti-dilution protection in the event the Company
effects a subdivision or combination of its common stock or declares or pays a
dividend or distribution in common stock; the warrants also provide for
adjustments in the event the Company declares or pays a dividend or other
distribution in other securities or property of the Company or is a party to a
reorganization, reclassification, merger or similar event.

Repayment of Note

         Suzanne Gombrich Note. On April 2, 2004, the $1,000,000 Convertible
Promissory Note due to Suzanne M. Gombrich was paid in full and her first
priority security interest in all the Company's assets was released. As of April
2, 2004, the Company repaid $936,114 of principal and accrued interest of
$126,114 on such note. In addition, Mrs. Gombrich agreed to convert the
remaining $190,000 into 1,900,000 shares of common stock of the Company, which
shares were issued on August 31, 2004 subsequent to stockholder approval of an
increase in the number of authorized shares of common stock of the Company.

Conversions

         Three Months Ended September 30, 2004

         Bridge II. During the three months ended September 30, 2004, holders of
an aggregate $55,000 principal amount of Bridge II Convertible Promissory Notes
elected to convert their notes and related accrued interest of $7,900 into
419,159 shares of unregistered common stock of the Company.

         Preferred Series E. During the three months ended September 30, 2004,
holders of Series E Convertible Preferred Stock elected to convert 184 preferred
shares including cumulative dividends into 6,363 shares of unregistered common
stock.

         Nine Months Ended September 30, 2004

         Bridge I. During the nine months ended September 30, 2004, holders of
an aggregate $1,225,000 principal amount of Bridge I Convertible Promissory
Notes elected to convert their notes and related accrued interest of $155,000
into 9,199,228 shares of unregistered common stock of the Company.



                                       27
<PAGE>

         Bridge II. During the nine months ended September 30, 2004, holders of
an aggregate $2,146,000 principal amount of Bridge II Convertible Promissory
Notes elected to convert their notes and related accrued interest of $251,000
into 17,619,242 shares of unregistered common stock of the Company. Included in
the above conversion amounts are amounts due Peter P. Gombrich, the Company's
Chairman, of $305,667 in Bridge II principal and $11,431 in accrued interest
thereon, which were converted into 2,113,987 shares of unregistered common
stock.

         Preferred Stock. During the first nine months of 2004, several holders
converted an aggregate 422,250 share of Series B convertible preferred stock,
including cumulative dividends due thereon, into 2,211,401 shares of
unregistered common stock.

         During the first nine months of 2004, several holders converted an
aggregate 930,000 shares of Series C convertible preferred stock, including
cumulative dividends due thereon, into 5,703,816 shares of common stock.

         During the first nine months of 2004, several holders converted an
aggregate 26,123 shares of Series E convertible preferred stock, including
cumulative dividends due thereon, into 898,517 shares of common stock.

         MDI issues securities in reliance on the safe harbor and exemptions
from registration provided under Rule 506 of Regulation D and/or Section 4(2) of
the Securities Act of 1933, as amended. No advertising or general solicitation
was employed in offering the securities. The offerings and sales or issuances
were made to a limited number of persons, all of whom were accredited investors,
and transfer was restricted by the Company in accordance with the requirements
of applicable law. In addition to representations by the above-referenced
persons, the Company has made independent determinations that all of the
investors were accredited or sophisticated investors, and that they were capable
of analyzing the merits and risks of their investment, and that they understood
the speculative nature of their investment. Furthermore, these investors were
provided with access to MDI's SEC filings.

         See also Note 6 - Notes Payable - Related Parties, Note 7 - Notes
Payable, Note 8 - Stockholders' Equity, and Note 10 - Subsequent Events for a
fuller description of the Company's securities and related events that occurred
prior and subsequent to the quarter ended September 30, 2004, including the
Company's conditional issuance of shares of common stock in connection with the
Seaside equity exchange investment.

Item 3.  Defaults upon Senior Securities

         MDI has failed to make the required principal and interest payments,
constituting events of default, on the following notes payable:

         o        $850,000 in Bridge I convertible promissory notes;

         o        $1,300,000 in Bridge II convertible promissory notes;

         o        $744,000 Monsun AS convertible promissory note;

         o        $148,932 Ungaretti & Harris secured promissory note;

         o        $30,800 Ernst & Young promissory note; and

         o        $21,000 Ventana Medical Systems, Inc. promissory note.

         The notes payable require the holder to notify MDI in writing of a
declaration of default at which time a cure period, as specified in each
individual note, would commence. There is no guarantee that MDI would be able to
cure any event of default if, or when, the holder provides the required written
notice. Other than the Monsun AS convertible promissory note and the note
payable to Ungaretti & Harris, which are the subject of legal actions described
under Part II Item 1 above and Note 11 - Legal Proceedings in the Notes to the
Consolidated Financial Statements included herewith, MDI has not received any
written declarations of default from holders of outstanding notes payable.

Item 4.  Submission of Matters to Vote of Security Holders

         At the Company's Annual Meeting of Stockholders held on July 29, 2004,
the following proposals were adopted by the votes specified below:



                                       28
<PAGE>

1.       To elect the following nominees to serve on the Board of Directors
         until the next annual meeting of stockholders and until their
         successors are elected and qualified:

                                                       FOR             WITHHELD
             Denis M. O'Donnell, M.D.               47,988,110          165,915
             Peter P. Gombrich                      35,317,752        12,836,273
             Alexander M. Milley                    47,479,708          674,317
             John H. Abeles, M.D.                   47,993,473          160,552

2.       To approve an amendment to the Company's Certificate of Incorporation
         (as amended to date) to increase the number of authorized shares of
         Common Stock ($.001 par value) of the Company by 200,000,000 shares
         from 100,000,000 to 300,000,000 shares.

                         FOR          AGAINST      ABSTAIN
                         ---          -------      -------
                      47,382,892      686,148      84,985

3.       To approve an amendment to the Company's 1999 Equity Incentive Plan to
         increase the number of shares of Common Stock authorized for issuance
         under the Plan from 5,500,000 to 20,000,000 shares.

              FOR            AGAINST        ABSTAIN          BROKER NON-VOTES
              ---            -------        -------          ----------------
           27,861,896       1,763,559       199,327             18,329,243

4.       To ratify the appointment of Altschuler, Melvoin and Glasser LLP as
         independent auditors of the Company for the fiscal year ending December
         31, 2004.

                         FOR          AGAINST      ABSTAIN
                         ---          -------      -------
                      47,594,543      56,015       503,467

Item 5.  Other Information

         None

Item 6.  Exhibits

         See the Exhibit Index.

                                   Signatures

         In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

                                      Molecular Diagnostics, Inc.

                                       /s/ Denis M. O'Donnell, M.D.
                                           -----------------------------
                                           Denis M. O'Donnell, M.D.
                                           Chief Executive Officer and
                                             President

                                       /s/ Dennis L. Bergquist
                                           -----------------------------
                                           Dennis L. Bergquist
                                           Chief Financial Officer

Date:    November 15, 2004



                                       29
<PAGE>

                                  EXHIBIT INDEX

Exhibit
Number            Description
------            -----------

3.1               Certificate of Amendment to Certificate of Incorporation, as
                  filed with the Delaware Secretary of State on August 6, 2004.
                  (Incorporated by reference to Exhibit 3.1 to the Company's
                  Quarterly Report on Form 10-QSB filed on August 16, 2004.)

4.1               Common stock purchase warrant issued to consultant on August
                  26, 2004 representing the right to purchase 500,000 shares of
                  common stock of the Company.

4.2               Common stock purchase warrant issued to consultant on
                  September 15, 2004 representing the right to purchase 192,000
                  shares of common stock of the Company.

4.3               Common stock purchase warrant issued to consultant on
                  September 15, 2004 representing the right to purchase 8,000
                  shares of common stock of the Company.

4.4               Common stock purchase warrant issued to consultant on
                  September 15, 2004 representing the right to purchase 25,000
                  shares of common stock of the Company.

4.5               Common stock purchase warrant issued to a vendor on September
                  15, 2004 representing the right to purchase 20,000 shares of
                  common stock of the Company.

4.6               Form of Subscription Agreement for the August 2004 Common
                  Stock offering.

4.7               Stock Purchase Agreement, made as of October 5, 2004, between
                  the Company and Seaside Investments Plc.

4.8               Escrow Agreement, dated as of October 5, 2004, by and between
                  the Company, Gottbetter & Partners, LLP as escrow agent, and
                  Seaside Investments Plc.

4.9               Registration Rights Agreement, dated as of October 5, 2004, by
                  and between the Company. and Seaside Investments Plc.

10.1              Settlement Agreement, effective as of October 14, 2004, by and
                  among the Company, AccuMed and MonoGen, Inc.

10.2              License Agreement, made as of October 14, 2004, by and between
                  MonoGen, Inc., the Company and AccuMed.

31.1              Section 302 certification by principal executive officer.

31.2              Section 302 certification by principal financial officer.

32.1              Section 906 certification by principal executive officer.

32.2              Section 906 certification by principal financial officer.


                                       30