<PAGE>
 
                                  FORM 10-QSB
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

             [X] Quarterly Report Pursuant to Section 13 or 15(d)
                    of the Securities Exchange Act of 1934

              For the quarterly period ended September 30, 1996
                                             ------------------

                                      OR

             [_] Transition Report Pursuant to Section 13 or 15(d)
                    of the Securities Exchange Act of 1934

       For the transition period from _______________ to _______________

                        Commission file number  0-21384
                                               ---------

                     INTERACTIVE MEDICAL TECHNOLOGIES LTD.
            -------------------------------------------------------
            (Exact name of registrant as specified in its charter)

               Delaware                                   13-3367421
     -------------------------------                -----------------------
     (State or other jurisdiction of                   (I.R.S. employer
      incorporation or organization)                 identification number)

     1717 Stewart Street, Santa Monica, California            90404
     ---------------------------------------------------------------------
        (Address of principal executive offices)            (Zip Code)

      Registrant's Telephone number, including area code: (310) 586-5532
                                                          --------------

      2193 Pontius Avenue, Los Angeles, California                 90025
      ------------------------------------------------------------------
 (former, name, address and former fiscal year, if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.        Yes  X       No 
                                              ---         ---

State the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date.

                                                Outstanding at
                Class of Common Stock          October 31, 1996
                ---------------------          -----------------
                   $.001 par value             45,902,040 shares
 
       Transitional Small Business Disclosure Format      Yes     No  X
                                                              ---    ---
 
          Number of sequentially numbered pages in the document:  26
                                                                 ----

<PAGE>
 
                                  FORM 10-QSB
                      Securities and Exchange Commission
                            Washington, D.C. 20549

                     INTERACTIVE MEDICAL TECHNOLOGIES LTD.

                                     Index

<TABLE>
<CAPTION>
 

<S>                                                                         <C>
PART I - FINANCIAL INFORMATION                                              Page
                                                                            ----

     Item 1. Consolidated Financial Statements

             Condensed Consolidated Balance Sheets at
              December 31, 1995 and September 30, 1996 (unaudited)             3
 
             Condensed Consolidated Statements of Operations
              for the three and nine months ended September 30, 1995 
              (unaudited) and 1996 (unaudited)                                 5
 
             Condensed Consolidated Statements of Cash Flows
              for the nine ended September 30, 1995 (unaudited)
              and 1996 (unaudited)                                             6
 
             Notes to Condensed Consolidated Financial Statements              7
 
     Item 2. Management's Discussion and Analysis of Financial Condition
              and Results of Operations.                                      14
 
     Item 3. Legal Proceedings                                                20
 
 
PART II. - OTHER INFORMATION
 
     Item 5. Other Information                                                25
 
     Item 6. Exhibits and Reports on Form 8-K                                 25
 
Signatures                                                                    26
 
</TABLE>

                                      -2-
<PAGE>
 
                        PART I.  FINANCIAL INFORMATION
                        ------------------------------


             INTERACTIVE MEDICAL TECHNOLOGIES LTD AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                   DECEMBER 31, 1995 AND SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
 
                                                              ASSETS
                                                              ------
                                                                                               December 31,      September 30,
                                                                                                  1995               1996
                                                                                               ------------      -------------
<S>                                                                                            <C>               <C>
                                                                          
CURRENT ASSETS                                                            
 Cash                                                                                          $  374,128        $  239,573
 Accounts Receivable, net of allowance for doubtful                       
   accounts of $20,516 in 1995 and $180,516 in 1996                                                65,377            82,740
 Interest receivable, net of allowance for doubtful                       
   accounts of $59,615 in 1995 and $55,615 in 1996                                                     --                --
 Notes receivable from shareholder, net of allowance                      
   for doubtful accounts of $16,548 in 1995 and $141,548                  
   in 1996                                                                                             --                --
 Leases receivable                                                                                 79,241           145,547
 Inventories                                                                                           --           109,800
 Prepaid Expenses                                                                                      --             7,112
 Due from related parties, net of allowance for doubtful                  
   accounts of $109,593 in 1995 and 1996                                                            1,725             1,725
                                                                                               ----------        ----------
      TOTAL CURRENT ASSETS                                                                        520,471           586,497
                                                                                               ----------        ----------
                                                                          
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS,                           
 at cost, net of accumulated depreciation and amortization of             
 $1,303,661 in 1995 and $1,648,982 in 1996                                
   Office Equipment                                                                               110,974           143,072
   Leasehold improvements                                                                         145,860            79,098
   Magnetic resonance imaging systems                                                           1,298,247         1,081,869
                                                                                               ----------        ----------
      Total Property, Equipment and Leasehold Improvements, net                                 1,555,081         1,304,039
                                                                                               ----------        ----------
                                                                          
OTHER ASSETS                                                              
 Goodwill - Note 4                                                                                     --           897,504
 Patents, net of accumulated amortization of $107,466 in 1995             
   and $125,532 in 1996                                                                           289,486           271,421
 Deposits and other assets                                                                         74,568           143,557
                                                                                               ----------        ----------
      Total Other Assets                                                                          364,054         1,312,482
                                                                                               ----------        ----------
                                                TOTAL ASSETS                                   $2,439,606        $3,203,018
                                                                                               ==========        ==========
 
</TABLE>
                The accompanying notes are an integral part of
                   these consolidated financial statements.

                                      -3-
<PAGE>
 
             INTERACTIVE MEDICAL TECHNOLOGIES LTD AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                   DECEMBER 31, 1995 AND SEPTEMBER 30, 1996

<TABLE>
<CAPTION>
                                               LIABILITIES AND SHAREHOLDERS' DEFICIT
                                               -------------------------------------
                                                                                                      December 31,    September 30,
                                                                                                         1995             1996
                                                                                                     --------------  --------------
<S>                                                                                                  <C>             <C>
 
CURRENT LIABILITIES
  Loans payable                                                                                      $     88,500    $     78,330
  Convertible notes                                                                                        75,000         333,379
  Current portion of long term note payable                                                               318,171         403,144
  Accrued compensation and payroll taxes                                                                  206,106         189,345
  Professional services payable                                                                           413,135         267,456
  Trade payables and other accrued expenses                                                                75,500         123,595
  Royalties payable                                                                                       535,518         383,425
  Pastels acquisition cost payable - Note 4                                                                    --         215,000
  Nutra Quest acquisition cost payable - Note 4                                                                --         560,000
  Income taxes payable                                                                                      3,946           5,965
  Deferred rent                                                                                             8,460           5,640
  Interest payable - long term note                                                                        21,609          42,494
  Interest payable - convertible notes                                                                     16,542          23,494
                                                                                                     ------------    ------------
      Total Current Liabilities                                                                         1,762,487       2,631,267
                                                                                                     ------------    ------------
 
LONG TERM NOTE PAYABLE, net of current
  portion                                                                                                 959,538         826,041
                                                                                                     ------------    ------------
 
COMMITMENTS AND CONTINGENCIES
 
SHAREHOLDERS' DEFICIT:
  Common Stock, authorized 50,000,000 shares
    of $.001 par value; issued and outstanding
    32,282,082 in 1995 and 45,902,040 in 1996                                                              32,282          42,832
  Additional paid-in capital                                                                           15,083,445      16,177,713
  Accumulated deficit                                                                                 (15,398,146)    (16,474,835)
                                                                                                     ------------    ------------
      Total Shareholders' Deficit                                                                        (282,419)       (254,290)
                                                                                                     ------------    ------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT                                                          $  2,439,606    $  3,203,018
                                                                                                     ============    ============
 
</TABLE>

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

                                      -4-
<PAGE>
 
             INTERACTIVE MEDICAL TECHNOLOGIES LTD AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
        FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996
                                  (UNAUDITED)
<TABLE>
<CAPTION>
 
                                                                                For the                         For the
                                                                            Three Month Ended               Nine Month Ended
                                                                              September 30,                   September 30,
                                                                     ------------------------------    ----------------------------
                                                                           1995             1996           1995            1996
<S>                                                                  <C>                <C>            <C>             <C>
 
REVENUES
  Products and services                                                $   237,127      $   200,452    $    717,685    $    443,526
  Lease rentals                                                            113,779           97,081         341,337         291,242
                                                                       -----------      -----------    ------------    ------------
                                                                           350,906          297,533       1,059,022         734,768
 
COST AND EXPENSES
  Cost of Revenues
    Product and services                                                    92,163           66,502         285,895         147,545
    Lease Operations                                                       120,339           72,126         361,017         216,378
                                                                       -----------      -----------    ------------    ------------
                                                                           212,502          138,628         646,912         363,923
 
  Research and development                                                  38,177           71,177         184,968         199,804
  Selling, general and administrative expenses                             491,592          498,356       1,289,744       1,120,255
                                                                       -----------      -----------    ------------    ------------
                                                                           742,271          708,161       2,121,624       1,683,982
                                                                       -----------      -----------    ------------    ------------
  Loss from operations                                                    (391,365)        (410,628)     (1,062,602)       (949,214)


 
INTEREST EXPENSE AND OTHER
  Interest expense - other                                                  88,031            6,952         309,477           9,880
  Interest expense - lease operations                                       31,176           28,072          99,867          88,299
  Interest Income                                                          (11,991)          (3,802)        (55,022)        (10,502)

  Settlements and arbitration award                                          9,721           35,000         136,325          35,000
                                                                       -----------      -----------    ------------    ------------
      Total interest expense and other                                     116,937           66,222         490,647         122,677
                                                                       -----------      -----------    ------------    ------------
      Loss before provision for state income taxes                        (508,302)        (476,850)     (1,553,249)     (1,071,889)

 
PROVISION FOR STATE INCOME TAXES (Note 6)                                      800              800           2,400           4,800
                                                                       -----------      -----------    ------------    ------------ 

NET LOSS                                                                 ($509,102)       ($477,650)    ($1,555,649)    ($1,076,689)
                                                                       ===========      ===========    ============    ============
 
WEIGHTED AVERAGE NUMBER OF
  COMMON SHARES OUTSTANDING                                             19,817,305       45,875,066      18,243,811      38,621,477
                                                                       ===========      ===========    ============    ============ 

NET LOSS PER SHARE                                                          ($0.03)          ($0.01)         ($0.09)         ($0.03)
                                                                       ===========      ===========    ============    ============
 
</TABLE>

                The accompanying notes are an integral part of
                     these condensed financial statements

                                      -5-
<PAGE>
 
                     INTERACTIVE MEDICAL TECHNOLOGIES LTD
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
            FOR THE NINE MONTHS ENDED STEPTEMBER 30, 1995 AND 1996
                                  (UNAUDITED)

<TABLE>
<CAPTION>

                                                                                                               For the
                                                                                                           Nine Month Ended
                                                                                                             September 30,
                                                                                                    --------------------------------

                                                                                                       1995                1996
<S>                                                                                                 <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES
  Net Loss                                                                                          ($1,555,649)        ($1,076,689)

  Adjustments to reconcile net loss to net cash
   (used in) operating activities:
      Research and development efforts contributed as capital                                            30,000                  --
      Depreciation and amortization                                                                     930,741             271,581
      Issuance of warrants                                                                               68,500                  --
  Decrease (increase) in:
      Accounts receivables                                                                              (72,458)            (17,363)
      Interest receivable                                                                               (37,160)                 --
      Notes receivable                                                                                   43,638                  --
      Lease receivable                                                                                  (75,145)            (66,306)
      Inventories                                                                                            --            (109,800)
      Prepaid expenses                                                                                 (225,000)             (7,112)
  Increase (decrease) in:
      Due to related parties and former shareholders                                                   (103,981)                 --
      Accrued compensation                                                                                   --             (16,761)
      Professional fees and other payables                                                              713,765            (249,677)
      Income taxes payable                                                                                   --               2,019
      Deferred rent                                                                                      (2,430)             (2,820)
      Interest payable                                                                                   76,579              27,837
                                                                                                    -----------         -----------
      NET CASH USED IN OPERATING ACTIVITIES                                                            (208,600)         (1,245,091)
CASH FLOWS FROM INVESTING ACTIVITIES:
  Expenditures for property, equipment and leasehold
   improvements                                                                                         (15,970)            (71,463)
  Investments in Pastels and NutraQuest, net                                                                 --            (122,504)
  Expenditures for patents                                                                              (26,597)                 --
  Investments in KCD Incorporated                                                                      (217,243)                 --
                                                                                                    -----------         -----------
      NET CASH USED IN INVESTING ACTIVITIES                                                            (259,810)           (193,967)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock                                                                                466,246           1,104,818
Additional capital contribution from shareholders                                                       121,946                  --
Proceeds from issuance of convertible notes                                                             300,000                  --
Payments on long-term note                                                                             (185,021)            (48,524)
Proceeds from exercise of warrants, net                                                                  54,511                  --
Proceeds from loans payable                                                                              75,000             258,379
Payments on loans payable                                                                                    --             (10,170)

                                                                                                    -----------         -----------
      NET CASH PROVIDED BY FINANCING ACTIVITIES                                                         832,682           1,304,503
                                                                                                    -----------         ----------- 
NET INCREASE (DECREASE) IN CASH                                                                         364,272            (134,555)

CASH, beginning of period                                                                                25,215             374,128

CASH, end of period                                                                                 $   389,487         $   239,573
                                                                                                    ===========         ===========
</TABLE>

             The accompanying notes are an integral part of these
                        condensed financial statements



                                      -6-
<PAGE>
 
            INTERACTIVE MEDICAL TECHNOLOGIES LTD. and SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                              September 30, 1996

   1.   Significant Risks
        -----------------

        During 1995 consolidated revenues of Interactive Medical Technologies
   Ltd. (Interactive) and subsidiaries (the Company) were generated from
   royalties from the sale of fat sequestrant, the sale of colored microspheres,
   and laboratory services, and lease revenues from magnetic resonance imaging
   system.  The licensing agreement for the fat sequestrants, which accounted
   for 49% of revenues in 1995, was terminated during the first quarter of 1996.

        The Company has incurred net losses since its inception in 1986.  This
   includes losses of $3,084,495 and $3,978,579 for the years ended December 31,
   1994 and 1995 and $477,650 and $1,076,690 for the three and nine months ended
   September 30, 1996.  Continuing losses have adversely affected the liquidity
   of the Company, as well as the Company's ability to raise necessary
   additional capital.  As of September 30, 1996, the Company had an accumulated
   deficit of $16,474,835 and negative working capital of $2,044,770.  In
   addition, the Company is subject to various business risks, including but not
   limited to its ability to maintain vendor and supplier relationships by
   paying bills when due, and overcoming future and ongoing product development
   and distribution issues.  The Company and its former management have been
   named in certain litigation. The Company has been subject to various claims,
   lawsuits, lawsuit settlements and judgments.  The Company's legal costs have
   been paid from available funds and unpaid amounts have been accrued.
   Although the Company has settled the majority of claims that were outstanding
   at the beginning of the year and there have not been additional claims
   presented or filed subsequent to December 31, 1996, there is no assurance
   such funds will continue to be available, and the inability to pay judgments
   when due or fees of defense counsel may result in settlement of the remaining
   or new  actions on unfavorable terms to the Company.

        Beginning in June 1995, new management implemented a plan of
   restructure.  Initial efforts were focused on reducing losses, settling the
   accumulation of debt and lawsuits referred to above, and raising working
   capital.  By October 1995, Management began shifting some of its resources to
   the internal development of new dietary and food supplement products,
   development of alternative financing for research projects, and the
   acquisition of strategic consumer product companies.

        The results of these efforts have produced a research grant for the
   National Institute of Health (NIH) to help finance ongoing contrast
   microshpere studies, a strategic partner agreement with E-Z EM which includes
   a provision for funding advanced pre-clinical and FDA studies as well as
   outlining a basic manufacturing and distribution understanding.
   Additionally, the Company acquired two strategic consumer products companies,
   each with a number of ready to market personal care and nutritional consumer
   products.  Those agreements also contain contingencies concerning
   preestablished performance criteria based on gross product sales, which if
   not achieved by the acquired companies allow for the Company to terminate the
   agreements and convert the monies previously invested into promissory notes
   to be repaid by those companies.  During the balance of 1996 and well into
   1997, Management has redirected its focus to the sales and marketing 

                                      -7-
<PAGE>
 
   of the consumer products which were acquired or developed internally. The
   Company has begun the initial phases of distribution, and sales and marketing
   during the third calendar quarter.

        Even though operating losses have been substantially reduced from
   previous years, Management anticipates that the revenues from the sales of
   existing microsphere products, laboratory services, MRI leasing operation and
   the consumer products operations during their initial phases of distribution
   will not be adequate to fund present scaled down commercial operations.
   Management intends to raise additional working capital to fund present
   commercial operations during the initial distribution phase of the new
   consumer products.

        Due to the above factors, losses are expected to continue at least for
   the immediate future.  In the event working capital is not available to the
   Company, the Company would curtail all non commercial operations while
   accelerating the distribution and sale of its consumer products and its
   efforts to license its contrast microsphere technologies.

        The Company believes it has made great progress during the past year and
   revenues from new consumer products began during the third calendar quarter
   and will continue grow well into the future.  The Company intends to follow
   the plan implemented in June of 1995, including seeking alternative sources
   to fund contrast microsphere studies.  According to current information, the
   costs of FDA clinical studies, which are subject to the rules, regulations
   and approval of protocols by the FDA, the Companys planned FDA studies could
   range between $3,000,000 and $10,000,000 over a span of thirty months from
   the date started. Operating revenues are not expected to be sufficient to
   provide all of these funds, therefore the Company will seek assistance from
   its strategic partners, and by collecting advanced royalty payments from
   other potential strategic partners, and to some extend raise additional
   capital from the sale of securities.

        The Company carries no direct product liability insurance, relying
   instead on the coverage afforded by its distributors and the manufacturers
   from whom it obtains products.  These coverages directly protect the insured
   who pay the premiums and only secondarily the Company.  There is no assurance
   that such coverages will adequately cover any claims which may be brought
   against the Company.  In addition, the Company does not have any general
   liability coverage.

        These factors raise substantial doubt that the Company may be able to
   continue as a going concern.  The financial statements do not include any
   adjustment relating to the realization or classification of liabilities that
   might be necessary should the Company be unable to continue as a going
   concern.

   2.   Summary of Significant Accounting Policies
        ------------------------------------------

             Basis of Presentation
             ---------------------

        The accompanying condensed consolidated financial statement have been
   prepared assuming that the Company will continue as a going concern.  Certain
   matters raise substantial doubt about the Company's ability to continue as a
   going concern.  As discussed in Note 1, the Company operates under extreme
   liquidity constraints and, because of recurring losses, increasing difficulty
   in raising necessary additional capital.  Management's plan in regard to
   these matters is described above.  The 

                                      -8-
<PAGE>
 
   financial statements do not include any adjustments relating to the
   recoverability and classification of asset carrying amounts or the amount and
   classification of liabilities that might result should the Company be unable
   to continue as a going concern.

        As more fully discussed in Note 5, the Company is subject to various
   claims, lawsuits, lawsuit settlements and judgments.

        In the opinion of the management of the Company, the accompanying
   condensed unaudited financial statements contain all adjustments, consisting
   of only normal recurring accruals, necessary to present fairly the financial
   position at September 30, 1996, the results of its operations for the three
   and nine months ended September 30, 1996 and 1995 and the cash flows for the
   nine months ended September 30, 1996 and 1995.  Certain information and
   footnote disclosures normally included in financial statements that would
   have been prepared in accordance with generally accepted accounting
   principles have been condensed or omitted pursuant to the rules and
   regulations of the Securities and Exchange Commission, although management of
   the Company believes that the disclosures in these financial statements are
   adequate to make the information presented therein not misleading.  It is
   suggested that these condensed financial statements and notes thereto be read
   in conjunction with the financial statements and the notes thereto included
   in the Company's December 31, 1995 Form 10-KSB.

        The results of operations for the three and nine months ended September
   30, 1996 are not necessarily indicative of the results of operations to be
   expected for the full fiscal year ending December 31, 1996.

          Income Taxes
          ------------

        Income taxes are provided for the tax effects of transactions reported
   in the financial statements and consist of taxes currently due plus deferred
   taxes related primarily to differences between the adjusted bases of fixed
   assets and patents for financial and income tax reporting.  The deferred tax
   assets and liabilities represent the future tax return consequences of those
   differences, which will either be taxable  or deductible when the assets and
   liabilities are recovered or settled. Deferred taxes also are recognized for
   operating losses that are available to offset future federal income taxes.

          Goodwill
          --------

        Goodwill associated with the acquisition of Pastels International, Inc.
   and Nutra Quest, Inc. (See Note 4. Acquisitions) under the purchase method of
   accounting is being amortized over a 20 year period.

          Loss Per Share
          --------------

        Loss per share is based upon weighted average number of common shares
   outstanding during the periods.

                                      -9-
<PAGE>
 
   3.   Capital Transactions and Long Term Debt
        ---------------------------------------

        There were privately held warrants outstanding as of September 30, 1996,
   to purchase a total of 14,818,556 shares of the Company's common stock at
   purchase prices per share ranging from $0.10 to $4.00.

        The Company's magnetic resonance imaging (MRI) system (the "Unit")
   currently is installed in a mobile van at an operating site in Jefferson
   Valley, New York and has been in use since September 1992 and is leased to
   Tri-County Mobil MRI, L.P. ("Tri-County"), whose general partner is
   Diagnostics Resource Funding.  This lease provides for monthly payments of
   $37,926 to Venus Management, Inc. ("VMI") through August 1999 and $68,589 in
   September 1999 (with such payments being guaranteed by Medical Funding of
   America, Inc., "MFA"), and VMI is required to make monthly installment
   payments (which includes interest at 10.5% per annum on the unpaid principal
   balance) for the Unit to a third party finance company of $32,360 through
   August 1999 and $68,589 in September 1999.  As of September 30, 1996, the
   balance of this debt aggregated $1,162,679 (including interest currently due
   of $42,494) of which $403,144 is due within the next twelve months.  This
   lease provides for a purchase option at the expiration of the initial term of
   such lease equal to the then fair market value of the Unit.

        Tri-County was delinquent in making certain of its lease payments to VMI
   under the terms of the lease agreement concerning the Unit, and MFA failed to
   make these payments to VMI under its guarantee of Tri-County's payments to
   VMI.  Accordingly, VMI had not made certain payments due to the third party
   finance company for the Unit.  As a result, the third party finance company
   commenced a lawsuit against MFA and the Company in which it sought repayment
   in full of MFA's note to that company (the debt service on which was to be
   serviced by VMI) and return of the Unit to that company.  The finance company
   subsequently dismissed its lawsuit without prejudice.  Should Tri-County fail
   to make its future lease payments to VMI and should VMI be unable to make its
   future required payments to the finance company (i) VMI could lose ownership
   and possession of the Unit and (ii) the entire remaining balance of the MFA
   note would become immediately payable, with VMI and the Company being liable,
   together with MFA, for any deficiency in repayment of the note.

        As of November 10, 1996, Tri-County was current in making the payments
   to the finance company.

        The Company has issued for value received $100,000 convertible note.
   The note is convertible to Company Common Shares at $0.125 per share, which
   matures September 10, 1999, with interest at 10% per annum payable quarterly
   in Company common shares.

        The Company has assumed the debt of Pastels International, Inc. under
   the acquisition agreement discussed in Note 4.  The debt consists of a note
   payable to the Small Business Administration  for $73,600 with interest at
   4%, with principal and interest of $355.00 payable monthly for 212 months and
   a short term note payable of $20,000 due December 31, 1996.  (See Note 4 
   Acquisitions)

        In October 1995, the shareholders of the Company approved amendments to
   the Company's Certificate of Incorporation to provide for:  (i) a reverse
   stock split of not less than one share for every four old shares nor more
   than one share for every eight old shares, with the specific exchange 

                                      -10-
<PAGE>
 
   ratio to be determined by the Board of Directors; (ii) an increase in the
   number of authorized shares of common stock from 25,000,000 to 50,000,000.


   4.   Acquisitions
        ------------

        During the quarter ended June 30, 1996, the Company entered into two
   separate memorandums to acquire Pastels, International, Inc. (Pastels) and
   Nutra Quest, Incorporated (Nutra Quest).   Both agreements contain certain
   contingencies relating to Pastels and Nutra Quest achieving predetermined
   gross sales amounts prior to the Company making payments related to the
   purchase price.  In the event these gross sales contingencies are not met,
   the Company has the option to terminate the agreements and convert any monies
   advanced into a promissory note payable to the Company secured by assets.

        The Company acquired Pastels for $250,000 in cash, the assumption of
   debt in an approximate amount of $90,000 (subject to an accounting and
   Pastels gross sales achieving predetermined amounts within a specified time
   periods) and warrants to purchase 500,000 shares of the Companys common stock
   at $.15 per share.  The Company acquired Nutra Quest for $600,000, payable
   $200,000 in cash over a period of 15 months subject to Nutra Quest gross
   sales achieving predetermined amount within specified time periods) in
   fifteen separate installments, the balance payable in shares of the Companys
   common stock, valued at $.15 per share which is also subject to similar
   performance criteria.  The founders and Presidents of both Pastel and Nutra
   Quest have been retained by the Company under employment agreements.
   Although not indentical, both employment agreements contain provisions to
   either purchase additional warrants of the Company common stock at prices
   ranging from $.15 to $1.00, and to receive royalties ranging from 2% to 5% of
   gross product sales from their existing and pending products.  The value of
   the employment agreements are in part subject to the performance of Pastels
   and Nutra Quest gross sales.


   5.   Contingencies
        -------------

             Litigation
             ----------


        In March 1995, Donald Seidel sued Clark Holcomb, Dr. Shell, George
   Berger and the Company in the Superior Court for the County of Los Angeles,
   which was served on the Company in May 1995.  This action alleges breach of
   contract, fraud, non-payment for services, conspiracy to defraud, unjust
   enrichment and conversion.  Plaintiff is seeking general and compensatory
   damages of at least $692,000 and special and consequential damages of not
   less than $170,000, together with exemplary and punitive damages.  It is
   alleged that the Company conspired to defraud plaintiff of his shares of
   Company stock and deprive him of payment for services.  The Company has
   denied these allegations.

        In February 1996, the Rudolf Steiner Research Foundation filed a
   complaint in the Unites States District Court for the Central District of
   California against Clark Holcomb, Lawrence Gibson, Murray Bettingen, Inc. and
   the Company.  This action alleges civil RICO, violation of the Securities 

                                      -11-
<PAGE>
 
   Act of 1933, violation of California Corporation Code, fraud, deceit and
   intentional misrepresentation, negligent misrepresentation, conversion,
   constructive trust and breach of contract. The complaint seeks damages of
   $201,333, rescission, punitive and exemplary damages. The Company believes it
   has no obligation to the Rudolf Steiner Research Foundation in connection
   with the matter.

        The Seattle Regional Office of the Federal Trade Commission had advised
   the Company that the staff believed that the Company's sequestration product,
   which was licensed to KCD, Incorporated under the brand name SeQuesterTM, had
   been improperly represented in advertising claims, and the same sequestrant
   product previously marketed by the Company under the Lipitrol brand was also
   improperly represented in advertising claims.  The staff indicated that it
   was prepared to recommend that a complaint be filed against the licensee, the
   Company and certain individuals in connection with the foregoing.  The
   Company and the FTC staff have since agreed upon the terms of a proposed
   settlement in this matter, pursuant to which the Company would consent to a
   permanent injunction prohibiting it from misrepresentations relating to
   weight loss or weight reduction products or services, or with respect to
   tests or studies relating to such programs or services.  In addition, the
   Company would pay consumer redress to the FTC in an aggregate amount of
   $35,000 over a period of twelve months.  This proposed settlement, which has
   been accepted by the Company, awaits final approval by the Federal Trade
   Commission.

        Except as otherwise specifically indicated above, management believes
   that the Company does not have any material liability for any lawsuits,
   settlements, judgments or fees of defense counsel which have not been paid or
   accrued as of September 30, 1996.  The Company will continue to vigorously
   defend against these actions.

        There can be no assurance that the Company will prevail in either of the
   foregoing lawsuits.  The Company may incur substantial expense in connection
   with this litigation and any unfavorable settlement or judgment against the
   Company in which the Company is a defendant could have a material adverse
   effect upon the Company.

             Transactions in Company Securities
             ----------------------------------

        In October 1995, the staff of the Securities and Exchange Commission
   (SEC) advised the Company pursuant to certain private placements and resale
   of unregistered Company shares, the Company was being investigated for
   alleged violations of the federal securities laws.  Subsequent to June 30,
   1996, the Company agreed to a consent decree with the SEC which, without
   admitting or denying any wrongdoing, enjoins the Company from violating the
   registration provisions of the federal securities law.  The agreement is
   subject to final approval by the SEC.


   6.   Commitments
        -----------

             Research and License Agreements
             -------------------------------

        In January 1996, the Company entered into a broad based, long-term
   agreement with E-Z-EM, Inc. ("E-Z-EM") for clinical testing of the Company's
   contrast microspheres.  Under the terms 

                                      -12-
<PAGE>
 
   of the agreement, E-Z-EM will commence clinical testing and provide funding
   for phase one animal studies. During phase two, E-Z-EM will analyze the
   impact of regulatory costs and expenses in preparation for capital funding to
   conduct FDA approved clinical trial (IND). The agreement establishes the
   Company as the product manufacturer, which E-Z-EM has an option for an
   exclusive license (including the right to sub-license) to all products
   developed under the patent and the rights to global sales and marketing of
   the products and related services for the life of the patent or 10 years,
   whichever is longer.

                                      -13-
<PAGE>
 
   ITEM 2.       MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

        The Company commenced operations in 1990, when it acquired 82.5% of
   See/Shell Biotechnology, Inc. ("S/S"), which was organized in 1987 and had
   commenced operations in 1988.  The Company's activities to date have
   consisted primarily of planning, research and development, and marketing of
   its microspheres and related products and services, performing clinical
   trials and licensing of its fat sequestrant technology and development of its
   biodegradable microspheres for human imaging applications, which the Company
   believes represents a significant long-term growth opportunity. On June 30,
   1993, the Company acquired Venus Management, Inc. ("VMI"), whose MRI leasing
   operations are reflected in the Company's operating results since that date.
   In May and August 1996 the Company acquired Pastels International, Inc. and
   Nutra Quest, Inc. (See Note 4. Acquisitions). Both Pastels and Nutra Quest
   are considered to be significant opportunities for future growth in revenues
   and income.

   RESULTS OF OPERATIONS

   Three and Nine Months Ended September 30, 1995 Compared to September 30, 1996
<TABLE>
<CAPTION>
 
                                                            Three Months                                  Nine Months
                                                         Ended September 30                            Ended September 30
                                               ----------------------------------------------------------------------------------
                                                       1995                 1996                   1995                  1996
                                               ----------------------------------------------------------------------------------
($ Thousands)                                    Amount      %         Amount     %          Amount       %         Amount     %
                                               ----------   ----       -------   ----      ---------     ----       -------   ----
<S>                                            <C>          <C>        <C>       <C>       <C>           <C>        <C>       <C>
                                                                                                                 
Revenues - Products and Services                                                                                 
  Microspheres and laboratory services         $  52         22%       $ 201     100%      $ 192          27%       $ 354      80%
  Fat sequestrant                                185         78%           0       0%        526          73%          90      20%
                                               -----        ----       -----     ----      -----         ----       -----     ----
                                                 237        100%         201     100%        718         100%         444     100%
Cost of Revenues                                                                                                 
  Microspheres and laboratory services            34         65%          67      33%        115          60%         148      42%
  Fat sequestrant                                 58         --           --      --          83          --           --      --
                                               -----        ----       -----     ----      -----         ----       -----     ----
                                                  34         14%          67      33%        115          16%         148      33%
Gross Margin - Product and Services            $ 203         86%       $ 134      67%      $ 603          84%       $ 296      67%
                                               =====        ====       =====     ====      =====         ====       =====     ====
Revenues - Lease Rentals                       $ 114        100%       $  97     100%      $ 227         100%       $ 291     100%
  Cost of revenues - lease operations            120        105%         100     103%        240         106%         304     104%
                                               -----        ----       -----     ----      -----         ----       -----     ----
Gross margin - lease operations                  ($6)        -5%         ($3)     -3%       ($13)         -6%        ($13)     -4%
                                               =====        ====       =====     ====      =====         ====       =====     ==== 

</TABLE>

        For the three and nine months ended September 30, 1996, revenues from
   products and services were approximately $201,000 and $444,000, a  decrease
   of  16% and 38%, respectively, over comparable 1995 periods.  The decreases
   are due to the termination of the fat sequestrant license agreement with KCD
   during the first three months of 1996. The Company has reserved all
   receivables from KCD as uncollectible.  The Company is currently developing
   an advanced fat 

                                      -14-
<PAGE>
 
   sequestrant product and is seeking new distributors for that product.

        Revenues from product and services increased approximately $149,000 and
   $162,000 (or 287% and 84%) for the three and nine months ended September 30,
   1996, respectively, over 1995.  The increases were due to the acquisition of
   Pastels and Nutra Quest which accounted for approximately $97,000 of product
   revenues during the quarter ended September 30, 1996.  The remainder of the
   increase was attributable to the increase sales of microspheres and related
   laboratory services in part do to the completion of an entirely new, more
   cost effective automated color microsphere counting system employing flow
   cytometry technology through an OEM relationship.

        While the Company to date has not encountered any significant
   difficulties in connection with its sale of products in foreign markets, any
   future developments such as significant increases in customs duties, export
   quotas or other trade restrictions or large fluctuations in foreign currency
   rates could have an adverse effect on the Company.

        The overall cost of revenues for products and services as a percentage
   of sales for the three and nine months ended September 30, 1996  were 33%,
   compared to 14% and 16% for 1995, respectively. Increases in cost of revenues
   as a percentage of sales resulted primarily from decrease in royalties from
   KCD.

        Research and development expense increased approximately $33,000 and
   $15,000 for the three and nine month periods ended September 30, 1996 from
   the comparable 1995 periods due to the increased efforts associated with the
   Companys National Institute of Health research grant efforts, to the efforts
   discussed below and the Company's consumer products research and development.

        During 1994, the Company enhanced its production capability for contrast
   microspheres for clinical trial purposes.  The Company has identified four
   specific imaging applications for its technology and initiated development on
   two of them.  These products include a contrast microsphere to CAT scan and
   detect lung blood clots (pulmonary emboli), an ultrasound contrast
   microsphere for detection of heart perfusion (myocardial perfusion), an MRI
   contrast microsphere for abdominal visualization and a contrast microsphere
   to compete with liquid x-ray contrast media.  The Company anticipates that
   any increases in research and development resources during 1996 and 1997 will
   be devoted primarily to these projects.

        SG&A expense decreased to approximately $1,120,000 from approximately
   $1,290,000 for the nine months of 1996, from 1995, a reduction of 13%.  For
   the three months ended September 30, 1996 SG&A expense increased to
   approximately $498,000 from approximately $491,000 in 1995, an increase of
   1%.  The decrease for the nine months were a result of restructuring and down
   sizing of operations which includes significant reductions in accounting
   fees, salaries, wages, selling and marketing expenses, and shareholder
   expenses all of which were phased in beginning in June 1995.  Included in
   1995 are non-cash expenditures for amortization of prepaid consulting fees of
   $371,375 for shareholder services.  In addition, the Company incurred
   officers' and directors' fees of $92,000 during 1995.  The Company
   experienced increases in legal fees during 1995 due primarily from matters
   related to the SEC investigation of Clark M. Holcomb's activities.  Included
   in 1995 are $220,420 of non-recurring financial consulting and legal fees.
   The increase for the three months ended September 30, 1996 was a result of
   the increased selling and administrative costs associated 

                                      -15-
<PAGE>
 
   with the start up costs resulting from the acquisition of Pastels and Nutra
   Quest. Pastels during the quarter incurred approximately $60,000 in media
   development costs associated with its Direct Response TV which is currently
   in market testing. Nutra Quest which is in its initial distribution phase, is
   expected to start generating revenues in the fourth quarter of 1996.

        Interest expense for operations decreased 92% and 97%  for the three and
   nine month periods ended September 30, 1996, respectively from comparable
   1995 periods. The 1995 periods included non-cash expenditures for
   amortization of deferred financing costs incurred in connection with
   financial advisory services and a private placement of convertible notes in
   November 1994 as well as accrued interest on such notes of $18,000 and
   $54,000 for the three and nine months ended September 30, 1995, respectively.

        Interest income decreased to approximately $3,800 for the third quarter
   of 1996 compared to approximately $12,000 for 1995.  For the nine months
   ended September 30, 1996 interest income decreased to $10,500 from $55,000
   from the comparable 1995 nine month period.  The decreases were due to
   interest earned on an outstanding note receivable from a shareholder, an
   outstanding note receivable from the sale of stock and delinquent royalties
   receivable.

        No provision was made for Federal income tax since the Company has
   incurred significant net operating losses from inception. Through December
   31, 1994, the Company incurred net operating losses for tax purposes of
   approximately $9,700,000 and approximately $11,420,000 for accounting
   purposes. Differences between accounting and tax losses consist primarily of
   differences in the accounting and tax treatment of depreciation, allowance
   for doubtful accounts and research and development expenses. The net
   operating loss carry forward may be used to reduce taxable income through the
   year 2008. The Company's tax returns have not been audited by the Internal
   Revenue Service. The carry forward amounts may therefore be subject to audit
   and adjustment. As a result of the Tax Reform Act, the availability of net
   operating loss carry forwards can be deferred, reduced or eliminated under
   certain circumstances. Net operating losses in the State of California were
   not available for use during 1992 and the carry forward period has generally
   been reduced from fifteen years to five years beginning in 1993.



   Liquidity and Capital Resources
   -------------------------------

        Since the inception of S/S, the Company has received capital for
   operations and research from private investors, issuance of private party
   debt, bank financing, and from licensing and product sales.  Revenues have
   been insufficient to cover operating expenses, research and development,
   costs of litigation, construction costs, and patent development, which costs
   have been unnecessarily well above the revenues from licensing and product
   sales.  The Company, therefore, has been dependent on private placements of
   securities, bank debt, loans from private investors and the exercise of
   warrants in order to sustain operations.  To correct this imbalance
   management made significant cuts and changes in the Company's operations
   resulting in reduced 1995 operating expenses approximately $1,066,359 (or
   34%) compared to 1994.  However, until such time as the Company can increase
   revenues the Company will continue to be dependent on private or
   institutional investment capital to support a percentage of the planned 1996
   operations.  Historically, the 

                                      -16-
<PAGE>
 
   Company has been able to generate private placement funds to provide capital
   for operations and growth. During 1995, new management was responsible for
   approximately $965,348 received by the Company from August through the
   balance of the year from private placements, and the conversion of
   approximately $839,458 of Company debt from a previous private placement.
   However, there can be no assurances that private or other capital will
   continue to be available, or that revenues will increase to meet the
   Company's cash needs, and there can be no assurance that a sufficient amount
   of the Company's securities can or will be sold or that any warrants will be
   exercised to fund any operating needs of the Company or its research and
   development programs. (Even assuming all of the warrants outstanding as of
   December 31, 1995 with exercise prices at or below the current market price
   of the common stock were to be exercised, the total gross proceeds to the
   Company from such exercise would be insignificant).

        The Company's consolidated financial statements have been prepared on
   the assumption the Company will continue as a going concern.  The Company has
   suffered recurring losses from operations, has an accumulated deficit and has
   negative working capital, and faces significant product development and
   distribution issues that raise substantial doubt about its ability to
   continue as a going concern.  Management's plans in regard to these matters
   are described below.  The financial statements do not include any adjustments
   relating to the recoverability and classification of asset carrying amounts
   or the amount of liabilities that might result should the Company be unable
   to continued as a going concern.

   Management's 1996 Plan of Operations
   ------------------------------------

        Objectives of the Plan
        ----------------------

        Beginning in May 1995, the Company's newly installed management began
   developing a plan intended to move the Company away from its dependence on
   investment capital and toward profitability.  Management began by making
   significant cuts in the Company's operational expense, the effect of which
   began in June 1995, and resulted in an overall decrease of 1995 operating
   expenses of approximately $1,066,359, or 34% as compared to 1994. However,
   that in itself is only a partial solution, what was needed was a major
   restructuring.  Management developed the operational plan described below:

        1.  make significant and lasting reductions in general and
            administrative costs

                                      -17-
<PAGE>
 
            while centralizing administrative operations, temporarily reduce
            spending on all research and development programs not directed at
            producing immediate revenues; and,
        2.  reorganize all Company subsidiaries to operate as profit centers 
            through cost cutting and the elimination of duplicate general and 
            administrative costs; and,
        3.  secure existing revenue base by eliminating licensees default; and
        4.  increase revenues from existing products; and,
        5.  develop new markets for existing products; and,
        6.  develop new products for existing and new markets; and,
        7.  develop strategic partners for distribution, sales and marketing,
            research and development, commercialization of products; and develop
            alternative research and development financing sources such as U.S.
            government sponsored research grants; and,
        8.  develop investment banking and public relation alliances; and
        9.  make strategic acquisitions of consumer products companies.

        Results of the Plan (As of November 10, 1996)
        ---------------------------------------------

        The plan described above was phased in beginning in June 1995.  The
   Company accomplished the majority of the goals set out in the plan including
   (1) the Company made significant and lasting reductions in G&A, temporarily
   halted all research and development, which it later resumed in order to
   manufacture contrast microspheres for pre-clinical testing required as a
   result of a strategic agreement signed with E-Z-EM; and, (2) reorganizing the
   E-Z Trac subdivision to operate as a profit center; and (3) secured
   sequetrant licensing revenues (temporarily, KCD defaulted again and was
   terminated); and, (4) increased E-Z Trac revenues (KCD was terminated); and,
   (5) began studying the feasibility of adapting the colored microsphere
   products for commercial pathology applications; and (6) began development on
   a series of new products in October 1995, which the Company announced
   completion of first stage development of those products in March 1996; and
   (7) signed a strategic agreement with E-Z-EM to develop contrast microspheres
   for commercial applications; and, (8) applied for and received a research
   grant from the National Institute of Health ("NIH"); and (9) developed
   investment banking relationships; and (10) acquired two consumer products
   companies; and (11) completed television advertisements (commercials) for
   personal care product, as well as establishing a network marketing
   distribution system. The Company expects to begin distribution of 20 or more
   consumer products during the 4th quarter, primarily through network
   marketing.

        Additionally, the Company raised approximately $965,348 from private
   placements from August 1995 to December 1995.  From January 1, 1996 to
   November 10, 1996, the Company has raised $1,100,000 in four private
   placements, with an option of an additional $500,00 to fund prior to December
   31, 1996.  The Company also received a $100,000 grant funded by the National
   Institute of Health grant, with up to $750,000 more conditioned on the
   success of phase one.

        As of September 30, 1996, the Company's working capital position
   improved to a negative $1,112,000 from a negative $1,242,000 at December 31,
   1995, primarily as a result of the working 

                                      -18-
<PAGE>
 
   capital raised through the private placements that occurred during the second
   quarter of 1996, this was offset by decreases in accrued compensation and
   payroll taxes, professional services payable, trade payables and other
   accrued expenses as well as increases in the allowance for doubtful accounts
   and acquisition costs payable associated with the acquisitions of the
   consumer products companies. At September 30, 1996, the Company's cash
   position had decreased to $239,573 from $374,128 December 31, 1995.


        At September 30, 1996, the Company had assets of $3,203,018 compared to
   $2,439,606 on December 31, 1995.  In addition, the Company had a total
   shareholders' deficit of $254,290 on    September 30, 1996 compared to
   $282,419 on December 31, 1995, an increase of $28,129.  The increase was the
   result of the issuance of common stock valued at $1,104,818 offset by a net
   loss from operations of $1,076,689.    Payments on a long term note with a
   balance of $1,162,679 (including interest currently due of $42,494) as of
   September 30, 1996 of which $403,144 is due within the next twelve months had
   been assumed by the Company as part of its acquisition of VMI;  this note is
   secured by guaranteed lease payments of an equivalent amount.

                                      -19-
<PAGE>
 
   ITEM 3.  LEGAL PROCEEDINGS


   SEC and Shareholder Proceedings Relating to Matters Directly by Effected by
   ---------------------------------------------------------------------------
   or Arranged by Clark M. Holcomb
   -------------------------------

        In July 1993, based on a concern the Company formed an independent
   committee of its Board of Directors who's purpose was to determine whether
   certain prior private placements of the Company's securities complied with
   all of the registration requirements of federal and state securities laws.
   In certain prior private placements of the Company's shares, a total of
   approximately 2,506,982 shares of the Company's common stock was issued to a
   smaller number of individuals.  Those issuances were structured in reliance
   upon the advice of the Company's then securities counsel, and the Company
   believes that these issuances, standing alone, would have qualified for
   exemptions from registration under federal and state securities laws.
   However, certain subsequent resale's of these shares, commencing in June
   1992, by the original purchasers or their transferees to a total of
   approximately 330 investors raised an issue as to whether a technical
   distribution occurred that might have required either the original issuances
   or the resales to have been registered.  All of the foregoing resales were
   either directly effected or arranged for by Clark M. Holcomb.

        In October 1993, the Company filed a registration statement with the SEC
   to register all of the foregoing 2,506,982 shares with the SEC.  However,
   even if the registration statement becomes effective so as to permit public
   resales by the holders of the shares involved in the transactions described
   above, these holders could have a right of rescission to recover the purchase
   price they paid for their shares plus interest from the date of purchase
   against the persons from whom they acquired the shares.

        The Company believes (based in part upon the opinion of its current
   special securities counsel) that these holders do not have a valid and
   enforceable right to such rescission. However, subject to any applicable
   statutes of limitation that might bar such future claims, these shareholders
   could assert such claims, and the Company has not set aside any reserves to
   fund any potential liabilities that it might incur in connection with any
   such future potential claims, which could be material.  Should the Company
   incur any such liabilities, it might seek indemnification or contribution for
   such liabilities from Mr. Holcomb or other third parties.

        In October 1995, the staff of the SEC advised the Company that it was
   considering recommending that the SEC file a civil injunctive action against
   the Company and Dr. William Shell for alleged violations of the registration
   provisions of the federal securities laws. The alleged violations appear to
   relate to the sale by the Company of unregistered shares of its common stock
   which involved a series of resales of these shares that were either directly
   effected or were arranged for by Clark Holcomb. These transactions have been
   the subject of an SEC investigation previously disclosed by the Company.

        In March 1995, Donald Seidel sued Clark M. Holcomb, Dr. Shell, George
   Berger and the Company in the Superior Court for the County of Los Angeles,
   which was served on the Company in May 1995.  This action alleges breach of
   contract, fraud, non-payment for services, conspiracy to

                                      -20-
<PAGE>
 
   defraud, unjust enrichment and conversion. Plaintiff is seeking general
   and compensatory damages of at least $692,000 and special and consequential
   damages of not less than $170,000, together with exemplary and punitive
   damages. It is alleged that the Company conspired to defraud plaintiff of his
   shares of Company stock and deprive him of payment for services. The Company
   denies these allegations and intends to vigorously contest the matter.


        In February 1996, the Rudolf Steiner Research Foundation filed a
   complaint in the United States District Court for the Central District of
   California against Clark M. Holcolm, Lawrence Gibson, Murray Bettingen,
   Bettingen, Inc., and the Company.  This action alleges civil RICO, violation
   of the Securities Act of 1933, violation of California Corporation Code,
   fraud, deceit and intentional misrepresentation, negligent misrepresentation,
   conversion, constructive trust and breach of contract.  The complaint seeks
   damages of $201,333, rescission punitive and exemplary damages.  The Company
   believes it has no obligation to the Rudolf Steiner Research Foundation in
   connection with the matter.  The Company denies the allegations and intends
   to vigorously contest the matter.

        Pursuant to the certain private placements and resale of unregistered
   Company shares discussed above, the Company agreed to a consent decree with
   the SEC that, without admitting or denying any wrongdoing, enjoins the
   Company from violating the registration provisions of the federal securities
   law.  The agreement is subject to final approval by the SEC.


   Proceeding Related to Licensing Agreements, Manufacturing Agreements, Royalty
   -----------------------------------------------------------------------------
   Agreements, and Patent Infringements
   ------------------------------------

        In September 1993, Dr. Shell commenced an action against Dynamic
   Products, Inc. ("Dynamic"), D&F Industries ("D&F") in his capacity as a 25%
   shareholder of FATCO in the Orange County Superior Court of the State of
   California seeking damages from these parties for their alleged breach of
   contract and misappropriation of certain trade secrets of FATCO and the
   Company relating to the first generation fat sequestrant product. Dr. Shell
   has asserted in this action that Dynamic has sold the first generation fat
   sequestrant product to Herbalife for resale in the United States without the
   required payment of royalties to FATCO (which is obligated to pay Dr. Shell
   25% of its royalty income, which Dr. Shell then contributes to the Company)
   based on those sales.

        In October 1994, Dr. Shell filed a related lawsuit against FATCO in the
   same court seeking the termination of a 1987 agreement between FATCO and
   Shell licensing certain fat sequestrant technology of Dr. Shell to FATCO
   based upon failure of FATCO to fully exploit the transferred technology for
   the benefit of Shell, failure to fully exploit the products, knowingly
   permitting sales of products made utilizing the technology transferred to
   continue even though no royalties were being paid on those sales, refusing to
   pursue legal action to collect the unpaid royalties and stopping the
   unauthorized sales, and by entering into a renewal of an agreement with a
   distributor on the same unfavorable terms which previously existed and which
   diverted monies which should have been paid to FATCO to other entities owned
   and controlled by some of the shareholders and members of the Board of
   Directors of FATCO. FATCO has filed a cross-complaint in this action against
   Shell alleging breach of the licensing agreement between Shell and FATCO.

                                      -21-
<PAGE>
 
        In January 1996, FATCO filed a First Amended Cross-Complaint alleging
   causes of action against Dr. Shell, the Company, EHI and KCD for breach of
   contract, breach of fiduciary duty, interference with prospective economic
   advantage, misappropriation of trade secrets, conversion, constructive trust,
   accounting and permanent injunction.  Each of these causes of action relate
   to the action of the Company in entering into the License Agreement with KCD.
   The Company filed an answer denying all of the allegations contained in the
   Cross-Complaint.  This matter was settled with a mutual release of claims
   discussed below. The basis of this cross complaint appeared to pertain to the
   license agreement between EHI and KCD, Inc. which as of March 1, 1996 was
   canceled as a result of KCD's failure to make royalty payments to the
   Company.

        In March 1994, the Company and S/S sued Herbalife (settled with respect
   to Herbalife) and D&F in Superior Court for the County of Orange, California
   for fraud, breach of contract and conspiracy to misappropriate trade secrets.
   The Company alleges in this lawsuit that S/S provided certain confidential
   information and trade secrets to D&F, which misappropriated this information
   to manufacture an advanced fat sequestrant product. The Company is seeking in
   this lawsuit injunctive relief and damages in an unspecified amount from
   defendants. This matter has been settled with a mutual release of claims
   discussed below.

        In January 1995, Dr. Shell, on behalf of FATCO, filed another action in
   the Orange County Superior Court of the State of California substantially
   similar to the action filed by Dr. Shell in 1993 against Dynamic Products,
   Inc. This newly filed action names certain individual shareholders and
   directors of FATCO, Dynamic and D&F Industries as well as Herbalife
   International Inc. ("Herbalife"). In March 1995, this action and the lawsuit
   against Herbalife were settled with respect to Herbalife and its directors,
   with neither party making any payments to the other in connection with this
   settlement.

        In March 1996, the Company, on behalf of its subsidiary EHI, filed an
   action against KCD in Los Angeles County Superior Court.  This action alleges
   causes of action against KCD for breach of the amended license, declatory
   relief and permanent injunction.  The action is abased upon the failure of
   KCD to pay the royalties due pursuant to the contract and their use of
   advertising claims in connection with the sale of the licensed products which
   were in excess of those which the Company authorized KCD to make.  On April
   8, 1996, KCD filed a cross complaint against the Company, Effective Health,
   Dr. Shell and William Pelzer alleging causes of action for breach of
   contract, breach of implied conversion, rescission, good faith and fair
   dealing, negligence, intentional misrepresentation, account and constructive.
   The Company denied all of the claims and was settled in the mutual release of
   claims discussed below.

        The legal proceedings described above relating to Licensing Agreements,
   Manufacturing Agreements, Royalty Agreements, and Patents involving the
   Company and its subsidiaries, Dynamic Products, Inc., D&F Industries, FATCO,
   KCD, Inc., and Dr. Shell have been dismissed under settlement agreements and
   mutual releases of claims without liability to the Company and its
   subsidiaries.

                                      -22-
<PAGE>
 
   Proceedings Related to MRI Lease Operations
   --------------------------------------------

        In August 1994, VMI sued MFA in Supreme Court for the County of New
   York, New York, for breach of contract and accounts due. VMI alleges in this
   lawsuit that MFA breached an equipment lease agreement for VMI's second MRI
   unit, the Resonex Machine, by failure to make lease payments due January 27,
   1994, and thereafter in the sum of $210,210 as well as interest thereon. VMI
   was seeking in this lawsuit a judgement against MFA in the sum of $210,210
   plus interest thereon with costs, attorney's fees and disbursements and other
   relief. VMI was also seeking judgement for all unpaid lease payments
   subsequent to August 1994 which total an additional $510,510 through December
   31, 1995. However, it was determined not be in the Company's interests to 
   pursue the claims and the actions were dismissed.

        In April, 1995, Johnson & Johnson Finance Corp. ("J&J Finance") brought
   an action against MFA and VMI in connection with a loan made by J&J Finance
   to MFA that was secured by a lien granted by MFA on the Resonex MRI unit
   owned by VMI. After MFA defaulted on the foregoing loan, J&J Finance, in June
   1995, obtained a writ of attachment on the Resonex MRI unit and has taken
   physical possession of that unit.  The Company's position was  MFA had no
   authority to secure the foregoing loan with VMI's MRI unit, since the loan
   was made solely for the benefit of MFA, the lien was placed on the MRI unit
   without VMI's knowledge or consent, and none of the loan proceeds were
   received by VMI or the Company. Although the Company believes VMI was
   entitled to recover the MRI unit from J&J Finance and that VMI should prevail
   in its claims against MFA should J&J Finance be permitted to retain the MRI
   unit, there would be no assurance that VMI will prevail against either party
   or that VMI will be able to collect any judgement that it may obtain against
   MFA.  The Company also learned that the current fair market value of the
   Resonex MRI unit is substantially below previous estimates and as such may
   not be worth the cost of continuing litigation.  As a result of all the
   foregoing the Company has written off the net book value of the second unit
   of $964,286 as of December 31, 1995.  Subsequent to September 30, 1996, the
   Company and  J&J Finance signed an agreement agreeing to a mutual dismissal
   of actions and a release of claims.

   Federal Trade Commission Proceedings
   ------------------------------------

        The Seattle Regional Office of the Federal Trade Commission has advised
   the Company that the staff believes that the Company's fat sequestrant
   product, which currently is marketed by a licensee under the name
   "SeQuester," has been improperly represented in advertising claims, and that
   the sequestrant product, when previously marketed by the Company under the
   name "Lipitrol", also was improperly represented in advertising claims. The
   staff has indicated that it is prepared to recommend that a complaint be
   filed against the licensee, the Company and certain individuals in connection
   with the foregoing. The Company presently is discussing this matter with the
   FTC staff with the objective of settling the matter. There is no assurance
   that a settlement will be reached or as to the impact on the Company of any
   settlement, although it is presently believed that any settlement may impact
   the claims utilized in the marketing of the sequestrant product and is likely
   to involve the payment of a fine or other financial penalty by the Company.
   The Company and the FTC staff have agreed upon the terms of a proposed
   settlement in this matter, pursuant to which the Company would consent to a
   permanent injunction prohibiting it from making misrepresentations relating
   to weight loss or weight reduction products or services, or with respect to
   tests or studies relating to 

                                      -23-
<PAGE>
 
   such programs or services. In addition, the Company would pay consumer
   redress to the FTC in an aggregate amounts of $35,000 over a period of twelve
   months. The Company's Board of Directors voted to accept the proposal in
   March 1996, which now must be formally approved by the FTC.

        Except as otherwise specifically indicated above, management believes
   that the Company doesn't have any material liability for any lawsuits,
   settlements, judgements or fees of defense counsel which have not been paid
   or accrued as of September 30, 1996.

        While the ultimate outcome of these issues, if claims were asserted and
   litigated, is complicated and not free from doubt, management with the advice
   of legal counsel believes, on the basis of the facts currently known, that it
   is not probable that the Company would have any material liability.  However,
   there can be no assurance that the Company will prevail in any of the above
   proceedings.  Also the Company may be required to continue to defend itself
   resulting in substantial additional expense.  In the event the Company is
   unable to pay the defense costs associated with the foregoing an unfavorable
   settlement or judgement could be awarded against the Company which could have
   a material adverse effect upon the Company.  Additionally, starting in June
   1995, the Company began taking the steps it considered necessary to insure
   that the Company, its subsidiaries, employees, consultants and affiliated
   companies and individuals are not involved in any activities, operations, or
   relationships which are not solely for benefit of the Company.

        There can be no assurance that the Company will prevail in any of the
   foregoing lawsuits.  The Company may incur substantial expense in connection
   with this litigation and any unfavorable settlement or judgement against the
   Company in which the Company is a defendant could have a material adverse
   effect upon the Company.

        The Company currently has no firm commitments for material capital
   expenditures, with any such future commitments being dependent upon the
   availability of funds.  The Company does not anticipate that future
   compliance with existing environmental and occupational safety regulations
   will have a significant impact on its capital expenditures or on its
   financial condition or future operating results.

   EFFECT OF INFLATION

        The Company does not believe that general inflation would have a
   material effect on its operations.

                                      -24-
<PAGE>
 
                          PART II.  OTHER INFORMATION
                          ---------------------------


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


        On October 26, 1995, the shareholders of the Company approved amendments
   to the Company's certificate of Incorporation to provide for:  (i) a reverse
   stock split of not less than one share for every four old shares nor more
   than one share for every eight old shares, with the specific exchange ratio
   to be determined by the Board of Directors; (ii) an increase in the number of
   authorized shares of common stock from 25,000,000 to 50,000,000.


   ITEM 5.  OTHER INFORMATION

        On July 6, 1995, the Company's common stock was deleted from the Nasdaq
   Small-Cap Market. The Company then requested a hearing before the Nasdaq
   Hearing Review Committee ("Committee"). On September 22, 1995, the Committee
   affirmed its original delisting decision.


   ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K:

        (a)      During the six months ended June 30, 1996, no Form 8-K were
                 filed.

        (10.24)  2nd & Final Revised Proposal to Acquire Pastels International,
                 Incorporated
 
        (10.25)  Revised Proposed Acquisition of Nutra Quest, Incorporated
 
        (27)     Financial Data Schedule (included only in EDGAR filing).

                                      -25-
<PAGE>
 
                                  SIGNATURES
                                  ----------

     Pursuant to the requirements of Section 13 or 15(d) of the Securities 
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.


                                  INTERACTIVE MEDICAL TECHNOLOGIES LTD.
                                  -------------------------------------
                                      (Registrant)


Date:   11-12-96                      By: /s/ Steven R. Westlund
        --------                          -----------------------------
                                          Steven Westlund
                                          (Chief Executive Officer)


Date:   11-12-96                      By: /s/ Peter T. Benz
        --------                          -----------------------------
                                          Peter T. Benz
                                          (President)


Date    11-12-96                      By: /s/ William R. Neil
        --------                          -----------------------------
                                          William R. Neil, CPA
                                          (Chief Financial Officer)

                                     -26-