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 June 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 510
                                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 JUly 31, 2004:           81,037,563
                                                          ------------


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



<PAGE>


                           MOLECULAR DIAGNOSTICS, INC.
                         QUARTERLY REPORT ON FORM 10-QSB
                                  JUNE 30, 2004

                                TABLE OF CONTENTS


<TABLE>
<CAPTION>
                                                                                                        PAGE
<S>      <C>                                                                                            <C>
PART I. -- FINANCIAL INFORMATION

Item 1.  Financial Statements

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

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

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

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

Item 2.  Management's Discussion and Analysis or Plan of
                  Operation......................................................................         19

Item 3.  Controls and Procedures.................................................................         25

PART II. -- OTHER INFORMATION

Item 1.  Legal Proceedings.......................................................................         25

Item 2.  Changes In Securities and Small Business Issuer Purchases of Equity Securities..........         25
         .........
Item 3.  Defaults upon Senior Securities.........................................................         27

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

Item 5.  Other Information.......................................................................         28

Item 6.  Exhibits and Reports on Form 8-K........................................................         28

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>
                                                                                                JUNE 30,      DECEMBER 31,
                                                                                                  2004           2003
                                                                                                ---------      --------
                                                                                               (Unaudited)
                                                          ASSETS
<S>                                                                                             <C>            <C>
Current Assets:
Cash and cash equivalents...................................................................    $     410      $     --
Accounts receivables, net of allowance for doubtful accounts of $50 at June 30,
         2004 and December 31, 2003.........................................................           30            26
Inventories   ..............................................................................           75             94
Prepaid financings costs....................................................................           69           307
Prepaid expenses and other current assets...................................................            7             7
                                                                                                ---------      --------
              Total current assets..........................................................          591           434
Fixed Assets, net...........................................................................          389           374
Licenses, patents and technology, net of amortization.......................................        6,664         6,907
                                                                                                ---------      --------
              Total assets..................................................................    $   7,644      $  7,715
                                                                                                =========      ========

                                      LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Checks issued in excess of amounts on deposit...............................................    $      --      $      5
Accounts payable............................................................................        4,450         5,540
Accrued payroll costs.......................................................................        1,410         1,745
Accrued expenses............................................................................        1,161         1,401
Deferred revenue............................................................................           --            50
Due to stockholder..........................................................................           38            53
Lease obligation............................................................................           96           279
Notes payable--related party................................................................          260         1,092
Notes payable ..............................................................................        4,350          6,099
                                                                                                ---------      ---------
              Total current liabilities.....................................................       11,765         16,264
                                                                                                ---------      ---------

Stockholders' Equity (Deficit):
Preferred stock, $0.001 par value;  10,000,000 shares authorized;  1,132,919 and
     2,511,108  shares issued and  outstanding at June 30, 2004 and December 31,
     2003, respectively
     (Liquidation value of all classes of preferred stock $9,587,021 at June 30, 2004)......        7,844        12,894
Common stock, $0.001 par value; 100,000,000 shares authorized; 81,037,610 and
     45,830,928 shares issued and 80,845,522 and 45,638,840 shares outstanding
     at June 30, 2004 and December 31, 2003,
respectively  ..............................................................................           81            46
Additional paid-in-capital..................................................................       43,954        29,553
Treasury stock; 192,088 shares at June 30, 2004 and December 31, 2003.......................         (327)         (327)
Accumulated deficit.........................................................................      (55,640)      (50,673)
Accumulated comprehensive loss--
         Cumulative translation adjustment..................................................          (33)          (42)
                                                                                                ---------      --------
              Total stockholders' equity (deficit)..........................................       (4,121)       (8,549)
                                                                                                ---------      --------
              Total liabilities and stockholders' equity (deficit)                               $  7,644      $  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 SIX MONTHS             FOR THE THREE MONTHS
                                                            ENDED JUNE 30,                  ENDED JUNE 30,
                                                            --------------                  --------------
                                                         2004             2003            2004            2003
                                                      ------------    ------------    ------------    ------------
                                                             (Unaudited)                       (Unaudited)

<S>                                                   <C>             <C>             <C>             <C>
Net revenues ......................................   $        154    $        232    $        101    $         61
Operating expenses
Cost of revenues ..................................             25              89              25               3
Research  and development .........................            485             266             328              59
Selling, general, and administrative expenses .....          3,070           2,807           1,556             970
                                                      ------------    ------------    ------------    ------------
         Total operating expenses .................          3,580           3,162           1,909           1,032
                                                      ------------    ------------    ------------    ------------

Operating loss ....................................         (3,426)         (2,930)         (1,808)           (971)

Other income (expense):
Interest expense -related party ...................            (48)            (35)             (8)            (32)
Interest expense ..................................         (1,137)         (1,254)           (477)         (1,016)
Restructuring settlements .........................            833              --             672              --
Gain on sale of fixed assets ......................             99              --              --              --
Other, net ........................................             10               7              --               5
                                                      ------------    ------------    ------------    ------------
         Total other income (expense) .............           (243)         (1,282)            187          (1,043)
                                                      ------------    ------------    ------------    ------------
Loss from continuing operations before income taxes         (3,669)         (4,212)         (1,621)         (2,014)
Income tax expense ................................             --              --              --              --
                                                      ------------    ------------    ------------    ------------
Loss from continuing operations ...................         (3,669)         (4,212)         (1,621)         (2,014)
Results from discontinued operations ..............             --             (93)             --             (54)
                                                      ------------    ------------    ------------    ------------
 Net loss .........................................         (3,669)         (4,305)         (1,621)         (2,068)

Preferred stock dividend ..........................           (570)           (752)           (258)           (328)
                                                      ------------    ------------    ------------    ------------

Net loss applicable to common stockholders ........   $     (4,239)   $     (5,057)   $     (1,879)   $     (2,396)
                                                      ============    ============    ============    ============

Basic and fully diluted net loss per common share .   $      (0.07)          (0.12)   $      (0.03)   $      (0.06)
                                                      ============    ============    ============    ============

Weighed average number of common shares outstanding     64,826,113      40,868,423      73,839,577      41,551,961
                                                      ============    ============    ============    ============
</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>
                                                                                     SIX MONTHS ENDED
                                                                                         JUNE 30,
                                                                                         --------
                                                                                     2004       2003
                                                                                     ----       ----
                                                                                       (Unaudited)
Operating Activities:
<S>                                                                                <C>        <C>
 Net loss ......................................................................   $(3,669)   $(4,305)
Adjustments to reconcile net loss to net cash used for operating activities:
         Amortization of debt discount .........................................       712      1,024
         Depreciation and amortization .........................................       348        470
         Amortization of fees ..................................................       238        224
         (Gain)/loss on sale of fixed assets ...................................       (99)         1
         Compensation expense related to stock appreciation rights .............        --         11
         Return of fixed assets in exchange for relief of indebtedness .........       149         --
         Stocks, warrants and options issued to non-employees for services .....       920        330
         Changes in assets and liabilities:
              Accounts receivable, net .........................................        (5)       (31)
              Inventories ......................................................        19        298
              Refundable taxes .................................................        --         13
              Due to stockholder ...............................................       (15)        13
              Prepaid expenses and other current assets ........................        --       (111)
              Checks issued in excess of amounts on deposit ....................        (5)        --
              Accounts payable .................................................    (1,020)       266
              Deposits .........................................................        --        (23)
              Lease obligation .................................................      (183)        --
              Deferred revenue .................................................       (50)      (174)
              Accrued expenses .................................................      (186)       259
                                                                                   -------    -------
Net cash used for operating activities .........................................    (2,846)    (1,735)
                                                                                   -------    -------

Investing activities:
Expenditures in licenses, patents and technology ...............................       (20)        --
Purchases of fixed assets ......................................................      (178)       (12)
                                                                                   -------    -------
Net cash used for investing activities .........................................      (198)       (12)
                                                                                   -------    -------

Financing activities:
Proceeds from issuance of convertible notes ....................................     4,236      1,126
Proceeds from issuance of convertible notes, related party .....................        --      1,015
Note issued in payment of an expense ...........................................        67         72
Payment of notes payable .......................................................      (877)      (300)
Proceeds from sale of fixed assets .............................................        28          8
                                                                                   -------    -------
Net cash provided by financing activities ......................................     3,454      1,921
                                                                                   -------    -------

Effect of exchange rate changes on cash and cash equivalents ...................        --          6
                                                                                   -------    -------

Net increase in cash and cash equivalents ......................................       410        180

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

Cash and cash equivalents at end of period .....................................   $   410    $   222
                                                                                   =======    =======

Supplemental  disclosure of cash flow  information:  Cash paid during the period
for:
 Interest ......................................................................   $   135    $    17
Non-cash transactions during the period for:
Financing costs ................................................................   $   919    $   173
Preferred stock and cumulative dividends converted into common stock ...........   $ 6,347    $ 4,378
</TABLE>



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


                                       5
<PAGE>

                           MOLECULAR DIAGNOSTICS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 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 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.

         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 six months of 2004,
MDI raised $4,236,000  through the sale of convertible debt.  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.

NOTE 2.  BASIS OF PRESENTATION

         The  consolidated  financial  statements for the periods ended June 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.  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.

         Certain  information  and  footnote  disclosures  normally  included in
financial statements prepared in accordance with accounting principles generally
accepted  in the  United  States  have been  omitted  pursuant  to the rules and
regulations  of  the  Securities  and  Exchange   Commission.   These  financial


                                       6
<PAGE>

statements should be read in conjunction with the audited  financial  statements
and the notes  thereto  included in our 2003 Annual  Report on Form  10-KSB,  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 reporting  amounts of revenues and
expenses  during the reported  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).

         See  also  the  following   Notes  to  these   consolidated   financial
statements.

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  assesses  licenses,  patents,  and technology
quarterly for impairment.



                                       7
<PAGE>

         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):

<TABLE>
<CAPTION>
                                           JUNE 30,  DECEMBER 31,
                                             2004        2003
                                         (unaudited)

<S>                                        <C>        <C>
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 ..........    (1,992)    (1,729)
                                           -------    -------
                 Total .................   $ 6,664    $ 6,907
                                           =======    =======
</TABLE>


         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 six months ended June 30, 2004 and 2003,  amortization  expense
was $263,000 and $331,000, respectively.

NOTE 5.         ACCRUED EXPENSES

         Accrued expenses included the following (in thousands):

<TABLE>
<CAPTION>
                                         JUNE 30,    DECEMBER 31,
                                           2004          2003
                                        (unaudited)

<S>                                        <C>          <C>
Accrued interest .......................   $  650       $  704
Accrued interest--related party ........       25          115
Accrued franchise taxes ................      476          476
Other accrued expenses .................       10          106
                                           ------       ------
        Total ..........................   $1,161       $1,401
                                           ======       ======
</TABLE>


         MDI was  delinquent  in filing  certain  federal  and state  income tax
returns for 2002 and 2001 and intends to complete the filing requirements within
the next 90 to 120 days.  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.  Delinquent  federal  payroll taxes relating to 2003 and 2002 were paid in
full in April 2004.

         The Company owed $466,000 and $686,000 as of June 30, 2004 and December
31,  2003,  respectively,  including  $85,000  and  $258,000,  respectively,  in
assessed and estimated statutory penalties and interest. MDI is currently in the
process of  communicating  through  counsel  with the Internal  Revenue  Service
regarding payment of the balance due and made a payment of approximately $77,000
on August 12,  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 resolution is not reached with
the Internal  Revenue  Service.  These amounts were included in accrued  payroll
costs in the accompanying balance sheet.




                                       8
<PAGE>

NOTE 6.          NOTES PAYABLE--RELATED PARTIES

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

<TABLE>
<CAPTION>
                                                                                            JUNE 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).....................................       190          761
                                                                                             -------       ------
                     TOTAL:                                                                  $   260       $1,092
                                                                                             =======       ======
</TABLE>


         Suzanne  Gombrich  Note.  On  April  2,  2004,  the  Company  paid  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,  therefore,  the  1,900,000  shares  will be  issued  to Mrs.  Gombrich  in
satisfaction of her remaining debt. (See Footnote 10: Subsequent Events)

         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 $37,936 and $52,953 at June 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 June 30, 2004 and December 31, 2003.


                                       9
<PAGE>

NOTE 7.           NOTES PAYABLE

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

<TABLE>
<CAPTION>
                                                                                                 JUNE 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.............................       1,326        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......................................................          97           --
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......................................................         896           --
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..................         708          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........................................................................          14           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.......          31           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.........................................         214          222
                                                                                                 ---------      -------
                     TOTAL:                                                                      $   4,350      $ 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,  which  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,  the
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 June 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 June 30, 2004.

         For the six months ended June 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 June 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 $320,689 and $1,826,743 to reflect
amortization  of the discount during the six months ended June 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 six months ended June 30, 2004, holders of $2,091,000 principal
amount of Bridge II Convertible  Promissory Notes elected to convert their notes
and related accrued interest of $243,000 into 17,200,083  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 $1,340,000 in principal Bridge II notes
remained unconverted and outstanding at June 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


                                       11
<PAGE>

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.

         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.

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  $38,014  to  reflect
amortization of the discount during the six months ended June 30, 2004.  Through
June 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 $113,799
to reflect  amortization  of the  discount  during the six months ended June 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 June 30, 2004, the Company had issued  $2,574,000 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 15% 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


                                       12
<PAGE>

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.

         Monsun has  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 has agreed
to pay Mr. Gombrich's legal costs to defend him against this action.  During the
first  quarter of 2004,  Monsun was  successful  in  obtaining a legal  judgment
against  Peter  Gombrich  as the  personal  guarantor  of the note.  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 June 30, 2004 and December 31, 2003.


NOTE 8.           STOCKHOLDERS' EQUITY

         The Company's preferred stock consist of the following:

<TABLE>
<CAPTION>
                                                                                   JUNE 30,          DECEMBER 31,
                                                                                     2004                2003
                                                                                     ----                ----
                                                                                SHARES ISSUED &     SHARES ISSUED &
         ISSUE                                                                    OUTSTANDING         OUTSTANDING
                                                                                  (unaudited)

<S>                                                                                    <C>                <C>
         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.....................           234,825            260,764
                                                                                  -----------        -----------
Total Preferred Stock......................................................         1,132,919          2,511,108
                                                                                  ===========        ===========
</TABLE>

         During the first six 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


                                       13
<PAGE>

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.

<TABLE>
<CAPTION>
         SUMMARY OF PREFERRED STOCK TERMS
<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 at June 30, 2004 were $516,596

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 at June 30, 2004 were $210,087

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 at June 30, 2004 were $466,506

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 at June 30, 2004 were $1,296,658
</TABLE>

         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.



                                       14
<PAGE>

         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.

         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.

         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 5.33% and 6% for
the June 30, 2004 and 2003 periods, respectively, volatility factors of 173% 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

         On May 25, 1999, MDI  stockholders  approved the  establishment  of the
1999 Equity  Incentive Plan (the "Plan")  effective as of June 1, 1999. The Plan
provides  that the  Board  may  grant  various  forms of  equity  incentives  to
directors,  employees,  and consultants,  including but not limited to incentive
stock options,  non-qualified  stock options,  stock  appreciation  rights,  and
restricted  stock awards.  Grants under the Plan are  exercisable at fair market
value  determined  as of the date of grant in  accordance  with the terms of the
Plan.  Grants vest  immediately or ratably over periods ranging from two to five
years, and expire five to ten years from the date of grant.

         On May 23, 2000,  stockholders  approved  Amendment  No. 1 to the Plan,
which increased the number of shares of common stock allocated for use under the
Plan from 2,000,000 shares to 3,000,000 shares.  On June 21, 2002,  stockholders
approved a second  amendment to the Plan,  which  increased the number of shares
allocated for use under the Plan from 3,000,000 shares to 5,500,000  shares.  On
July 29,  2004,  stockholders  approved  a third  amendment  to the Plan,  which
increased the number of shares of common stock  allocated for use under the Plan
from 5,500,000 shares to 20,000,000 shares.

         The Board of  Directors  has also  granted  options to purchase  common
stock of MDI that are not covered by the terms of the Plan.



                                       15
<PAGE>

         MDI applies APB No. 25, "Accounting for Stock Issued to Employees," and
related interpretations in accounting for options granted to employees under the
Plan.  No  compensation  cost was recorded  during the six months ended June 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:

<TABLE>
<CAPTION>
                                                                 FOR THE SIX MONTHS ENDED,  FOR THE THREE MONTHS ENDED
                                                                          JUNE 30,                    JUNE 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...............................    $  (4,239)    $ (5,057)    $ (1,879)    $  (2,426)
Deduct: Total stock-based compensation
      expense determined under the fair value based
             method for all awards, net of related taxes......         (171)          33          (14)          (16)
                                                                  ----------    --------     ---------    ----------
PRO FORMA NET LOSS APPLICABLE TO
      COMMON SHAREHOLDERS.....................................    $  (4,410)    $ (5,024)    $ (1,893)    $  (2,442)
                                                                  ==========    =========    =========    ==========

Basic loss per share applicable to common
shareholders - as reported....................................    $     (.07)   $   (.12)    $   (.03)    $    (.06)
                                                                  ===========   =========    =========    ==========
Basic loss per share applicable to
         common shareholders - pro forma......................    $     (.07)   $   (.12)    $   (.03)    $    (.06)
                                                                  ===========   =========    =========    ==========
</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 5.33% and 6% for the June 30, 2004 and
2003 periods,  respectively,  volatility factors of the expected market price of
the Company's  common stock of 173% 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:


<TABLE>
<CAPTION>
                                                                                               WEIGHTED AVERAGE
                                                                                 OPTIONS        EXERCISE PRICE
<S>                                                                             <C>            <C>
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
Forfeited.........................................................               (253,588)        $  0.4845
                                                                                ---------
OUTSTANDING AT JUNE 30, 2004......................................              5,741,060
                                                                                =========
EXERCISABLE AT JUNE 30, 2004......................................              3,955,060         $  0.9681
                                                                                =========
</TABLE>

         At the Annual Meeting on May 25, 1999, the  stockholders  also approved
the Employee  Stock  Purchase Plan (the "ESPP").  The ESPP offers  employees the
opportunity  to  purchase  shares  of  common  stock of MDI  through  a  payroll


                                       16
<PAGE>

deduction  plan at 85% of the fair  market  value of such  shares  at  specified
enrollment  measurement  dates.  The  aggregate  number of shares  available for
purchase under the ESPP is 200,000.


NOTE 10.          SUBSEQUENT EVENTS

         STOCKHOLDERS' MEETING

         On July 29,  2004,  the  Company  held its  2004  annual  stockholders'
meeting.  At the meeting,  stockholders  approved an amendment to the  Company's
Certificate  of  Incorporation  (as amended to date) to  increase  the number of
authorized  shares of  common  stock,  par  value  $.001,  of the  Company  from
100,000,000  shares to  300,000,000  shares.  The approval of such increase will
permit the  Company to issue  shares it was  obligated  to issue  contingent  on
stockholder  approval,  including but not limited to 1,900,000 shares to Suzanne
Gombrich  in complete  satisfaction  of the  Company's  note  obligation  and an
aggregate 1,150,000 shares to non-employee professional service firms.

         As noted  above,  the  stockholders  also  approved an amendment to the
Company's 1999 Equity  Incentive Plan to increase the number of shares of common
stock available for issuance under the Plan from 5,500,000  shares to 20,000,000
shares.  In  addition,   the  stockholders  also  ratified  the  appointment  of
Altschuler,  Melvoin and Glasser LLP as independent auditors for the Company for
the fiscal year ending  December 31, 2004 and elected  members to the  Company's
Board of Directors.

NOTE 11.          LEGAL PROCEEDINGS

         Bowne of Chicago, Inc. On January 2, 2003, Bowne of Chicago, Inc. filed
suit against MDI (Circuit Court of Cook County, County  Department-Law  Division
(Case No. 03 L 000009))  claiming  approximately  $342,000,  plus  interest  and
attorney fees and costs,  related to financial printing service fees provided by
Bowne during the period October 25, 2001 through  November 7, 2002. In May 2004,
MDI entered into a settlement  agreement with Bowne,  which requires 24 payments
of $16,667, or a total sum of $200,000. As part of the settlement, MDI agreed to
have a judgment  in the amount of  $342,061  entered  against it. As long as MDI
honors the  agreed-upon  monthly  payments,  Bowne has  agreed to  refrain  from
enforcing the entire agreed judgment amount.

         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 $13,187  each.  MDI has made the first four
required monthly payments. MDI also agreed to issue 280,000 shares of its common
stock as part of the final settlement. The issuance of the shares was subject to
shareholder  approval  of the  increase  in the number of  authorized  shares of
common stock of the Company, discussed above.

         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,


                                       17
<PAGE>

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 in the amount of $675,000.  Monsun is
currently seeking to obtain an additional $545,000 to cover legal fees and costs
incurred in enforcing the guaranty  agreement.  Since Mr.  Gombrich's  potential
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.  Management  and  counsel are unable to
determine the result of this pending litigation as of June 30, 2004.

         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.

         The parties are presently engaged in settlement  negotiations,  but the
Company cannot predict whether those negotiations will be successful.

         Patterson.  On April 14,  2003,  the Company  received  notice from the
attorney for the licensor,  Dr. Bruce  Patterson,  M.D., Ph.D, under the License
and Development Agreement covering certain HPV technology, which forms the basis
for our In-Cell HPV test, indicating that the licensor intended to terminate the
license  in  accordance  with a  specific  clause of the  license  that  permits
termination  in the event the  Company  makes an  assignment  for the benefit of
creditors or bankruptcy,  or otherwise  relinquishes or loses control of all its
assets.  On April 15, 2003,  we informed the attorney that the facts used by the
licensor to invoke the termination  right were incorrect,  that we were still in
control of all of our  assets,  and that such  assets  were  pledged as security
under debt  instruments  but that such pledges  were not  included  under events
which would permit the licensor to terminate the license.  MDI believes that MDI
would prevail should the licensor attempt to pursue a termination action.

         Invirion. On July 2, 2003, Dr. Patterson and his company Invirion, Inc.
filed suit against MDI in the Circuit Court of Cook County,  Illinois  (Case No.
03 L 7995). Dr. Patterson seeks approximately $86,000 that he claims is due from
MDI under an agreement for his scientific consulting services. This is a dispute
with the licensor over  completion  of the third  milestone of the license under
which completion  requires process and procedure  verification by an independent
third party. This verification requirement has not been satisfied as of yet, and
therefore,  MDI is contesting this claim.  Invirion,  in a separate claim, seeks
approximately $57,500 for certain HPV test kits that it claims were sold to MDI.
MDI is engaged in  settlement  discussions  with Dr.  Patterson  and Invirion to
resolve all outstanding  issues,  including those discussed above with regard to
the License and Development Agreement.

         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,


                                       18
<PAGE>

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 have tentatively agreed to monetary  settlement terms, but have
not yet executed a final settlement agreement.

         Eric  Gombrich.  On May 19, 2004,  Eric Gombrich filed suit against the
Company in the Circuit Court of Cook County,  Illinois (04 L 5661). Mr. Gombrich
claims  that MDI  breached a written  employment  contract  and that it owes him
approximately  $630,000 (plus  interest) and 300,000 shares of MDI common stock.
Although MDI made  initial  attempts to resolve  this  dispute,  it is currently
contesting Mr. Gombrich's action.

         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. The parties are currently  engaged in
settlement discussions.

         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 engaged in 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.

         West  Virginia  Rescission  Offer.  By letter dated July 26, 2004,  the
Securities  Commission of the West Virginia Office of the State Auditor informed
the Company of a violation of the state's registration requirements with respect
to sales of MDI  securities  to residents  of West  Virginia.  Specifically,  an
individual  engaged by the Company who solicited  sales of MDI  securities  from
West Virginia investors and received  compensation in connection with such sales
was not  appropriately  registered with the state as a  broker-dealer  or issuer
agent. The Company therefore was not entitled to rely on an exemption from state
registration  for  sales  in  the  jurisdiction.   After  discussions  with  the
Securities  Commission,  the  Company  agreed  to make an  offer to the two West
Virginia investors to rescind their purchase of Company securities and receive a
full  refund.  Both  investors  declined  the  Company's  rescission  offer  and
therefore the Company will not be required to refund their investments.

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,"   and   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.

         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


                                       19
<PAGE>

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.

         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  Report on Form 10-QSB for the
quarter ended March 31, 2004.

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 six months of 2004,
MDI raised $4,236,000  through the sale of convertible debt.  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.


                                       20
<PAGE>

RESULTS OF OPERATIONS

                THREE MONTHS ENDED JUNE 30, 2004 AS COMPARED TO
                        THREE MONTHS ENDED JUNE 30, 2003

REVENUE


         Revenue  of  $101,000   for  the  three  months  ended  June  30,  2004
represented an increase of $40,000 or 65.6% over revenue of $61,000 for the same
period in 2003.  This increase was  primarily the result of deferred  revenue of
$50,000 being recorded upon the shipment of two automated  microscopy systems in
connection with a settlement with a prior customer.

COSTS AND EXPENSES

         Cost of Goods Sold

         Cost of goods  sold for the  three  months  ended  June 30,  2004  were
$25,000,  an increase  of $22,000 or 733.3%  over the same  period in 2003.  The
increase related to the shipment of the two automated  microscopy systems during
the period.

         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 $269,000 to $328,000 for the three-month period
ended June 30, 2004, an increase of 455.9% 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.  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 begun 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")  increased
$586,000 to  $1,556,000  for the  three-month  period  ended June 30,  2004,  an
increase of 60.4% over the period ended June 30, 2003.  This  increase  included
increases of $613,000 in financing  costs and $70,000 in legal and  professional
fees,   and  was  offset  by  a  decrease  of  $97,000  in  other   general  and
administrative costs.

         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.


                                       21
<PAGE>

OTHER INCOME AND EXPENSE

         Interest Expense

         Interest  expense,  including  interest  expense  to  related  parties,
decreased  $563,000 for the quarter ended June 30, 2004 to $485,000,  a decrease
of  53.7%  over the  quarter  ended  June 30,  2003.  Bridge  I, II,  III and IV
convertible  promissory  notes  in  principal  amounts  totaled  $6,440,000  and
$4,876,000  for the  periods  ended June 30,  2004 and 2003,  respectively.  The
change  included  an  increase  in  interest  expense of $60,000  related to the
increase in the notes and a decrease of $623,000  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 June 30, 2004 in
relation to the  shorter  maturity  periods of the Bridge I and II notes  issued
during the period ended June 30, 2003.

         Restructuring Settlements

         For the three months ended June 30,  2004,  MDI recorded  $672,000 as a
gain from the settlement of various  litigation and credit payment matters.  For
the same three-month  period ended June 30, 2003, the Company did not record any
restructuring settlement amounts.

NET LOSS

         The net loss for the  three-month  period  ended June 30,  2004  before
preferred  dividends totaled  $1,621,000,  compared with $2,068,000 for the same
period in 2003, a decrease of $447,000 or 21.6%.  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  $258,000 for the quarter
ended June 30, 2004,  compared  with  $328,000 for the same period in 2003.  The
combined net loss applicable to common  stockholders  for the three months ended
June 30, 2004 of $1,879,000 or $0.03 per share, on 73,839,577  weighted  average
common shares outstanding,  compared with the net loss and net loss available to
common stockholders for the three-month period ended June 30, 2003 of $2,396,000
or $0.06 per share, on 41,551,961 weighted average common shares outstanding.

         The weighted average shares  outstanding  during the three months ended
June 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  5,680,883
shares of  common  stock;  the  Series B, C and E  convertible  preferred  stock
conversions  resulted in the issuance of an aggregate 3,230,198 shares of common
stock.


                  SIX MONTHS ENDED JUNE 30, 2004 AS COMPARED TO
                         SIX MONTHS ENDED JUNE 30, 2003

REVENUES

         Revenues for the six months ended June 30, 2004 decreased  $78,000,  or
33.6%,  to $154,000 from revenues of $232,000 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.

COSTS AND EXPENSES

         Cost of Goods Sold

         Cost of goods sold for the six months ended June 30, 2004 were $25,000,
a decrease of $64,000 or 71.9% over the same  period in 2003.  The cost of goods
sold amount is related to the shipment of the two automated  microscopy systems.
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.


                                       22
<PAGE>

         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  $219,000 to $485,000 for the six-month  period
ended June 30, 2004,  an increase of 82.3% 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.  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 consist of costs related to specific  development programs
with scientists and researchers at universities and hospitals; full scale device
development contracts begun 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

         SG&A  increased  $263,000  for the six months  ended  June 30,  2004 to
$3,070,000,  an increase of 9.4% over the same period ended June 30, 2003.  This
change  included an increase of  $272,000  in  financing  costs,  an increase of
$188,000 in legal and professional fees and was offset by a decrease of $197,000
in other general and administrative costs.

         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 $104,000 for the six-month period ended June 30, 2004 to $1,185,000, a
decrease  of 8.1%  over  the  same  period  of 2003.  Bridge  I, II,  III and IV
convertible  promissory  notes  in  principal  amounts  totaled  $6,440,000  and
$4,876,000  for the  periods  ended June 30,  2004 and 2003,  respectively.  The
change  included  an increase  in  interest  expense of $208,000  related to the
increase in the notes and a decrease of $312,000  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 June 30, 2004 in
relation to the  shorter  maturity  periods of the Bridge I and II notes  issued
during the period ended June 30, 2003.

         Restructuring Settlements

         For the six months ended June 30, 2004, MDI recorded $833,000 as a gain
from the settlement of various  litigation and credit payment  matters.  For the
same  six-month  period  ended June 30,  2003,  the  Company  did not record any
restructuring settlement amounts.

NET LOSS

         The net loss for the  six-month  period  ended  June  30,  2004  before
preferred  dividends totaled  $3,669,000,  compared with $4,305,000 for the same
period in 2003, a decrease of $636,000 or 14.8%.  The decrease was primarily the
result of reduced operating  capacity due to capital and liquidity  constraints.


                                       23
<PAGE>

In addition,  cumulative dividends on the outstanding Series B, Series C, Series
D and Series E convertible  preferred  stock totaled  $570,000 for the six-month
period ended June 30, 2004,  compared with $752,000 for the same period in 2003.
The combined net loss applicable to common stockholders for the six months ended
June 30, 2004 of $4,239,000 or $0.07 per share, on 64,826,113  weighted  average
common shares outstanding,  compared with the net loss and net loss available to
common  stockholders  for the six-month period ended June 30, 2003 of $5,057,000
or $0.12 per share, on 40,868,423 weighted average common shares outstanding.

         The weighted  average  shares  outstanding  during the six months ended
June 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  26,399,311
shares of  common  stock;  the  Series B, C and E  convertible  preferred  stock
conversions  resulted in the issuance of an aggregate 8,807,371 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.  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  $2,846,000  and  $1,735,000 for the first six months ended
June 30, 2004 and 2003, respectively, to support our operating activities.

         As of the six  months  ended  June  30,  2004,  we had  cash on hand of
$410,000,  an  increase of  $410,000  over cash on hand at December  31, 2003 of
zero. This increase  resulted from the receipt of bridge  financing funds during
the period, as discussed below.

         Beginning in January  2004,  Bathgate  Capital  Partners,  LLC began an
issue of 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. The holders were also granted a security position in all of
the  Company's  assets.  MDI granted each note holder the right to receive a 25%
warrant coverage on all money invested;  therefore, for every $100,000 invested,
an investor will receive 25,000 warrants to purchase common stock at an exercise
price of $0.15.  The warrants  will expire on December  31, 2008.  For the three
months  ended June 30,  2004 the  Company  had issued  $1,662,500  in Bridge III
convertible promissory notes.

         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
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. MDI granted
each note  holder  the  right to  receive a 25%  warrant  coverage  on all money
invested;  therefore,  for every  $100,000  invested,  an investor  will receive
25,000  warrants to purchase  common  stock at an exercise  price of $0.15.  The
warrants  will expire on December 31, 2008.  Through June 30, 2004 and March 31,
2004  the  Company  had  issued  $1,281,500  and  $1,292,000,  respectively,  in
principal amount of Bridge IV Convertible Promissory Notes in exchange for cash.

         We incurred  approximately  $178,000 in capital expenditures during the
first six months of 2004 as compared to capital  expenditures of $12,000 for the
first six months of 2003,  an increase of  1,383.3%.  Capital  expenditures  are
defined as  disbursements  for  laboratory  equipment,  leasehold  improvements,


                                       24
<PAGE>

software, and  furniture/fixtures  with a purchase price in excess of $1,000 per
item and 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.
We have incurred  significant  operating losses since inception.  We expect that
significant  on-going  operating  expenditures will be necessary to successfully
implement our business plan and develop, manufacture and market our products. As
a result of capital and  liquidity  constraints,  we  significantly  reduced our
staff and all other  operating  expenditures  during  2003 and the first half of
2004,  and will continue that focus during the remainder of this fiscal year and
beyond.  These  circumstances  raise  substantial  doubt  about our  ability  to
continue as a going  concern.  There can be no assurance that we will be able to
obtain  additional  capital 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.


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  to  the  Consolidated   Financial
Statements  included herein for a discussion of the most recent events regarding
the Company's pending and threatened legal proceedings.

ITEM 2.  CHANGES IN SECURITIES AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY
         SECURITIES

CHARTER AMENDMENT

         At the  Company's  Annual  Meeting of  Stockholders  on July 29,  2004,
stockholders approved an amendment to the Company's Certificate of Incorporation
(as amended to date) to increase the number of authorized shares of common stock
of the Company from  100,000,000  to  300,000,000  shares.  The Company  filed a
Certificate  of  Amendment  to its  charter  to effect  such  increase  with the
Delaware Secretary of State on August 6, 2004.

ISSUANCE OF SECURITIES

         Bridge III  Convertible  Promissory  Notes.  Beginning in January 2004,
Bathgate  Capital  Partners,  LLC  began  an  issue of  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


                                       25
<PAGE>

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. The holders
were also  granted a  security  position  in all of the  Company's  assets.  MDI
granted  each note  holder the right to receive a 25%  warrant  coverage  on all
money invested; therefore, for every $100,000 invested, an investor will receive
25,000  warrants to purchase  common  stock at an exercise  price of $0.15.  The
warrants  will expire on December 31, 2008.  For the three months ended June 30,
2004 the  Company had issued  $1,662,500  in Bridge III  convertible  promissory
notes.

         Bridge IV Convertible Promissory Notes. 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 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.  MDI  granted  each note  holder the right to
receive a 25%  warrant  coverage  on all money  invested;  therefore,  for every
$100,000  invested,  an investor will receive 25,000 warrants to purchase common
stock at an exercise  price of $0.15.  The warrants  will expire on December 31,
2008. Through June 30, 2004 and March 31, 2004 the Company had issued $1,281,500
and  $1,292,000,  respectively,  in  principal  amount of Bridge IV  Convertible
Promissory Notes in exchange for cash.

         Warrants.  In March 2004,  MDI issued 67,000  warrants 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 a current  quarter  administrative
expense.

         In March 2004,  MDI issued  500,000  warrants 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 a current quarter administrative expense.

         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.

         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.

         Each of the above warrants expires five years from the date of issuance
and is  exercisable  immediately  upon  issuance,  or  became  exercisable  upon
stockholder  approval  of the  increase  in the number of  authorized  shares of
common  stock of the  Company.  None of the  warrants are subject to any vesting
schedules  or  conditions  except as set forth in the  preceding  sentence.  The


                                       26
<PAGE>

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
such shares can now be issued following  stockholder  approval of an increase in
the number of  authorized  shares of common stock of the  Company.  (See Note 10
-Subsequent Events).

CONVERSIONS

         Bridge I  Conversions.  From  January 1, 2004  through  June 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.

         Bridge II  Conversions.  From  January 1, 2004  through  June 30, 2004,
holders of an aggregate  $2,091,000  principal  amount of Bridge II  Convertible
Promissory  Notes elected to convert their notes and related accrued interest of
$243,000 into  17,200,083  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  Conversions.  During  the first  six  months of 2004,
several holders converted 422,250 share of Series B convertible preferred stock,
including  cumulative  dividends due thereon,  into  2,211,401  shares of common
stock.

         During the first six 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.

         During the first six months of 2004,  several holders  converted 25,939
shares of Series E convertible  preferred stock,  including cumulative dividends
due thereon, into 892,154 shares of common stock.

         MDI is issuing  such  securities  in  reliance  on the safe  harbor and
exemptions from registration provided under Rule 506 of Regulation D and 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 such act. 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 our 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 ending June 30, 2004.

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     $1,340,000 in Bridge II convertible promissory notes
            o     $708,000 Monsun AS convertible promissory note;



                                       27
<PAGE>

            o     $148,932 Ungaretti & Harris secured promissory note;
            o     $30,800 Ernst & Young promissory note; and
            o     $31,000 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 in Notes to  Consolidated  Financial  Statements,
Note 11 - Legal  Proceedings,  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

         None

ITEM 5.  OTHER INFORMATION

         None

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         (a)  Exhibits

                  See Exhibit Index

         (b)  Reports on Form 8-K

                  None


                                       28
<PAGE>

                                   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:    August 16, 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.

4.1       Common stock  purchase  warrant  issued to  consultant  on May 5, 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 June 4, 2004
          representing  the right to purchase  530,000 shares of common stock of
          the Company.

4.3       Common stock  purchase  warrant  issued to  consultant on June 4, 2004
          representing  the right to purchase  250,000 shares of common stock of
          the Company.

4.4       Form of common  stock  purchase  warrant  issued to private  placement
          agents  on June  15,  2004  representing  the  right  to  purchase  an
          aggregate 681,625 shares of common stock of the Company.

4.5       Form of common stock purchase warrant issued to vendors as part of our
          restructuring  settlements during the three months ended June 30, 2004
          representing  the right to purchase  an  aggregate  483,984  shares of
          common stock of the Company.


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.




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