MOLECULAR DIAGNOSTICS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 0R 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
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 0-935
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MOLECULAR DIAGNOSTICS, INC.
(Exact Name of Registrant as Specified in Its Charter)

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

414N. ORLEANS ST., SUITE 510, CHICAGO, IL 60610
(Address of Principal Executive Offices) (Zip Code)

(312) 222-9550
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)

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 [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [ ]

The aggregate market value of the Common Stock held by non-affiliates of
the Company as of March 28, 2002 was $24,182,987, based upon the closing sales
price of shares of the Company's Common Stock, $0.001 par value per share
("Common Stock"), of $0.95 per share as reported on the Nasdaq Over-the-Counter
Bulletin Board Market on that date.

The number of shares of Common Stock outstanding as of March 28, 2002 was
25,455,776

The following document is incorporated by reference into Part III of this
Form 10-K:

Molecular Diagnostics, Inc. Proxy Statement, relating to the 2002 annual
meeting of shareholders.

Index to Exhibits is on page F-25.
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MOLECULAR DIAGNOSTICS, INC.
ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 2001

TABLE OF CONTENTS

iii

PART I

ITEM 1. BUSINESS

GENERAL DEVELOPMENT OF BUSINESS

We were incorporated in Delaware in December 1998 as the successor to Bell
National Corporation. Bell National was incorporated in California in 1958. In
December 1998, Bell National, which was then a shell corporation without any
business activity, acquired InPath, LLC, a development stage company engaged in
the design and development of products used in screening for cervical and other
types of cancer. For accounting purposes, the acquisition was treated as if
InPath had acquired Bell National. However, Bell National continued as the legal
entity and the registrant for Securities and Exchange Commission filing
purposes. Bell National merged into Ampersand Medical Corporation, its
wholly-owned subsidiary, in May 1999 in order to change the state of
incorporation of the company to Delaware. In January 1999, we purchased all of
the assets of Samba Technologies, SARL, ("Samba") based in France, from Unilog
Regions, S.A. In September 2001, we acquired 100% of the outstanding stock of
AccuMed International, Inc., ("AccuMed") by means of a merger of AccuMed into
our wholly-owned subsidiary. Shortly after the AccuMed merger we changed our
corporate name to Molecular Diagnostics, Inc. The name change was effected by
the merger of our wholly-owned subsidiary, Molecular Diagnostics, Inc., with and
into Ampersand Medical Corporation. In October 2001, we became a minority
shareholder in Cell Solutions, LLC, a Virginia limited liability company. Except
where the context otherwise requires, "MDI", the "Company", "we" and "our"
refers to Molecular Diagnostics, Inc., its subsidiaries, and its predecessors.

MDI is focused on the design, development and marketing of the InPath
System. The component products of the InPath System are intended to detect, at
the earliest possible stage, cancer and cancer related diseases and may be used
in a laboratory, clinic, or doctor's office. We also design and manufacture the
AcCell computer aided automated microscopy instrument and the AcCell Savant, an
instrument that includes an AcCell and software, which collects quantitative
cellular information used in support of a diagnostic process. These instruments
are sold to laboratories and medical diagnostic companies for use in the
customers' proprietary applications. The instruments, in certain instances, are
also placed in the customers' facility on a fee-for-use basis. Samba designs,
develops and markets web-enabled software based systems for image analysis,
image capture, and image transmission and management for clinical and industrial
applications. Samba also is developing the software used in the InPath System.
Nearly all of our reported revenue to date has been from the sale of Samba
products and services.

RECENT DEVELOPMENTS

BRIDGE FINANCING

On March 19, 2002, we issued a convertible promissory note in the principal
amount of $500,000 to NeoMed Innovations III, L.P. for cash. The note bears
interest at the rate of 7% per year and is due June 15, 2002. The note is
convertible at any time into shares of our common stock at a conversion rate of
no more than $1 per share, subject to adjustment. The note also may be converted
into shares of common stock on the same terms as the price per share of common
stock offered in a proposed private placement. As additional consideration for
the note, we issued NeoMed a warrant to purchase 150,000 shares of our common
stock at an exercise price of $1 per share.

RESIGNATION OF AN OFFICER

On December 31, 2001, Leonard R. Prange tendered his resignation from his
positions as our President, Chief Operating Officer, Chief Financial Officer and
Secretary. Our Board of Directors appointed Peter P. Gombrich, the Chairman of
the Board of Directors, in those offices until a successor was hired. On March
3, 2002, we contracted from Tatum CFO Partners, LLP., Michael A. Brodeur, for
the possible future hire as President, Chief Operating Officer, Chief Financial
Officer, Treasurer and Secretary.

SPECTRX LITIGATION

On February 1, 2002, we reached an out-of-court settlement with SpectRx,
Inc. Under the terms of the settlement, SpectRx paid a lump sum cash payment to
us, and we have granted SpectRx an option to license certain of our technology.
Additional terms of the settlement are confidential. Under the settlement,
neither party admitted any liability or wrongdoing. Welch Allyn, Inc. also was a
party to the settlement agreement.

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

We operate primarily in an industry segment involving medical devices,
diagnostics, and supplies. All of our operations during the reporting period
were conducted within this segment. We expect to continue to focus our
operations on this industry segment.

DESCRIPTION OF BUSINESS

GENERAL OVERVIEW

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.

SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition. Molecular Diagnostics, Inc. recognizes revenue upon
shipment of product to customers and no remaining Company obligations or
contingencies exist, or in the case of sales of software by its wholly owned
subsidiary Samba, upon shipment if 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 twelve months. 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. Samba calculates 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. Implementation and installation services are generally completed
within 120 days.

License, Patents, and Technology. License, patents, and purchased
technology are recorded at their acquisition cost. Costs to prepare patent
filings are capitalized when incurred. Costs related to abandoned or denied
patent applications are written off at the time of abandonment or denial.
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 seventeen years. The Company assesses licenses, patents, &
technology quarterly for impairment.

Stock Compensation. As permitted by the Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), Molecular
Diagnostics, Inc. uses the intrinsic value method to account for stock options
as set forth in Accounting Principles Board No. 25, Accounting for Stock Issued
to Employees (APB 25).

2

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 6% for 2001 and
2000, a volatility factor of 90% for 2001 and 216% for 2000, and a fair value of
the underlying common shares of closing market price on the date of the grant.
The expected life equaled the term of the warrants, options, or restricted
shares.

PRODUCTS

The InPath System

We are currently developing and testing a family of products for use in
cancer screening and diagnosis. We call this family of products the InPath
System. The core of the InPath System is a combination of protein
antibodies -- the Cocktail-CVX -- that allows the InPath System to detect and
highlight abnormal cervical cells in a rapid and objective fashion. We intend to
use different antibody combinations to detect and diagnose different types of
cancer and other cancer-related diseases.

The initial application of the InPath System is designed to enhance the
current cervical cancer screening process performed in laboratories, commonly
referred to as the PAP test. Our ultimate goal is to perform this screening test
in a matter of minutes at the point of service, whether in a laboratory,
doctor's office, clinic or mobile medical vehicle. The InPath System includes
the following components:

- A unique sample collection device consisting of a small disposable
balloon, shaped to fit the cervix. The device is intended to replace the
spatula and brush currently used to collect patient cytology samples.

- A biochemical assay, fully-automated, is applied to a sample to identify
abnormal cells.

- In the laboratory version of the InPath System slide based test, this
biochemical assay is applied to sample cells released from a collection
device and deposited on a glass slide.

- In the point of service version of the InPath System, this biochemical
assay is applied directly to the cellular sample and analyzed either in
solution or while still on the collection device.

- An instrument which performs an automated analysis of a sample by means
of an optical scan that detects the presence of multiple wavelengths of
fluorescent light. This light is produced by fluorescent reporter tags,
which are attached to certain components used in the biochemical assay.

- In the laboratory version of the InPath System, the AcCell computer
aided automated microscopy instrument uses a camera to read the various
wavelengths of light from the collector.

- In the point of service version of the InPath System, the proprietary
instrument uses custom designed optical devices and lasers to capture
the various wavelengths of light.

- Custom designed software that controls the automated instruments and
processes the analysis of the captured light detected.

IN-CELL HPV TEST

In June 2000, we obtained world-wide exclusive license from Invirion and
Bruce Patterson, M.D., its principal, for a proprietary medical technology to
detect the presence of E6 and E7 genes of the human papillomavirus ("HPV"), a
sexually transmitted disease. These viral oncogenes signify that the virus has
assimilated into the patient's cellular DNA, and presence of E6/E7 genes is much
more closely associated with a woman's risk of developing cervical cancer than
currently marketed HPV tests. We will use this technology as part of the InPath
System to allow physicians to manage patient care. The combination of the two
tests will give the healthcare provider a better picture of the level of any
disease present and whether a patient may be at an increased risk to develop
certain diseases in the future. Based on these results, the health care provider
may prescribe a more thorough course of treatment. We began to offer this
product for sale as an Analyte Specific Reagent ("ASR") for use by laboratories
qualified to perform high complexity tests in "home-brew" applications at the
end of 2001 and recorded initial orders in the first quarter of 2002.

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SAMBA SOFTWARE PRODUCTS AND SERVICES

Samba designs, develops and markets web-enabled software based systems for
image analysis, image capture, and image transmission and management in clinical
and industrial applications. Samba also designs the imaging and analysis
software used in the laboratory version of the InPath System. Samba is currently
working on control and analysis software for other instruments in the InPath
System. Nearly all of our reported revenue to date is derived from the sale of
Samba's products and services to other researchers, and other instrument
manufacturers, and pharmaceutical companies.

Samba software suites, a group of programs that may be used alone or in
combination for a particular application, allow the user to capture and share
digital images and related data. Examples of applications are radiology,
pathology, and real-time coordination between a pathologist and a physician
during surgical procedures. Samba software can create a single data folder,
where patient information, physician case notes and diagnostic images from
various sources are maintained or annotated. The software can be employed in
local or wide area networks, or through an Internet browser using
security-encrypted files. All of Samba's software, developed using Visual Basic,
C/C++ and Java, can be used on a wide variety of image capture instruments or
devices and can employ static, historical, or dynamic (live) images. Samba also
provides software customization, installation, interface, network, and Internet
consulting services to the users of its products.

AUTOMATED MICROSCOPY INSTRUMENTS

AcCell

In November 2001, Ventana Medical Systems, Inc. agreed to purchase and
distribute AcCell with their image analysis software, a computer aided automated
microscopy instrument, designed to help medical specialists examine and diagnose
specimens of human cells. AcCell may be delivered with a variety of features
including:

- Robotic slide-feeding systems to load and unload slides from the
microscope;

- Bar code readers to ensure proper identification of samples being
analyzed;

- Electro-mechanical scanning stages to facilitate accurate slide
screening;

- Automated cellular focusing on slides; and

- Data management software to facilitate primary or secondary review of
samples and report results into record-keeping systems.

The current AcCell instrument is a key tool of our research process,
clinical trials, and the InPath System laboratory based test. During the fourth
quarter of 2001, we initiated development of the next generation of the AcCell
instrument, AcCell 2500, utilizing strategic design and manufacturing partners.
During that same fourth quarter, we also signed contracts with customers to
deliver both the current version and the next generation of AcCell instruments
beginning late in 2001. We are continuing to sell and market the instrument to
other potential customers, OEM laboratories and into the diagnostics
marketplace.

AcCell Savant

The AcCell Savant includes an AcCell base instrument as well as an
electronic imaging system and image analysis software. This instrument is
designed for use as a quantitative microscopy platform. We currently have
instruments in use in a customer's laboratory or clinical facility for research
purposes under a fee-per-use contract, which we recently extended through 2003.
As a part of the contract extension, we agreed to provide additional instruments
to handle the customer's laboratory or clinical facility for research purposes
and increased test volumes. The customer has also agreed to be a beta test site
for a new and updated version of the proprietary image analysis software used in
the application. Variations of this platform may also be used with image
analysis software developed by Samba.

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BACK-LOG OF ORDERS

At December 31, 2001, we had a backlog (that is, firm purchase orders for
goods or services) of signed contracts of $1,251,362, to be completed within the
next twelve months, amounting to $150,000 for InPath System products; $995,560
for AcCell instruments and AcCell Savant products; and $105,802 for Samba-
related products.

MARKETS

According to several industry reports , there are approximately 60,000,000
PAP tests performed annually in the United States. The U. S. market for cervical
screening today amounts to approximately $1,000,000,000, based on current
average costs to perform the existing test. We do not plan to develop and train
a large direct sales force to sell the InPath System. Our initial strategy is to
market the laboratory version of the InPath System to major laboratory
organizations in the United States. Once the InPath System has been successfully
established in the laboratory market, our strategy is to form alliances with
these laboratories and other medical products distribution companies and utilize
their sales forces to broaden sales of the InPath System to hospitals, clinics,
managed care organizations and office-based physician groups.

The cost of the PAP test outside of the United States, where approximately
100,000,000 tests are performed, vary widely from country to country. Outside of
the United States, most healthcare services are provided by governmental
organizations. Healthcare in many of these countries is managed by governmental
agencies, often at the local level, making the precise number of tests performed
difficult to validate. In developing countries where healthcare, especially
cancer screening may be minimal, non-profit organizations often supplement
government health programs. We estimate the total of the non-U.S. market today
at between $500,000,000 and $600,000,000.

We intend to distribute InPath System into both markets pursuant to our
statutory regulatory approvals. We also anticipate that because our products are
more cost-effective and designed to increase access to cervical screening, the
potential combined market could be expanded to a level in excess of
$3,000,000,000.

The AcCell is a key proprietary component of the laboratory version of the
InPath System. In addition, we are marketing the AcCell instrument platform,
including the version currently in development, to medical diagnostic companies
as a means to automate specific diagnostic testing processes. We will attempt to
expand our existing customer base and to supply the AcCell platform to
additional customers who are interested in automating their proprietary
diagnostic testing processes. We market the AcCell as the most versatile and
cost-effective automated microscopy platform currently available. We are
expanding our existing customer base for the AcCell Savant and will continue to
market this product to customers interested in image analysis and quantitative
microscopy. We are introducing a new version of the analysis software used on
the AcCell Savant in mid 2002. We believe these innovations will allow us to
increase the level of potential customer interest in the instrument, thus
enabling us to expand our market.

Samba currently sells its products and services through direct sales and
representatives in Europe and through a distribution arrangement in Central and
South America. Prior to 1999, Samba had a distribution arrangement in North
America. Since our acquisition of Samba, we have marketed Samba products in the
United States. Samba is adding to its distribution agreements to cover specific
countries or market segments in Europe, Asia, the Middle East and North Africa.
During 2000, we added a full time marketing person to introduce the Samba
products to a broad range of potential customers and distribution partners in
the United States. This potential market includes large laboratories, integrated
healthcare delivery networks, web-based medical information providers, and
laboratory and hospital information system vendors. We have licensed Samba
software to a large medical diagnostics company in the United States and have
several pilot-study installations currently in place or planned for 2002 in the
United States.

GOVERNMENT REGULATION CLINICAL STUDIES AND REGULATORY STRATEGY

The development, manufacture, sale, and distribution of some of our
products is regulated by the Food and Drug Administration ("FDA") and comparable
authorities in certain states and foreign countries. In the

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United States, the Food, Drug and Cosmetic Act (the "FD&C Act") and related
regulations apply to some of our products. These products cannot be shipped in
interstate commerce without prior authorization from the FDA.

Medical devices may be authorized by the FDA for marketing in the United
States either pursuant to a pre-market notification under Section 510(k) of the
FD&C Act, commonly referred to as a 510(k) notification, or a pre-market
approval application (a "PMA"). The process of obtaining FDA marketing clearance
and approval from other applicable regulatory authorities is costly and there
can be no guarantee that the process will be successful. The 510(k)
notifications and PMA applications typically require preliminary internal
studies, field studies, and/or clinical trials, in addition to submission of
other design documentation. We manage the regulatory process through the use of
consultants, Clinical Research Organizations, ("CROs") and members of our
Medical Advisory Board.

A 510(k) notification, among other things, requires an applicant to show
that its products are "substantially equivalent" in terms of safety and
effectiveness to an existing FDA cleared predicate product. An applicant may
only market a product submitted through a 510(k) notification after the FDA has
issued a written notification determining the product has been found to be
substantially equivalent.

To obtain PMA approval for a device, an applicant must demonstrate,
independent of other similar devices, that the device in question is safe and
effective for its intended uses. A PMA must be supported by extensive data,
including pre-clinical and clinical trial data, as well as extensive literature
and design documentation to prove the safety and effectiveness of the device.
The PMA process is substantially longer than a 510(k) notification process.
During the review period, the FDA may conduct extensive reviews of our clinical
trial center documentation and our manufacturing facilities and processes or
those of our strategic partners. In addition, the FDA may request additional
information and clarifications and convene a physician advisory panel to assist
in its determination.

The FD&C Act generally bars advertising, promoting, or other marketing of
medical devices that the FDA has not approved or cleared. Moreover, FDA
enforcement policy strictly prohibits the promotion of known or approved medical
devices for non-approved or "off-label" uses. In addition, the FDA may withdraw
product clearances or approvals for failure to comply with regulatory standards.

Our current and prospective foreign operations are also subject to
government regulation, which varies from country to country. Many countries,
directly or indirectly through reimbursement limitations, control the price of
most healthcare products. Developing countries put restrictions on the
importation of finished products, which may delay such importation. European
Directives establish the requirements for medical devices in the European Union.
The specific directives are the Medical Device Directive (MDD 93/42/EEC) and the
In-Vitro Diagnostics Device Directive (IVDD/98/79/EEC). The International
Organization for Standardization ("ISO") establishes standards for compliance
with these directives, particularly for quality system requirements.

The FDA has adopted regulations governing the design and manufacture of
medical devices that are, for the most part, harmonized with the ISO's quality
system standards for medical devices. The FDA's adoption of the ISO's approach
to regulation and other changes to the manner in which the FDA regulates medical
devices will increase the cost of compliance with those regulations.

We will be subject to certain registration, record-keeping and medical
device reporting requirements of the FDA. Our manufacturing facilities, or those
of our strategic partners, will be obligated to follow the FDA's Quality System
Regulation and be subject to periodic FDA inspections. Any failure to comply
with the FDA's Quality System Regulation or any other FDA or other government
regulations would have a material adverse effect on our future operations.

The InPath System will need to be cleared for marketing by the FDA, as
described above, prior to its sale and use in the U.S. clinical market. We
cannot be sure whether or when the FDA will clear the InPath System.
Internationally, the InPath System may be subject to various government
regulations, which may delay the introduction of new products and services and
adversely affect our business.

6

The InPath System may be subject to regulation in the United States under
the Clinical Laboratory Improvement Act ("CLIA"). CLIA establishes quality
standards for laboratories conducting testing to ensure the accuracy,
reliability and timeliness of patient test results, regardless of where the test
is performed. The requirements for laboratories vary depending on the complexity
of the tests performed. Thus, the more complicated the test, the more stringent
the requirement. Tests are categorized as high complexity, moderate complexity
(including the category of provider performed microscopy) and waived tests. CLIA
specifies quality standards for laboratory proficiency testing, patient test
management, quality control, personnel qualifications and quality assurance, as
applicable.

The FDA is responsible for categorization of commercially marketed
laboratory tests. The Centers for Disease Control ("CDC") is responsible for
categorization of laboratory procedures such as provider-performed microscopy.
For commercially-marketed tests, the FDA now determines the appropriate
complexity category as it reviews pre-market submissions for clinical laboratory
devices. Manufacturers are asked to include an extra copy of the package insert
identified as "FOR CLIA CLASSIFICATION" in the submission for product
commercialization (i.e., 510(k) or PMA). Manufacturers are notified of the
assigned complexity through routine FDA correspondence (that is, as an enclosure
with a clearance or approval letter or as a separate letter in response to other
submissions). Categorization is effective as of the date of the written
notification to the manufacturer.

We are developing the InPath System to be user-friendly, require minimum
operator training, and have safety and operating checks built into the
functionality of the instruments. We believe that our efforts will result in the
FDA and/or the CDC assigning the lowest possible classification of the InPath
System. If, however, these products are classified into a higher category, it
may have a significant impact on our ability to market the product in the United
States.

We continue to conduct clinical studies and trials on our InPath System
during its development. These studies and trials vary in terms of number of
patient samples, individual product components, specific processes and
conditions, purpose, and other factors which may affect the results.

We have publicly reported the results of some of the studies of the InPath
System and Cocktail-CVX to various medical meetings, in publications and in
public announcements. In January and March 2000, April 2001, and most recently
during the third quarter of 2001, we reported results on specific studies
conducted to demonstrate the system's capability to detect cervical cellular
abnormalities. The average sensitivity for these reported studies and trials was
in excess of 90% and the average specificity was approximately 80%. The
sensitivity factor, the test's performance in detecting versus missing actual
disease, commonly called false negatives, is critical in terms of patient
health. The specificity factor, the test's performance in correctly identifying
patients with disease versus those without, commonly called false positives, is
related to over-treatment and healthcare economics.

In each of the reported studies and trials, the InPath System demonstrated
nearly 100% accuracy in detecting high-grade cervical disease and cancer. In
addition, the results demonstrate that the InPath System produces more accurate
results than the current PAP test. A study conducted in 2000 on the PAP test,
which reviewed the results of 94 previous studies, showed an average sensitivity
of 74% and an average specificity of 68%.

Data from studies of other InPath System products has also been presented
at medical conferences. A study of our In-Cell HPV test showed the test
accurately detected 100% of patients with high-grade disease and 64% of patients
with low-grade disease.

In a presentation of early results of the clinical trial of the InPath
System collector, data showed that the cytology reports on samples collected
with the InPath System collector were at least as accurate as those collected
with the conventional brush/spatula method. The InPath System collector also
proved to be more comfortable for the patient and provided an easier and shorter
examination for the physician. The results of the additional clinical patients
data were submitted in January 2002.

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We believe the results of these studies support the continued development
process of the InPath System. We are moving ahead with additional studies and
clinical trials, some of which were begun in late 2001 and others are planned to
begin in mid-2002.

We are using the data from our completed and ongoing clinical trials and
studies to offer for sale our InPath System as an ASR in countries such as the
United States, Mexico, Peru, Chile, India, China and other developing nations.
We are not permitted to market non-ASR our products in certain countries,
including the United States, with clinical or diagnostic claims until we have
received clearance from the appropriate regulatory agency. ASR tests make no
medical claims but may be used by laboratories, who are qualified to perform
high complexity tests, and physicians as components of "home-brew" procedures.
We received our first U.S. ASR orders in early 2002.

We are pursuing regulatory approval of the InPath System products through a
series of submissions and in some cases, using data from a single clinical
study. This tiered approach is designed to accelerate revenue opportunities for
the InPath System in the short term and to drive adoption of our innovative
products over the long term, while minimizing the expense and time involved in
undertaking the appropriate study.

The first stage of the overall strategy involved the submission of our e(2)
Collector for approval as a substantially equivalent device to the brush and
spatula method of gathering samples used in the current PAP tests. The 510(k)
notification was completed and filed in late September 2001. Subsequent data was
furnished to the FDA in the first quarter of 2002.

The second stage of our overall strategy involves a continuing study of the
InPath System and Cocktail-CVX. This submission will cover the InPath System as
a means to eliminate true negative samples from further testing. We anticipate
completion of this portion of the study and submission of the data to the FDA by
the third quarter of 2002. We will also submit the data to foreign regulatory
authorities that have jurisdiction over these products. Subsequently, we will be
collecting and submitting data for the InPath System point of service test.

We anticipate that we will begin launching our clinical trials of the
InPath In-Cell HPV test during the fourth quarter of 2002 and expect completion
of the trial and submission of the data to the FDA during the first quarter of
2003, depending on our ability to raise necessary capital.

If the submissions for the various InPath System products are cleared by
the FDA for sale in the U.S. market or approved for sale by foreign regulatory
agencies, we intend to sell the cleared products in the respective clinical
markets.

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INPATH SYSTEM PRODUCT INTRODUCTION TIMELINES

We currently distribute AcCell, AcCell Savant and Samba software products
into commercial markets that do not require regulatory clearance. In order to
distribute these products for use in certain clinical applications, however, we
will be required to conduct clinical trials and to make submissions to
applicable regulatory agencies for clearance. We do not have any current plans
to make any submissions to the FDA or other foreign regulatory agencies covering
these products. In the future, some of our customers may include these products
in submissions to the FDA or other foreign regulatory agencies covering their
use in a customer's proprietary diagnostic or clinical process.

COMPETITION

Historically, competition in the healthcare industry has been characterized
by the search for technological innovations and efforts to market such
innovations. The cost of healthcare delivery has always been a significant
factor in markets outside of the United States. In recent years, the U.S. market
has also become much more cost conscious. We believe technological innovations
incorporated into certain of our products offer cost effective benefits that
address this particular market opportunity.

Competitors may introduce new products that compete with ours or those
which we are developing. We believe the portion of our research and development
efforts devoted towards continued refinement and cost reduction of our products
will permit us to remain or become competitive in all of the markets in which we
presently distribute or intend to distribute our products.

The market for our cancer screening and diagnostic product line is
significant but highly competitive. We are unaware of any other company that is
duplicating our efforts to develop a fully-automated, objective analysis and
diagnostic system for cervical cancer screening that can be used at the point of
service. There are a number of companies attempting to develop in-vivo systems
to differentiate between cancerous, pre-cancerous and normal tissue. Our
competition includes many companies with financial, marketing, and research and
development resources substantially greater than ours. There can be no assurance
that our technological innovations will provide us with a competitive advantage.

9

Similarly, the worldwide markets in which we sell Samba's products are
highly competitive. Several U.S. and foreign companies are developing and
marketing products and services that compete directly with Samba's products and
services. However, Samba has the benefit of a robust customer base throughout
Europe, as well as a few long-term customers in the United States. Our strategy
is to use these customers as references in our marketing efforts to expand the
sales and use of Samba products.

There are several U.S. and foreign companies that produce automated and
quantitative microscopy instruments. In the past, the market for these
instruments has been primarily limited to research applications. However, as a
result of recent advances in the area of molecular diagnostics, we believe the
market for such instruments and applications will increase over the next several
years. We believe our instruments are the most versatile cost-effective
platforms available in the current market whether as an outright purchase or a
fee-for-use application.

We believe that all of our products must compete primarily on the basis of
accuracy, functionality, product features and effectiveness of the product in
standard medical applications. We also believe that cost control and cost
effectiveness are additional key factors in achieving or maintaining a
competitive advantage. We focus a significant amount of product development
effort on producing systems and tests which will not add to overall healthcare
cost. Specifically, there are several companies whose technologies are similar
to, or overlap with MDI's. These include Cytyc Corporation, Tripath Corporation,
Digene Corporation, ChromaVision Systems, Inc., and Applied Imaging, Inc.
However, none of these companies have developed the fully integrated
requirements necessary to deliver a fully-automated solution. To develop
fully-automated solutions, companies must have technologies that fully integrate
microscopy instruments, imaging software and cancer-detecting biochemistry. At
most, our competitors have two of the three technologies. Only our Company has
developed and integrated all three technologies into a solution for cervical
cancer screening.

OPERATIONS

We conduct research and development work for the InPath System using a
combination of our employees, contract workers, and contract laboratory
facilities which are primarily located in Chicago, Illinois, Minneapolis,
Minnesota, San Antonio, Texas and in other various states.

We do not intend to invest capital to construct and maintain a
medical-products manufacturing facility and all its related quality systems
requirements. Our strategy is to utilize the operations, quality systems, and
facilities of a contract manufacturer specializing in medical products
manufacturing to meet our current and future needs. This strategy covers
manufacturing requirements related to InPath System chemical components, plastic
and silicone parts for the sample collector, InPath System instruments and the
AcCell and AcCell Savant instruments.

We have preliminary agreements, including design and development work, with
manufacturers of medical grade components to supply low volumes of the silicone
balloon and other components of the sample collection device. We are negotiating
additional agreements with manufacturers to supply much higher volumes that will
be needed once we begin to sell the sample collection device. These
manufacturers have the capacity to handle high volume production through
facilities in both the United States and several foreign countries.

We entered into a strategic partnership with Cell Solutions, LLP, in
October 2001, to design, develop and improve leading-edge manual slide based
preparation systems with state-of-art biochemical preservatives.

We also have a preliminary agreement with a large manufacturer of chemical
and biological tests to integrate the various combinations of ingredients that
make up our assay Cocktail-CVX into a single product delivered in high volume.

We have a sufficient supply of AcCell platforms. The computers, cameras,
automated slide staining equipment and slide preparation equipment, that make up
the remainder of the laboratory version of the InPath System, are available from
several manufacturers. These instruments are used in a sequential process. The
AcCell platform on which the actual sample screening is done is computer
controlled by our proprietary Samba software.

10

We have preliminary agreements with medical instrument manufacturers
covering the design, development and initial manufacturing of both the next
generation AcCell platform and the point of service instrument.

Samba develops its software products at its own facility located in France.
Additional software development work is conducted at our facility in Chicago.
The Samba software products are installed and integrated with off-the-shelf
computer and imaging components at the customer's location, or at our French or
Chicago facility, immediately prior to delivery. Consulting services are
generally performed at the customer's location, or at our French or Chicago
facility, using customer data and communications access. We have added staff at
our Chicago facility to support the delivery of Samba and image analysis
software products to customers in the United States.

INTELLECTUAL PROPERTY

We rely on a combination of patents, licenses, trade names, trademarks,
know-how, proprietary technology, and policies and procedures to protect our
intellectual property. We consider such security and protection a very important
aspect of the successful marketing of our products in the U.S. and foreign
markets.

In the U.S. we follow the practice of immediately filing a provisional
patent application for each invention as soon as it has been determined that the
invention meets the minimum standards for patentability. While a provisional
patent application does not provide any formal rights or protections, it does
establish an official priority date for the invention that carries over to any
utility patent applications that are derived from the provisional application
with the next 12 months. A utility patent application begins the process that
can culminate in the issuance of a U.S. patent. We convert each outstanding
provisional patent application into some number of utility patent applications
within this 12 month period. In most cases each provisional application results
in one utility filing. However, in some cases a single provisional application
has generated two independent utility filings or multiple (up to five)
provisional applications have been consolidated into a single utility
application. During the prosecution of a utility application, the U.S. Patent
Office may require us to divide the application into two or more separate
applications or we may file a continuation-in-part patent application that
expands upon the technology claimed in another patent application and which has
the potential of superceding the earlier application. For these reasons,
estimating the number of patents that are likely to issue based upon the numbers
of provisional and utility applications filed is problematical.

Prior to filing a utility application in the U.S., we review the
application to determine whether obtaining patent coverage for the invention
outside of the U.S. is necessary or desirable to support our business model. If
so, a patent application is filed under the Patent Cooperation Treaty (PCT) at
the same time that the U.S. filing is made. Depending upon the nature of the
invention and business considerations, we typically specify the patent offices
in three to six countries to which the PCT application is to be submitted after
the initial examination is completed.

As of December 31, 2001 we have filed ten U.S. utility patent applications
and four PCT applications. We have been informed that one of the U.S. utility
applications has been "allowed" and will issue as a U.S. Patent during the first
quarter of 2002. Twelve additional provisional U.S. patent applications have
also been filed and are expected to be converted to utility applications during
the first half of 2002. These patent applications cover all aspects of the
InPath system including, but not limited to the point of service instrument; the
personal and physicians collectors; and the slide-based test. As a result of the
acquisition of AccuMed, we acquired seventeen issued U.S. patents, six U.S.
utility patent applications; two U.S. design patents; twenty-six foreign
patents; and twenty-four foreign patent applications primarily covering the
AcCell and AcCell Savant technology and related software. We also hold an
exclusive license from Invirion and Dr. Bruce Patterson covering a patent and
certain medical technology for detection of E6 and E7 genes in cancer causing
types of HPV virus. We purchased the license for cash, future royalties, and
other consideration.

We continue to prepare additional patent applications for processes and
inventions arising from our research and development process. The protections
provided by a patent are determined by the claims that are allowed by the patent
office that is processing the application. During the patent prosecution process
it is not
11

unusual for the claims made in the initial application to be modified or deleted
or for new claims to be added to the application. For this reason it is not
possible to know the exact extent of protection provided by a patent until it
issues.

Patent applications filed prior to November 29, 2000 in the U.S. are
maintained in secrecy until any resulting patent issues. As there have been
examples of US patent applications that have remained "in prosecution" and,
therefore, secret for decades, it is not possible to know with certainty that
any U.S. patent that we may own, file for or have issued to us will not be
pre-empted or impaired by patents filed before ours and that subsequently issue
to others. Utility patent applications filed in the U.S. after November 29, 2000
are published eighteen months after the earliest applicable filing date. As this
revised standard takes full effect, the chances that such a "submarine" patent
will impair our intellectual property portfolio will be significantly reduced.
Foreign patent applications are automatically published eighteen months after
filing. As the time required to prosecute a foreign utility patent application
generally exceeds eighteen months and the foreign patents use a "first to file"
rather than a "first to invent" standard, we do not consider submarine patents
to be a significant consideration in our patent protection outside of the U.S.

Samba software and technology consists primarily of trade secrets,
know-how, and technical documentation. To further enhance security, we restrict
access to our software source codes and the details of the step-by-step
instructions for command, control and operation of a software program.
Furthermore, a hardware security key, or "dongle," is required in order for a
user to operate the software.

Our products are or will be sold worldwide, under trademarks that we
consider to be important to our business. We own the Samba trademark and trade
names of "Samba", "InPath", "e2 Collector", "Cocktail-CVX", "In-Cell HPV Test",
"AcCell" and "AcCell Savant". We may file additional U.S. and foreign trademark
applications in the future.

Our future technology acquisition efforts will be focused towards those
technologies that have strong patent or trade secret protection.

We cannot be sure that patents or trademarks issued or which may be issued
in the future will provide us with any significant competitive advantages. We
cannot be sure any of our patent applications will be granted or that validity
or enforceability will not be successfully challenged. The cost of any patent
related litigation could be substantial even if we were to prevail. In addition,
we cannot be sure that someone will not independently develop similar
technologies or products, duplicate our technology or design around the patented
aspects of our products. The protection provided by patents depends upon a
variety of factors, which may severely limit the value of the patent protection,
particularly in foreign countries. We intend to protect much of our core
technology as trade secrets, either because patent protection is not possible
or, in our opinion, would be less effective than maintaining secrecy. However,
we cannot be sure that our efforts to maintain secrecy will be successful or
that third parties will not be able to develop the technology independently.

RESEARCH AND DEVELOPMENT

Our research and development efforts are focused on introducing new
products as well as enhancing our existing product line. We utilize both
in-house and contracted research and development efforts. We believe research
and development is critical to the success of our business strategy. During the
years 2001, 2000, and 1999, our research and development expenditures were
approximately $4,034,000, $3,426,000, and, $1,782,000, respectively.

We completed clinical testing of the sample collection device, the e(2)
Collector, and submitted the results of this trial to the FDA in the form of a
510(k) notification on September 28, 2001.

The design and validation of the laboratory version of the InPath System,
including image analysis software developed in-house by Samba, is currently in
process. We have reviewed and validated the performance of over thirty
biological components for use in our Cocktail-CVX. We used samples from patients
with normal and abnormal (those with cancer or its precursors) pathology reports
in our studies. We

12

selected a specific combination of chemical and biological components for the
Cocktail-CVX and commenced testing in the fourth quarter of 2001.

The development of the In-Cell HPV test for use in flow-cytometry and slide
based applications is current in process. We anticipate launching the clinical
trial for the In-Cell HPV test in the fourth quarter of 2002.

The design specifications for the point of service analysis instrument are
complete and several prototypes have been assembled. Additional development work
will progress with an outside strategic design/manufacturing partner based upon
further funding.

Our research work in the area of chemical and biological components will
continue for the foreseeable future as we seek to refine the current process and
add additional capabilities to our analysis procedure, including the detection
of other forms of cancer and precursors to cancer.

We have entered into a contract with an outside strategic
design/manufacturing partner to develop the next generation AcCell instrument
platform. The design specifications are complete and prototypes are in process.

We expect development completion of a new version of the AcCell Savant
image analysis software, which will make the device more user friendly and
in-line with current software technologies in the second quarter, 2002.

We anticipate the need to invest a substantial amount of capital in the
research and development process, including the cost of clinical trials, in
order to complete the development and use of the InPath System and bring it to
market.

COMPONENTS AND RAW MATERIALS

Low cost products are a key component of our business strategy. We designed
the sample collection device using widely available and inexpensive silicone and
plastic materials. These materials are available from numerous sources and can
be fabricated into finished devices by a variety of manufacturers within and
outside the United States. We can use sources outside of the United States so
that we may service a particular market at the lowest possible cost.

The instrument components of the laboratory version of the InPath System
are available from a number of sources. Computers, cameras, automated
slide-staining instruments and automated slide-preparation instruments are
currently available from several large manufacturers. We have an adequate supply
of current AcCell platforms used in the InPath System and have contracted for
the design and manufacture of the next generation of the AcCell platform.

The point of service instruments are designed to use off-the-shelf
components and a limited number of custom manufactured parts or use a third
party manufactured instrument. The strategic partner chosen to manufacturer the
unique final instrument, as is the case with the company building the
prototypes, will be responsible for sourcing, fabrication, and assembly of all
components into the final instrument.

Samba's software products are based on leading edge technology and are
compatible with numerous off-the-shelf computers, computer components,
microscopes, and imaging equipment.

WORKING CAPITAL PRACTICES

As of December 31, 2001, we have not sold any InPath System products,
except for ASR's. During the final quarter of 2001 we sold several AcCell
instrument platforms, billed and received fees under an AcCell Savant
fee-for-use contract and closed on the first sale of Samba software products in
the United States. We have financed our U. S. operations and research and
development by raising funds through the sale of debt or equity. We will
continue to use these methods to fund our operations until such time as we are
able to generate adequate revenues and profits from the sales of some or all of
our products.

13

The sale of Samba products, totaling approximately $877,000 for the year
ended December 31, 2001, outside the United States generates revenue that is
used to support Samba operations. Samba has obtained a 200,000 Euro
(approximately $178,920) revolving line of credit from its bank to provide
supplemental funds, as needed. Availability of funds under the line of credit is
based on and secured by Samba's monthly billings to customers. The line is
especially helpful since collection periods for many customers may exceed
standard thirty-day terms. Customers requiring government funding to pay their
bills or customers outside France often take longer than thirty days to pay. At
times Samba requires a deposit on an order before ordering any equipment or
beginning any work.

Similarly, we believe that future sales of the InPath System or other
products into foreign markets will result in collection periods that may be
longer than those expected for domestic sales of these products. Our strategy
will be to use letters of credit or other secured forms of payment, whenever
possible, in sales of products in foreign markets.

EMPLOYEES

As of March 28, 2002, we employed a total of eighteen full-time employees
in the United States and eleven full-time employees in France. The Samba
employees in France are represented by a national labor union (customary to all
French workers) and Samba management considers its relations with its employees
to be good.

FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES

Our current operations outside North America are conducted by Samba. Sales
of Samba products have accounted for a nearly all of our sales reported to date.

Markets outside of North America are an important factor in our business
strategy. Any business that operates on a worldwide basis and conducts its
business in one or more local currencies is subject to risks of fluctuations in
the value of those currencies against the dollar. It is subject to changing
political climates, differences in culture and the local practices of doing
business. It is also subject to North American and foreign government actions,
such as export and import rules, tariffs and duties, embargoes, trade sanctions.
We do not regard these risks, however, a significant deterrent to our strategy
to introduce our InPath System to foreign markets.

As we begin to market and sell our InPath System, we will closely review
our foreign operational practices. We will attempt to adopt strategies to
minimize risks of changing economic and political conditions within foreign
countries.

As part of the Series D convertible preferred stock offering in November
2001, we licensed to Ventana Samba software but were unable to obtain a
valuation of the software license and therefore did not recognize revenue
related to the license agreement as of December 31, 2001. In order to provide a
valuation benchmark, we noted in Ventana's year end financial statements as of
December 31, 2001, the valuation placed on the software license agreement
between MDI and Ventana was $240,000.

14

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995

There are forward-looking statements throughout this report that are not
historical facts, including statements in this Item 1 and statements contained
in material incorporated into this report by reference. These statements are
based on our current expectations and plans and involve many risks and
uncertainties. Some of these risks and uncertainties are factors that affect all
international businesses, while others are specific to us and the areas of the
medical products industry in which we operate.

The factors below in some cases have affected our historical results and
could affect our future results, causing them to differ, possibly materially,
from those expressed in this report's forward-looking statements. These factors
include: economic conditions; technological advances in the medical field;
demand and market acceptance risks for new and existing products, technologies,
and healthcare services; the impact of competitive products and pricing;
manufacturing capacity; new plant start-ups; U.S. and international regulatory,
trade, and tax policies; product development risks, including technological
difficulties; ability to enforce patents; and foreseeable and unforeseeable
foreign regulatory and commercialization factors.

Currency fluctuations are also a significant variable for global companies,
especially fluctuations in local currencies where hedging opportunities are
unreasonably expensive or unavailable. If the value of the U.S. dollar
strengthens relative to the currencies of the countries in which we market or
intend to market our products, our ability to achieve projected sales and net
earnings in such countries could be adversely affected.

We believe that our expectations with regard to forward-looking statements
are based upon reasonable assumptions within the bounds of our current business
and operations knowledge, but we cannot be sure that our actual results or
performance will conform to any future results or performance expressed or
implied by any forward-looking statements.

ITEM 2. PROPERTIES

We occupy approximately 5,700 square feet of leased space at 414 N. Orleans
St., Suite 510, Chicago, Illinois 60610, under a five-year lease, which expires
in September 2006. This space houses our executive offices and a research
laboratory. Samba leases approximately 300 square meters of space in a suburb of
Grenoble, France, at 53, chemin du Vieux Chene, 38240 Meylan. The Samba lease
has a term of nine years expiring in 2008. Samba has the option to terminate the
lease at the end of each three-year period. The location houses Samba's
administrative, sales, and research and development activities. We consider our
facilities to be well utilized, well maintained, and in good operating
condition. We consider the facilities to be suitable for their intended purposes
and to have capacities adequate to meet current and projected needs for our
operations.

ITEM 3. LEGAL PROCEEDINGS

On October 20, 2000, we filed suit in Circuit Court of Cook County,
Illinois (Case No. 00 CH 15652), against SpectRx, Inc. and Welch Allyn, Inc. Our
suits sought injunctive relief and damages from SpectRx based on a complaint of
fraud and breach of certain confidentiality agreements with regard to our
business plans, marketing plans, and technology related to in-vivo diagnostic
devices. Our claim arose from disclosure of confidential information to SpectRx
in the course of negotiations contemplating a joint venture to develop new
medical products. The information covered cancer detection systems relying on
fluorescence technologies as well as bio-molecular marking agent for use in
applications within and outside of the body. We also provided SpectRx with
marketing plans, revenue, income and cash flow projections, product development
and launch plans, and product distribution strategies. In addition, we provided
SpectRx with certain confidential technical information regarding patent
applications, measurement technologies, design specifications, quantitative
analyses, optimization techniques, positional information for cellular mapping,
and other technical specifications. Subsequent to the disclosure of our
information to SpectRx, they entered into a business arrangement with Welch
Allyn to develop products of a similar nature to ours. The suit also charged
SpectRx and Welch Allyn with misappropriation of our trade secrets in violation
of the Illinois Trade Secrets Act.

15

Our suit was filed in response to a suit filed by SpectRx in the Superior
Court of Gwinnett County, Georgia (Civil Action NO. 00-A-7604 1), seeking a
declaratory judgment (but no monetary damages or other relief) that SpectRx did
not breach the confidentiality agreements as charged in our suit. On July 5,
2001, we filed counterclaims, similar to the claims outlined in our Illinois
suit, to the SpectRx action in Georgia.

On January 31, 2002, we reached an out-of- court settlement with SpectRx.
Under the terms of the settlement, SpectRx paid a lump sum cash payment to us,
and we have granted SpectRx an option to license certain of our technology.
Additional terms of the settlement are confidential. Under the terms of the
settlement, neither party admitted any liability or wrongdoing. Welch Allyn also
was a party to the settlement agreement.

Dawn H. Grohs, a former employee of the Company, filed suit against the
Company and certain affiliated companies, as well as two of the Company's senior
officers (C.A. No. 02-C-1010 (U.S. District Court for the Northern District of
Illinois). Ms. Grohs' claims fraud, unjust enrichment, misrepresentation, breach
of contract and quantum meruit related to her assertions that the defendants
allegedly failed to provide her with equity; tortuous interference with
contractual relations and intentional interference with contractual relations
based on alleged encouragement of changes to the business relationship with Ms.
Grohs; breach of the covenant of good faith and fair dealing, negligent
infliction of emotional distress and intentional infliction of emotional
distress based on defendants' treatment of Ms. Grohs; and violation of state law
for alleged unfair and deceptive acts by defendants for the purpose of inducing
Ms. Grohs to continue to provide services without compensation. Ms. Grohs is
seeking $85,000 in wages, $40,250 in expenses, equity for contributions and
efforts during the formation of certain of the Company's affiliates, payment of
a sum to be determined by the court for the intentional and/or negligent
infliction of emotional distress, a finding that the actions of defendants
constitute unfair and deceptive acts, and that the court treble the damages
awarded. In addition to the specific relief described above, each count seeks an
award of attorneys' fees and costs and such other and further relief as the
court deems just and appropriate.

Prior to our 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 is claiming approximately $50,000 is
due them. Even though AccuMed has since vacated the premises, Garrett also is
continuing to claim rent on an ongoing basis. Following completion of MDI's
merger with AccuMed, management decided to vacate AccuMed's leased facility and
consolidate its operations into MDI's headquarters facility. Management is
expected to enter into negotiations with AccuMed's landlord in order to reach a
settlement arrangement relating to the remaining minimum lease payments. Since
MDI has 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.

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

There were no matters submitted to a vote of shareholders during the fourth
quarter of 2001.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

Our common stock is quoted on the Nasdaq Over-the-Counter Bulletin Board
under the symbol "MCDG" (prior to September 25, 2001 our common stock traded
under the symbol "AMPM"). AccuMed's common stock was quoted on the Nasdaq
Over-the-Counter Bulletin Board under the symbol "ACMI".

16

The following table lists the high and low closing sale prices per share of
our common stock for the periods indicated, as reported on the Nasdaq
Over-the-Counter Bulletin Board. These prices represent prices between dealers,
and may not include retail mark-ups, mark-downs, or commissions.

HOLDERS

As of March 31, 2002, we had approximately 1,369 record holders of our
shares of common stock. This number does not include other persons who may hold
only a beneficial interest, and not an interest of record, in our common stock.

DIVIDENDS

We have not paid a cash dividend on common shares, and the Board of
Directors is not contemplating paying one for the foreseeable future. We have
accrued non-cash cumulative dividends for various preferred share offerings
through December 31, 2001 totaling approximately $1.9 million.

STOCK TRANSFER AGENT

Our stock transfer agent is LaSalle Bank NA, 135 South LaSalle Street,
Chicago, IL 60603, and its telephone number is (312) 904-2000.

RECENT SALES OF UNREGISTERED SECURITIES AND USE OF PROCEEDS

In November 2001, we completed a private placement of Series C convertible
preferred stock to accredited investors pursuant to Regulation D. We received
$3,635,000 in net proceeds from the sale of 1,331,499 shares of Series C
convertible preferred stock. The Series C convertible preferred stock has a
dividend rate of 10% and is convertible into our common stock at a conversion
rate equal to $0.60 per share. In connection with the private placement, we paid
$359,000 in cash and issued 597,750 warrants to purchase our common stock at a
purchase price of $1.00 per share to Bathgate McColley Capital markets as
compensation for their services as placement agent.

Also in November 2001, we completed a private placement of Series D
convertible preferred stock to Ventana Medical Systems, Inc. pursuant to
Regulation D. We received $1,750,000 in net proceeds from the sale of 175,000
shares of Series D convertible preferred stock. The Series D convertible
preferred stock has a dividend rate of 10% and is convertible into our common
stock at a conversion rate equal to $1.00 per share. We also issued a three-year
warrant to Ventana entitling the holder to purchase 1,750,000 shares of our
common stock at an exercise price of $1.15 per share. The sale of the Series D
Convertible preferred stock to Ventana was made in conjunction with a license
and technology agreement under which Ventana was granted a perpetual license to
Samba software and agreed to purchase AcCell instruments over a three year
period.

17

In December 2001, we completed an exchange offer in which our shareholders
tendered 10,859,088 shares of our common stock in exchange for approximately
434,388 shares of Series E convertible preferred stock. The Series E convertible
preferred stock has a dividend rate of 10% and is convertible into our common
stock at any time after December 1, 2002 at a conversion rate equal to $0.80 per
share.

REIMBURSEMENT OF LEGAL FEES

On November 1, 2001 MDI issued a Convertible Promissory Note to Schwarz,
Cooper, Greenberger & Krauss ("SCGK") in exchange for $500,000 in legal
services. The Note bears interest at the rate of 12% per year and is due in five
installments. The Note is convertible into Common Stock of MDI upon issuance of
the Note at a conversion price equal to the stock price on the conversion date.

In accordance with Promissory Note provisions, SCGK forgave the final
installment on the note which was due February 28, 2002. Therefore, MDI did not
include the final payment in its debt balance as of December 31, 2001.

MDI executed a settlement agreement with SpectRx in January 2002 regarding
the outstanding litigation in which SCGK served as MDI's counsel. MDI also
executed an agreement with SCGK for its outstanding legal fees, dated February
13, 2002, that stipulated that MDI would provide SCGK with warrants to purchase
750,000 shares of common stock, a promissory note in the amount of $118,500 and
a personal guaranty of the note from Peter Gombrich. MDI was required to pay a
$25,000 fee upon the execution of the agreement.

On February 13, 2002, MDI issued 750,000 warrants to SCGK for its common
stock. The warrants are exercisable at $.01 per share. SCGK is entitled to an
additional set of 750,000 warrants in the event of the default of the promissory
note as described above. The initial 750,000 warrants represent payment for the
SpectRx settlement while the second 750,000 warrants represent a contingent
payment in the event of default under the note. The expiration date of the
warrant is February 12, 2012 and warrants may not be exercised until February
14, 2003.

The Company has not made any payments on the Promissory Note and therefore
the note is in default. The default provisions in the note agreement indicate
that the warrant issued in conjunction with the settlement agreement will be
increased from 750,000 to 1,500,000 shares. Terms of the default are currently
being re-negotiated.

On April 5, 2002 SCGK agreed not to enforce for 60 days a judgment entered
against the Company in favor of SCGK for the amount of $100,000 plus interest
accruing at 12% annually.

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data shown below is derived from the audited
Consolidated Financial Statements and notes included elsewhere in this Annual
Report on Form 10-K.

18

FOR THE FISCAL YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER-SHARE DATA)

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

OVERVIEW

We were incorporated in Delaware on December 15, 1998, as the successor to
Bell National Corporation which was incorporated in California in 1958.

On December 4, 1998, Bell National, then a shell corporation without any
business activity, acquired InPath, LLC, a development-stage company engaged in
the design and development of products used in screening for cervical and other
types of cancer. In the acquisition, Bell National issued 4,288,790 shares of
common stock and warrants to purchase 3,175,850 shares of common stock to the
members of InPath in exchange for their membership interests. The senior
executives of InPath assumed management control of the Company.

For financial reporting and accounting purposes the acquisition was
accounted for as a reverse acquisition whereby InPath was deemed to have
acquired Bell National. However, Bell National was the continuing legal entity
and registrant for SEC filing purposes and income tax filing purposes, until its
merger into Ampersand in May 1999. Because Bell National was a non-operating
public shell company with nominal assets and InPath was a private operating
company, the acquisition was recorded as the issuance of stock for the net
monetary assets of Bell National, accompanied by a recapitalization and no
goodwill or other intangible assets were recorded in accordance with generally
accepted accounting principles.

On September 25, 2001, the Company changed its corporate name to "Molecular
Diagnostics, Inc." in order to better represent its operations and products. The
name change was affected by the merger of Ampersand's wholly owned subsidiary,
Molecular Diagnostics, Inc., with and into Ampersand. The Company retained its
Certificate of Incorporation, except as amended to reflect its new name, bylaws
and capitalization.

The Company is focused on the design, development and marketing of the
InPath System of products. These products are intended to detect cancer and
cancer related diseases. These products may be used in a laboratory, clinic or
doctor's office.

The Company has a wholly owned subsidiary, Samba Technologies, Sarl. Samba
designs, develops, and markets web-enabled software based systems for image
analysis, image capture, and image transmission and management for clinical and
industrial applications. Samba is also developing software used in the InPath
System. Nearly all revenues, since the inception of the Company, have been
generated by Samba.

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On September 17, 2001, the Company completed its acquisition of AccuMed
pursuant to a merger. In consideration for the acquisition, the Company issued
3,911,245, shares of its common stock to holders of AccuMed common stock, and
218,438 shares of its Series A convertible preferred stock to holders of AccuMed
Series A preferred stock. The value of the transaction, based on the fair value
of the shares of common stock and preferred stock issued by the Company, the
value of options and warrants assumed, the direct acquisition costs incurred,
and the fair market value of tangible and intangible assets purchased, as
determined by a third-party valuation, was approximately $14,178,000.

On October 11, 2001, MDI obtained a 30% investment in Cell Solutions, LLC.
Cell Solutions was formed for the purposes of developing and improving slide
preparation systems. As consideration, MDI provides Cell Solutions five-year
warrants to purchase 172,120 shares of common stock with an exercise price of
$0.82. These warrants were valued using Black-Scholes and determined to have a
value of $127,000. MDI has included the value of these warrants as an investment
at December 31, 2001. MDI determined the fair value of the investment to be
impaired at December 31, 2001. The investments was written down to zero as a
result of the uncertainty of future benefit or revenue stream.

MDI is contractually committed to issue a total of 1,549,086 warrants with
the same terms based upon delivery of certain products by Cell Solutions. As of
December 31, 2001, Cell Solutions had not delivered these products and MDI was
not liable for the issuance of the warrants.

The Company has incurred a significant operating loss since its inception.
Additionally, the Company has raised approximately $23,511,000 since March 1998.
The Company expects that significant on-going operating expenditures will be
necessary to successfully implement its business plan and to develop,
manufacture and market its products. These circumstances raise substantial doubt
about the Company's ability to continue as a going concern. Implementation of
the Company's plans and its ability to continue as a going concern may depend
upon it securing substantial additional financing. Management's plans include
efforts to obtain additional capital. During the nine-months ended September 30,
2001, the Company raised approximately $5,840,000 including $500,000 received as
a deposit in December 2000 from the private sale of 1,499,856 shares of its
Series B convertible preferred stock (See Note 13 to the Consolidated Financial
Statements). The Company received $725,000 in cash in exchange for four
convertible promissory notes. The notes have interest rates of 12% to 15% per
annum and are due between November 15, 2001 and May 15, 2002. The notes are
convertible into the common stock of the Company at a conversion price of $1.00
per share. The Company also received $535,000 in cash in exchange for promissory
notes which were due between February 28, 2001 and December 31, 2001. These
notes have interest rates between 9% and 15% per annum. In November 2001 the
Company received $3,635,000 from the private sale of 1,331,499 shares of Series
C convertible preferred stock and $1,750,000 from the private sale of 175,000
shares of Series D convertible preferred stock (See Note 13 to the Consolidated
Financial Statements). In December 2001, the Company's shareholders tendered
10,859,688 shares of common stock in exchange for approximately 434,388 shares
of Series E convertible preferred stock. There can be no assurance that the
Company will continue to be successful in raising capital. If the Company is
unable to obtain additional capital or generate profitable sales revenues, the
Company may be required to curtail its product development and other activities
and may even be forced to cease operations.

As mentioned in Item 1, for financial reporting and accounting purposes, we
treated the acquisition of InPath by Bell National as if InPath had acquired
Bell National. We recorded the issuance of common stock, combined the equity of
the two companies, and did not record any goodwill. Information presented in our
Consolidated Financial Statements includes the operations of InPath from March
16, 1998 (inception) and the operations of the combined company from December 4,
1998.

REVENUE

Revenues for the year 2001 were $877,000, a decrease of $217,000, or 19.8%,
over revenues for the year 2000. The 2001 revenue decrease was a result of a
decrease in revenues at Samba of $292,000, offset by $75,000 of revenues
generated by MDI in the United States. Samba's revenue declined primarily as a
result of the timing of completing contract deliverables in 2001 compared to
2000 and a decline in the value of the Euro

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compared to the U.S. Dollar. This decline in the value of the Euro reduced
Samba's revenues by approximately $44,000. Samba conducts its operations in
local currency, the Euro. We convert the local currency into U.S. Dollars for
consolidated reporting purposes. Samba's revenue recognition is also subject to
the timing of receipt and completion of customer contracts from period to
period. We may experience quarter-to-quarter and year-to-year variability in
revenues as a result of these contract-timing issues until we begin to market
some or all of our other products. MDI generated revenues were comprised of
$52,000 from the acquisition of AccuMed's contracts and $23,000 from the re-sale
of one AcCell Unit.

All of our reported revenues for the years 2000 and 1999, amounting to
$1,094,000 and $1,040,000 respectively, were produced through the sales of Samba
products and services. Revenues for the year 2000 reflect an increase of
$54,000, or 5%, over 1999 revenues. During 2000, the average exchange rate of
the Euro (the European Union currency to which the French Franc is fixed) to the
U.S. Dollar declined by approximately 15%. This decline reduced the translated
U.S. Dollar value of Samba's 2000 revenues by approximately $169,000.

COSTS AND EXPENSES

Cost of Goods Sold

Cost of goods sold for 2001 amounted to $476,000, a decrease of $161,000,
or 25.3% over 2000 cost of goods sold, resulting primarily from reductions of
net sales and increases in software products sold with higher gross margins.

Cost of goods sold for 2000 and 1999, amounting to $637,000 and $542,000
respectively, relate to the Samba revenues and represent the cost of computer
and imaging hardware, purchased services and products and software engineering
labor and related expenses. The increase in 2000 costs over 1999 costs reflects
the increase in the level of business as well as a change in the product-mix
components of sales. The hardware component of Samba sales generates a much
higher level of cost and a lower gross margin, than do the software or service
components of sales. Samba may supply necessary hardware or the customer may
supply hardware directly. There is no set pattern in contract hardware and
software components.

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.

In 2001, our R&D expenses were $4,034,000, an increase of $608,000, or
17.7% over 2000 R&D expenses a result of increased product development costs for
the Cocktail CVX and HPV assays, the next version of AcCell -- the AcCell 2500,
and the Point-of-Service (POS) product. 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, and payroll related
costs for in-house engineering, scientific, laboratory, software development;
and research management staff.

In 2000, our R&D expenses were $3,426,000 compared to $1,782,000 in 1999,
an increase of 92%. During 2000, we incurred significant additional costs of
$160,000 to expand our in-house research related staff; $170,000 to cover
additional medical and technical consultants, including costs related to full
year engagements for those added in 1999; $260,000 to expand our contract
research staffs and related laboratory operations; $110,000 to cover costs
related to clinical trials and studies; and $700,000 in additional outside
design and development costs related to instruments and disposable test
products. These costs were offset by a reduction in software development costs
related to Samba products of approximately $150,000.

In order to reduce our R&D expenses, a portion of the compensation paid to
consultants may be in the form of awards of our common stock (with restrictions
attached) or grants of options to purchase our common
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stock. Since these awards and/or option grants cover services to be performed
over a future time period, we are required to calculate their market value at
the end of each reporting period until the work is complete. Included in the
above R&D expense amounts for 2001, 2000 and 1999 are non-cash costs of
$215,000, $446,000 and $67,000 respectively, related to the calculated cost of
these share awards and options that were charged to expense in each period. We
also closed our Cleveland laboratory facility in January, 2002.

SELLING, GENERAL AND ADMINISTRATIVE

In 2001, selling, general and administrative expenses ("SG&A") were
$6,374,000, an increase of $2,655,000, or 71.2%, over similar expenses for the
year 2000. This increase is primarily due to increased salaries and wages and
related payroll costs and other operating expenses resulting from AccuMed merger
operations integration. Significant components of SG&A are compensation costs
for executive, sales and administrative personnel, professional fees primarily
related to legal or accounting services, travel costs, fees for public and/or
investor relations services, insurance premiums, recruitment fees, marketing
related costs, amortization and depreciation.

In 2000, SG&A expenses were $3,719,000 compared to $2,833,000 in 1999, an
increase of 31.3%. The increase in SG&A expenses for 2000 included additional
costs of approximately $210,000 for staff and expenses related to the newly
established sales and marketing activity; $100,000 in legal costs primarily
related to litigation; and $200,000 in travel costs related to the sales and
marketing activity, management of a broader operation, and continued efforts to
raise new equity.

In 1989, we issued 450,000 stock appreciation rights ("SARs") to various
individuals. In 1990, Cadmus Corporation, a company controlled by Alexander
Milley, one of our directors and a significant stockholder, purchased the SARs
from the individual holders. These SARs entitle the holder to receive a payment
equal to the amount by which the market price of our common stock, at the time
of exercise, exceeds $0.30 per share. We can make the payment in cash or by
issuing an equivalent number of shares of common stock. The SARs expired in
November 2001. We are required to charge an amount to expense at the end of each
interim reporting period, which represents the excess of the closing market
price of our common stock over the exercise price at that point in time, until
the SARs are exercised or expire. The charge to expense is cumulative over the
life of the SARs and increases or decreases from period to period in conjunction
with the movement of our common stock price. Included in the above SG&A expense
amounts for 2001, 2000 and 1999 are non-cash expenses (or reductions of
expenses) of ($79,000), $91,000 and $231,000 respectively, which represent the
calculated cost of the SARs charged to expense in each period.

In order to reduce our cash SG&A expenses, we may issue shares of our
common stock (with restrictions attached) or grant options, or warrants to
purchase shares of our common stock in lieu of compensation or payments for
financial advisory work, including advice on deal structure, finder fees,
investor relations and introductory services, and general financial and
investment advice. If the services are completed, we record an expense based on
the value of the services. If the services are to be completed over a future
period of time, we are required to calculate a market value for the shares,
options, or warrants at the end of each reporting period until the services are
completed. Included in the above SG&A expense amounts for 2001 and 2000 are non-
cash expenses of $443,081 and $66,000 respectively, related to the calculated
cost of these share awards, options and warrants, charged to expense in each
period. There were no such non-cash costs in 1999.

OTHER INCOME AND EXPENSE

Interest Income

During 2001, we earned interest income on notes from Seaside Partners,
L.P., a related party, and AccuMed of, $25,000, and $85,000, respectively. The
interest earned on the AccuMed notes during 2001 and 2000 amounting to $95,000
was reclassified from accrued interest receivable to inter-company accounts
payable in accordance with generally accepted accounting principles when we
closed the acquisition of AccuMed in September 2001.

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During 2000, we earned interest income on the notes receivable from Seaside
Partners, L.P. and AccuMed amounting to $73,000. We had no interest income in
1999.

Interest Expense

In 2001, our interest expense amounted to $526,000, an increase of
$291,000, or 123.8% over 2000 interest expense. The increase reflects interest
on a higher level of average outstanding debt during the current year. The
amount includes a non-cash expense of $264,000 representing the amortization of
debt discount on two $500,000 convertible promissory notes issued in September
and November 2000 and an additional $500,000 convertible promissory note issued
in May of 2001 in exchange for cash under the same terms as the notes issued in
2000. The conversion price of the 2001 note was less than the market price of
our common stock at the time of the transaction and the holders of this note are
also considered to have a beneficial conversion feature. We recorded the
calculated value of the beneficial conversion feature amounting to $50,000 as
debt discount, and we are amortizing the discount as additional interest expense
over the life of the note. The 2001 amount also includes an additional non-cash
expense of $11,589 representing the value of warrants issued as additional
consideration for a $470,000 note issued to Azimuth Corporation in February
2001, a $100,000 note issued to Azimuth Corporation in August 2001, a $100,000
note issued to Cadmus Corporation in July 2001, and a $25,000 note issued to
Northlea Partners, Ltd. in August 2001. Alexander Milley, one of our directors
and significant stockholder, has a controlling interest in and is considered a
control person of Azimuth Corporation and Cadmus Corporation, and John Abeles,
M.D., also one of our directors, is the managing general partner of Northlea
Partners, Ltd. Lastly, the 2001 amount includes the calculated value of a
warrant issued to Azimuth Corporation in exchange for their waiver of the
conversion feature of the September 2000 convertible promissory note and the
calculated value of a warrant issued to Monsun, SA as consideration for a three
month extension of the due date of the convertible promissory note issued in
November 2000.

In 2000, our interest expense amounted to $235,000 compared to $86,000 in
1999, an increase of 173.3%. The increase reflects a higher rate of interest
paid on new borrowings issued during the year offset by elimination of interest
on a series of 6% convertible subordinated notes issued during 1999, which
automatically converted into common stock on April 28, 2000. The 2000 amount
also includes a non-cash expense of $139,000 representing the amortization debt
discount. We issued two $500,000 convertible promissory notes, to Azimuth
Corporation in September 2000 and to Monsun, SA in November 2000, in exchange
for cash. The notes provide the holder with an option to convert the principal
of the note into our common stock at a conversion price of $1.00 per share any
time after 180 days from the original note issue date. Since the conversion
price was less than the market price of our common stock at the time of the
transaction the holders are considered to have a beneficial conversion feature.
We are required to record the calculated value of this beneficial conversion
feature, amounting to $250,000, as debt discount, and to amortize the discount
as additional interest expense over the life of the note.

In 1999 we incurred interest expense of $86,000. The amount primarily
reflects the interest due on the series of 6% convertible subordinated notes due
2000 issued during 1999.

Other Income and Expense, Net

In 2001, we recorded a $127,000 expense for write-off of warrants earned by
Cell Solutions, LLP, a Virginia limited liability company, as a result of the
uncertainty of future benefit or revenue stream.

In 2000, we had a dispute with our former outside legal counsel regarding
services and fees. We recorded the disputed fee expense represented by invoices
and a note payable in 2000 and 1999. In September 2000, we settled the dispute
for approximately $226,000, less than the existing liability, and recorded the
amount as other income. To be consistent with 1999 consolidated reporting we
also treated $14,000 in refundable income taxes, related to a R & D credit due
to Samba under French taxation rules, as other income. In 1999, we wrote off
$100,000 paid to AccuMed as compensation for a "no shop" clause in a Letter of
Intent whereby we sought to license and purchase certain automated microscopy
technology. We were unable to reach a final agreement

23

and terminated negotiations in September 1999. We also moved our corporate
offices to a new location and wrote off $21,000 representing the net remaining
value of leasehold improvements related to the old space.

In accordance with French taxation rules, Samba recorded refundable income
taxes in 1999 in the amount of $100,000. These refundable taxes represent a
research and development credit against future income taxes or a direct cash
refund available to Samba. For consolidated reporting purposes, we treated this
credit as other income.

NET LOSS

Our net loss for 2001 was $16,657,000. Cumulative dividends on the
outstanding Series B convertible preferred stock, Series C convertible preferred
stock, Series D convertible preferred stock and Series E convertible preferred
stock totaled $562,000. Deemed dividends on the Series B convertible preferred
stock, resulting from the beneficial conversion feature of the Series B
convertible preferred stock totaled $1,933,000. The combined total of the loss
and the preferred dividends results in a net loss available to common
stockholders of $19,152,000, or $0.60 per share on 32,071,334 weighted average
shares outstanding. The 2001 weighted average shares outstanding reflect
additional shares of common stock issued during the year and the exchange of
10,859,688 shares of common stock into shares of Series E convertible preferred
stock in December 2001.

Our net loss for 2000 was $6,611,000, or $0.24 per share, on 27,869,274
weighted average outstanding shares. The 2000 weighted average outstanding
shares are 94% higher than the 1999 average. During the year we sold additional
shares of our common stock in a private offering and a series of 6% convertible
subordinated notes issued in 1999 that were automatically converted into shares
of common stock in 2000.

Our net loss for 1999 was $4,226,000, or $0.29 per share, on 14,336,667
weighted average outstanding shares.

We did not have any shares of preferred stock outstanding in 2000 and 1999.

LIQUIDITY AND CAPITAL RESOURCES

R&D, 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 may 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 $8,223,000 and $5,902,000 during 2001 and 2000, respectively, in
operating activities.

At December 31, 2001 we had cash on hand of $1,025,000, an increase of
$1,012,000 over cash on hand at December 31, 2000 of $13,000. This increase
results from increased funding activities through our convertible notes and
preferred share offerings.

During January 2000, funds received under a late 1999 private offering
cleared our bank and we completed the sale of 1,712,120 shares of common stock
for total gross proceeds of $565,000.

Between February 7, 2000 and April 30, 2000 we sold 3,583,330 shares of our
common stock at a price of $1.50 per share, for total proceeds of $5,329,000 in
a private offering. We received $23,000 in cash proceeds during 2000 from the
exercise of a warrant to purchase 70,000 shares of our common stock. We also
received cash proceeds of $17,000 from the sale of 21,989 shares of common stock
to employees in accordance with the terms of the Employee Stock Purchase Plan.

Of the 3,583,330 shares sold in the private offering, we sold 1,333,333
shares of our common stock to Seaside Partners, L.P., a hedge fund, at $1.50 per
share, for total proceeds of $2,000,000. Dr. Denis M. O'Donnell, one of our
directors, is a member and manager of Seaside Advisors, L.L.C., which provides
investment management services to Seaside Partners, L.P. In lieu of cash, we
agreed to accept payment in the
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form of a $2,000,000 promissory note due July 27, 2000, bearing interest at the
rate of 8% per year. We agreed to extend the original due date of the note until
November 30, 2000. Seaside Partners, L.P. made payments against the principal of
the note amounting to $1,550,000 during 2000. The remaining principal amount of
the note was repaid between June 2001 and August 2001. Accrued interest due on
the note amounting to $88,000 was paid in August and December of 2001.

Between March 1, 1999 and June 30, 1999, we issued a series of 6%
convertible subordinated notes in exchange for $994,600 in cash. A $25,000 note
was converted into our common stock on June 4, 1999. All of the remaining notes,
plus accrued interest due thereon, were automatically converted into our common
stock on April 28, 2000. Notes held by Seaside Partners, L.P. and Leonard R.
Prange, our former President and COO/CFO were automatically converted into our
common stock under the same terms and conditions as all the other notes in the
series.

In July 1999, Samba negotiated a Revolving Credit Line with Banc National
de Paris ("BNP"). The terms of this revolver provide that Samba may borrow, in
the form of an advance on payment against monthly billings, up to a maximum of
200,000 Euros, approximately $122,000 U. S. Dollars. The terms of the revolver
require Samba to pay interest at Euribor plus 2.5% (5.9% at December 31, 2001)
on advances outstanding under the revolver and grant BNP a security interest in
Samba accounts receivable. The revolver was renewed in January 2002. As of
December 31, 2001, an amount of $65,748 was outstanding against the revolver.

On December 10, 1999, we issued a senior convertible promissory note to
Azimuth Corporation, a company controlled by Alexander M. Milley, one of our
directors and a significant shareholder, in exchange for $50,000 in cash. The
conversion price of the note was $0.20 per share. On February 22, 2000 Azimuth
exercised its right to convert the note and accrued interest due thereon into
256,250 shares of our common stock.

On March 30, 2000, we signed an agreement with AccuMed to resolve a dispute
over a Patent and Technology License Agreement ("License"), originally dated
September 4, 1998, between InPath and AccuMed. The Amendment to the License
("Amendment"), contemplated by that agreement, was signed on June 9, 2000. The
Amendment assigned the License directly to us, eliminated the minimum royalty
payment schedule in the original License, and reduced the royalty rate to 4%. We
made cash payments to AccuMed under the Amendment totaling $600,000, issued a
$100,000 convertible promissory note, which we prepaid on December 11, 2000, and
issued 128,571 shares of our common stock to AccuMed. The Amendment provided
that the cash payments represent the final minimum license payment and advanced
non-refundable royalty payments. The Amendment also provided that the $100,000
principal amount of the note and the 128,571 shares of common stock at a value
of $450,000 also represented advanced non-refundable royalty payments.

As a further result of the signing of the Amendment in June 2000, we
recorded $500,000 in prepaid royalties. This amount represented the reversal of
an accrual of minimum royalty payments due under the original License and their
related charge to expense, including $250,000 accrued and charged to expense in
1999.

On September 22, 2000, in conjunction with the signing of a Letter of
Intent to merge with AccuMed we loaned AccuMed $300,000 in cash in exchange for
a promissory note bearing interest at 2.5% above the prime rate. On February 7,
2001, this note was cancelled and replaced by a new promissory note, secured by
AccuMed's inventory, issued in conjunction with the signing of a definitive
agreement under which we acquired AccuMed.

On December 28, 2000, we loaned AccuMed an additional $30,000 in
conjunction with the merger. The loan was included in the new secured promissory
note signed on February 7, 2001.

On February 7, 2001, we signed a definitive agreement to merge our
subsidiary, AccuMed Acquisition, Corp., with AccuMed. We formed AccuMed
Acquisition Corp. to acquire AccuMed. Under the terms of this agreement, we
exchanged 3,911,245 shares of our common stock for all of the outstanding common
stock of AccuMed. In addition, we exchanged 218,438 shares of our Series A
convertible preferred stock for all of the outstanding convertible preferred
stock of AccuMed. The 218,438 shares of our Series A convertible preferred
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stock are convertible into approximately 250,000 shares of our common stock. On
September 17, 2001 we completed the acquisition of AccuMed. This acquisition was
recorded as a purchase business combination in accordance with Statement of
Financial Accounting Standards No. 141, "Business Combination". The Company has
consolidated the results of operations of AccuMed from the date of acquisition.
Fair market value of tangible and intangible assets of AccuMed have been
determined by a third-party valuation resulting in a total purchase price of
approximately $14,178,000.

In June 2000, we entered into a License and Technology Agreement with
Invirion, a company controlled by Dr. Bruce Patterson, granting us worldwide
exclusive rights to certain medical technology for the detection of oncogenic
(cancer causing) types of the HPV. This agreement provides for $500,000 in cash
payments and warrants to purchase 400,000 shares of our common stock at an
exercise price of $0.01, based on technology delivery milestones. On September
12, 2000, we signed an addendum to the agreement. The first addendum provided
that Invirion's ownership and patentability of the technology was established,
the initial HPV probe was delivered, and the first development milestone was
met, and that the $250,000 in cash payments due would be paid in equal
installments over a period of ten months. We also issued warrants to purchase
250,000 shares of our common stock at an exercise price of $0.01 per share in
accordance with the terms of the agreement and first addendum. We used the
Black-Scholes valuation model to determine a fair value for the warrants of
$530,000 and recorded the amount as capitalized license and additional paid in
capital. In January 2001, we signed the second addendum. This second addendum
provided that the second development milestone was met in December 2000 and that
$150,000 cash payment due would be paid in equal installments over a period of
six months beginning in January 2000. The second addendum also amended the
agreement to more closely reflect Dr. Patterson's inventorship and ownership of
the technology. In June 2001, we signed the third addendum to the agreement.
This third addendum provided that the final milestone would be split into three
parts and that the first one was met in June 2001. As a result, we paid Dr.
Patterson $35,000 in cash and issued a warrant to purchase 50,000 shares of our
common stock at an exercise price of $0.01 per share. We used the Black-Scholes
valuation model to determine the fair value for the warrants of $49,000 and
recorded the amount as capitalized license costs and additional paid in capital.

We also signed a Development Agreement with Invirion and Dr. Patterson in
June of 2000 to complete the development and integration of the HPV product with
the InPath System. We paid $100,000 in cash and continue to pay $5,000 monthly
consulting fees to cover all costs to complete the development project.

On September 22, 2000, we issued a convertible promissory note to Azimuth
in exchange for $500,000 in cash. The note bears interest at the rate of 15% per
year and was due twelve months from the date of issue. The note was convertible
into our 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. Since the conversion
price was less than the market price of our common stock at the time of the
transaction the holders are considered to have a beneficial conversion feature.
We recorded a value of $125,000 to this beneficial conversion feature as debt
discount, reducing the carrying amount of the debt. The debt discount is
amortized as additional interest expense over the life of the note. During 2001
and 2000, we recorded non-cash charges of $91,000 and $34,000 respectively, to
interest expense to reflect the amortized amount of debt discount. In August
2001, we issued Azimuth a warrant, which entitled the holder to purchase 500,000
shares of our common stock at an exercise price on $1.00 per share in exchange
for Azimuth's agreement to relinquish the conversion feature of the note and
extend the due date. We used the Black-Scholes valuation model to calculate a
fair value of the warrant of $25,000 and charged the amount to interest expense.
We repaid the note in full in November 2001. We used $300,000 in proceeds from
this note to fund the AccuMed notes described above. The balance was used to
fund license payments and the initial payment of a settlement arrangement with
our former legal counsel.

On November 1, 2000, we issued a convertible promissory note to Monsun, AS
in exchange for $500,000 in cash. The note bears interest at the rate of 15% per
year and was due twelve months from the date of issue. The note is convertible
into our 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. Since the conversion
price was less than the market price of our common stock at the time of the
transaction the holders are considered to have a beneficial conversion feature.
We recorded a value of $125,000 to this beneficial conversion feature as debt
discount, reducing the carrying amount of the debt. The debt discount is
amortized as additional interest expense over the life of the note.
26

During 2001 and 2000, we recorded charges of $104,000 and $21,000 to interest
expense to reflect the amortized amount of debt discount. On October 31, 2001 we
issued a warrant to Monsun, AS entitling the holder to purchase 100,000 shares
of our common stock at an exercise price of $0.60 per share, a discount of 20%
to the market price of our common stock at the time, as consideration for
Monsun's agreement to extend the due date of the note until January 31, 2002. We
used the Black-Scholes valuation model to determine a fair value of the warrant
of $25,000 and charged the amount to interest expense during the period.

On December 4, 2000, we issued a promissory note to Azimuth in exchange for
$200,000 in cash. The note bore interest at the rate of 12% per year and was due
December 31, 2000. As additional consideration for the note we issued Azimuth a
warrant to purchase 50,000 shares of our common stock at a price of $0.937 per
share, the approximate market price of our common stock at the time. Since the
note was not repaid until February 20, 2001 we were required to pay a 3%
increase in the rate of interest from January 1, 2001. We also were required to
issue Azimuth two warrants, each to purchase 12,500 shares of our common stock,
at an exercise price of $0.01 per share.

On December 11, 2000, we issued a promissory note to Azimuth in exchange
for $100,000 in cash. The note bore interest at the rate of 12% per year and was
due 180 days from date of issue. As additional consideration for the note we
issued Azimuth a warrant to purchase 1,000,000 shares of our common stock at a
price of $1.25 per share, an approximate 15% premium to the market price of our
stock at the time. The proceeds of this note were used to repay a convertible
promissory note to AccuMed in conjunction with negotiations to acquire AccuMed.

On February 1, 2001 and February 7, 2001, we issued promissory notes to
Azimuth in exchange for $25,000 and $470,000, respectively, in cash. Those notes
bore interest at the rate of 15% per annum. Those notes were required to be
repaid from the proceeds of any new offering of debt or equity undertaken by us
subsequent to the dates of the notes. As additional consideration for the note
issued on February 7, 2001, we granted Azimuth a warrant to purchase 1,000,000
shares of common stock at an exercise price of $0.25 per share, an approximate
83% discount from the $1.50 market price of the common stock on the date the
warrant was issued. That warrant expires five years from the date of the grant.
We determined the value of the warrant to be $118,000, using the difference
between the fair market interest rate and the stated interest rate. We used
$470,000 to partially fund the loan to AccuMed made on February 7, 2001, in
connection with the signing of a definitive agreement to acquire AccuMed. We
repaid both notes and accrued interest on February 20, 2001. Since the February
7, 2001 note was repaid on February 20, 2001, we charged the entire value of the
warrant, issued as additional consideration for the note, to interest expense
during February 2001. We also repaid two additional promissory notes, issued in
December 2000, and accrued interest on February 20, 2001. The proceeds of the
February 2001 notes were used to fund a portion of the loan to AccuMed upon the
signing of the agreement on February 7, 2001, pursuant to which AccuMed was
merged into our subsidiary.

In February 2001, we sold 1,333,856 shares of Series B convertible
preferred stock to a limited number of U.S. and foreign accredited investors in
a private offering. We received net cash proceeds from the offering of
$5,176,000, including $500,000 received as a deposit in December 2000. On
February 20, 2001, we used $809,000 of the proceeds to repay these two
additional notes issued to Azimuth in December 2000, and all of the related
accrued interest.

Several advisory groups that assisted us in the February 2001 offering were
compensated through the payment of $159,000 in cash, the issuance of 374,000
shares of common stock and the issuance of warrants to purchase 534,000 shares
of common stock at an exercise price of $1.20 per share.

On May 15, 2001, we completed the sale of the remaining 166,000 shares of
authorized Series B convertible preferred stock in the private offering. We
received net cash proceeds of $664,000. An advisory group that assisted us in
finding investors was compensated through the issuance of 66,400 shares of our
common stock and the issuance of a warrant to purchase 66,400 shares of our
common stock at an exercise price of $1.20 per share. We determined a fair value
of approximately $81,000 for the common stock issued to the advisory group. The
fair value was based on the closing price of our common stock on the date of the
transaction. We used the Black-Scholes valuation model to determine a fair value
of $81,000 for the warrants issued to the advisory group.
27

On May 15, 2001, we issued a convertible promissory note to NeoMed
Innovations III, LP in exchange for $500,000 in cash. The note bears interest at
the rate of 12% per year and is due twelve 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. The
conversion price of the note was less than the market price of the common stock
at the date of issuance and therefore, the holder is considered to have a
beneficial conversion feature. We determined the value of this beneficial
conversion feature to be $50,000. This value was recorded as a reduction to the
debt and will be amortized as additional interest expense over the life of the
note. During the period from May 15, 2001 through September 30, 2001, we
recorded $18,500 to interest expense to reflect the amortization of the debt
discount on this note.

On July 26, 2001, we issued a promissory note to Cadmus Corporation
("Cadmus") in exchange for $100,000 in cash. Alexander Milley, one of our
directors and a significant stockholder, is also considered a control person of
Cadmus. On August 6, 2001, we issued a promissory note to Azimuth in exchange
for $100,000 in cash. The notes which were due on September 22, 2001 and
subsequently extended to November 15, 2001 bore interest at the rate of 15% per
annum. As additional consideration for the notes, we issued five-year warrants
to Cadmus and Azimuth entitling each holder to purchase 250,000 shares of the
common stock at an exercise price of $1.00 per share. The closing market prices
of the common stock on the respective issue dates of the warrants entitling each
holder to purchase 250,000 shares of common stock were $1.00 per share and $0.95
per share. We determined using the fair value interest rate method, the fair
value of these warrants to be $7,200. This value was charged to interest expense
during the third quarter.

In August 2001, we agreed to issue a five-year warrant to Azimuth,
entitling the holder to purchase 500,000 shares of common stock at $1.00 per
share. In conjunction with the issuance of this warrant, Azimuth agreed to
relinquish the conversion rights of a convertible promissory note issued by us
in September 2000, which entitled Azimuth to convert the principal and accrued
interest due under the note into common stock at a conversion price of $1.00 per
share. The September 2000 note was considered to have a beneficial conversion
feature for which we had determined a fair value of $125,000 in 2000. This fair
value was recorded as a discount to the debt and was being amortized as
additional interest expense over the term of the note. The closing market price
of the common stock on the issue date of this warrant was $0.97 per share. We
determined the fair value of the warrant to be approximately $21,000 based on
the value of the unamortized debt discount at the date this warrant was issued
and the conversion right on the note was waived. This value was charged to
interest expense during the third quarter.

In November 2001, we received $3,636,000 in net proceeds from the private
sale of 1,331,499 shares of Series C convertible preferred stock to a limited
number of accredited investors. The Series C preferred stock has a dividend rate
of 10% and is convertible into common stock at a conversion rate equal to $0.60
per share.

Also in November 2001, we received $1,750,000 in proceeds from the sale of
175,000 shares of Series D convertible preferred stock in a private sale to
Ventana. The Series D convertible preferred stock has a dividend rate of 10% and
is convertible into the common stock at a conversion rate of $1.00 per share. We
also issued a three-year warrant to Ventana entitling the holder to purchase
1,750,000 shares of common stock at an exercise price of $1.15 per share.

In December 2001, we completed a tender offer to exchange 1/25 of a share
of Series E convertible preferred stock, par value $0.001 per share, for each
outstanding share of our common stock, par value $0.001 per share, up to a
maximum of 20,000,000 shares of common stock, or a maximum of 800,000 Series E
convertible preferred stock. Since the transaction provided no liquidity or
capital resources, further discussion is not considered necessary for this
purpose.

We incurred approximately $542,000 and $307,000 in capital expenditures for
the years ended December 31, 2001 and 2000 respectively. Capital expenditures
are defined as disbursements for laboratory equipment, leasehold improvements,
software, and furniture/fixtures with a purchase price in excess of $1,000 per
item and useful life in excess of one year. The increase in 2001 capital
expenditures resulted in increased purchases of laboratory and computer
equipment and software in support of our product development and research
efforts and in support of our clinical trial network.

28

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 of the business.
We expect that significant on-going operating expenditures will be necessary to
successfully implement our business plan and develop, manufacture and market our
products. 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 and other activities and may be forced to cease operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

A market risk inherent in our financial statements is the potential loss in
fair value arising from adverse changes in interest rates. We do not engage in
any hedge transactions or use derivative financial instruments to reduce our
exposure to interest rate changes since all of our indebtedness is at fixed
interest rates. At December 31, 2001, the carrying amount of our debt
instruments approximated their fair value. In addition, as of December 31, 2001,
we were not exposed to any material foreign-currency, equity-price or other type
of market or price risk. Samba conducts the majority of its operations in Europe
using local European currencies. At December 31, 2001, we have recorded a
negative cumulative translation adjustment of $53,472 reflecting the valuation,
using December 31, 2001 currency exchange rates, of our investment in and
current account with Samba.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our Consolidated Financial Statements for the years ended December 31,
2001, 2000, and 1999, together with the report thereon of Ernst & Young LLP
dated April 8, 2002, are filed as part of this report commencing on page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

The information required for this item is incorporated by reference to the
discussion captioned "ELECTION OF DIRECTORS" in our Proxy Statement for the 2002
annual meeting of shareholders.

ITEM 11. EXECUTIVE COMPENSATION

The information required for this item is incorporated by reference to the
discussion captioned "EXECUTIVE COMPENSATION" in our Proxy Statement for the
2002 annual meeting of shareholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required for this item is incorporated by reference to the
discussion captioned "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT" in our Proxy Statement for the 2002 annual meeting of shareholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Of the 3,583,330 shares sold in the private offering we sold 1,333,333
shares of our common stock to Seaside Partners, L.P. at $1.50 per share for
total proceeds of $2,000,000. Denis M. O' Donnell, one of our directors is a
member and manager of Seaside Advisers, L.L.C., a firm which provides investment
management services to Seaside Partners, L.P. The sale, in conjunction with a
private offering of our common stock to accredited investors, was made under
terms similar to other investors in the offering. In lieu of cash,

29

we agreed to accept payment in the form of a $2,000,000 promissory note due July
27, 2000 that bore interest at the rate of 8% per annum. The note provisions
allowed for prepayment at anytime and the due date could be extended by mutual
agreement. We retained the stock certificates until the note principal and
accrued interest was paid in full. We agreed to extend the due date of the note
until November 30, 2000. Seaside made principal payments amounting to $1,550,000
during 2000 and the remaining $450,000 principal amount was repaid between June
and August of 2001. The accrued interest on the note was paid in August and
December of 2001.

On September 22, 2000, we issued a convertible promissory note to Azimuth
Corporation, a company controlled by Alexander M. Milley, one of our directors
and a significant stockholder, in exchange for $500,000 in cash. The note bore
interest at the rate of 15% per year and was due twelve months from the date of
issue. The note was convertible into our 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. Since the conversion price was less than the market price of
our common stock at the time of the transaction the holder was considered to
have a beneficial conversion option. We are required to record the $125,000
calculated value of this beneficial conversion option as debt discount, reducing
the carrying amount of the debt and additional paid in capital. The debt
discount was amortized as additional interest expense over the life of the note.
During 2001 and 2000, we recorded charges of $91,000 and $34,000, respectively,
to interest expense to reflect the amortized amount of debt discount in each
period.

In August 2001, we agreed to issue a five-year warrant to Azimuth entitling
the holder to purchase 500,000 shares of our common stock at an exercise price
of $1.00 per share. In conjunction with the issuance of this warrant, Azimuth
agreed to relinquish the conversion rights granted to it under the terms of the
convertible promissory note described above. The closing market price of our
common stock on the issue date of the warrant was $.97 per share. We determined
the fair value of the warrant to be approximately $21,000 based on the value of
the unamortized debt discount at the date the warrant was issued and the
conversion right under the note was waived. This value was charged to interest
expense during the third quarter of 2001.

We used $300,000 from the September 22, 2000 note described above to fund a
loan to AccuMed International, Inc. in accordance with the terms of an agreement
under which AccuMed was merged into our wholly-owned subsidiary. The balance was
used to fund license payments and the initial payment of a settlement
arrangement with our former legal counsel.

On December 4, 2000, we issued a promissory note to Azimuth in exchange for
$200,000 in cash. The note bore interest at the rate of 12% per year and was due
December 31, 2000. As additional consideration for the note, we issued Azimuth a
five-year warrant to purchase 50,000 shares of our common stock at a price of
$0.937 per share, the approximate market price of our stock at the time. The
note was repaid on February 20, 2000. In that the note was not repaid when due,
we were obligated by the terms of the note to pay a 3% increase in the rate of
interest from January 1, 2001 until the date of payment. We were also obligated
to issue Azimuth two warrants, each to purchase 12,500 shares of our common
stock, at an exercise price of $0.01 per share, representing a two month late
payment penalty.

We determined the value of these warrants to be $1,184 and charged the
amount to interest expense during 2001. The proceeds of the note were used for
general working capital and to pay license fees.

On December 11, 2000, we issued a promissory note to Azimuth in exchange
for $100,000 in cash. The note bore interest at the rate of 12% per year and was
due 180 days from date of issue. As additional consideration for the note we
issued Azimuth a five-year warrant to purchase 1,000,000 shares of our common
stock at a price of $1.25 per share, an approximate 15% premium over the market
price of our common stock on the date the warrant was issued. The proceeds of
this note were used to repay a convertible promissory note to AccuMed due on
March 29, 2001. The prepayment was made in conjunction with ongoing negotiations
to acquire AccuMed. We repaid the note and accrued interest on February 20,
2001.

On February 1, 2001 and February 7, 2001, we received $495,000 in cash from
Azimuth in exchange for two promissory notes bearing interest at 15% per year.
Of the cash received, $470,000 was used to partially fund a loan to AccuMed made
on February 7, 2001, in connection with a definitive agreement to acquire

30

AccuMed. As additional compensation for these loans, we issued Azimuth a
five-year warrant to purchase 1,000,000 shares of our common stock at an
exercise price of $0.25 per share, an approximate 83% discount from the $1.50
market price of our common stock on the date the warrant was issued. We
determined the value of the warrant to be $118,000, using the difference between
the fair market interest rate and the stated interest rate, and recorded the
value as additional paid in capital and also charged the entire value to
interest expense during February 2001. On February 20, 2001, we used $809,000 of
the proceeds from a private offering of Series B convertible preferred stock to
repay these notes, two additional notes issued to Azimuth in December 2000 and
described above, and all of their related accrued interest.

On July 26, 2001, we issued a promissory note to Cadmus Corporation in
exchange for $100,000 in cash. On August 6, 2001, we issued a promissory note to
Azimuth Corporation in exchange for $100,000 in cash. Alexander M. Milley, one
of our directors and a significant stockholder, is also considered a control
person of Cadmus. The notes which were due on September 22, 2001, and
subsequently extended until November 15, 2001 bear interest at the rate of 15%
per annum. As additional consideration for the notes, we issued five-year
warrants to Cadmus and Azimuth entitling the holders to each purchase 250,000
shares of common stock at an exercise price of $1.00 per share. The closing
market prices of common stock on the respective issue dates of the warrants
entitling each holder to purchase 250,000 shares of common stock were $0.97 per
share and $0.93 per share. We determined the fair value of these warrants to be
$7,200 using the fair value interest rate method. This value was charged to
interest expense during the third quarter. The notes were repaid in November
2001.

On August 6, 2001, we issued a promissory note to Northlea Partners, Ltd.
in exchange for $25,000 in cash. John Abeles, one of our directors, is the
general partner of Northlea Partners, Ltd. The terms of the note are the same as
the notes issued to Cadmus and Azimuth. As additional consideration for this
note, we issued a five-year warrant to Northlea Partners, Ltd. entitling the
holder to purchase 62,500 shares of common stock at an exercise price of $1.00
per share. The closing market price of the common stock on the issue date of
this warrant was $0.93 per share. We determined the fair value of the warrant to
be $845 using the fair value interest rate method. This value was charged to
interest expense during the third quarter. The note remains outstanding as of
the date of this report.

On September 18, 2001, we issued a promissory note to Northlea Partners,
Ltd. in exchange for $15,000 in cash. The note was due on December 17, 2001 and
bears interest at the rate of 9% per annum. Also on September 18, 2001, we
issued a promissory note to Robert Shaw, one of our directors, in exchange for
$25,000 in cash. The note was due December 17, 2001 and bore interest at the
rate of 9% per annum. The notes remain outstanding as of the date of this
report.

In October of 2001, Leonard R. Prange, our former President and COO/CFO,
purchased 20,000 shares of our Series C convertible preferred stock at a
purchase price of $3.00 per share. The purchase was made in conjunction with a
private offering of our Series C convertible preferred stock to accredited
investors and was made under the same terms and conditions as other investors in
the offering. The Series C convertible preferred stock has a dividend of 10% and
is convertible into our common stock at a conversion price of $0.60 per share.

31

Mr. Gombrich, our CEO and chairman of the board, tendered 2,631,825 shares
of common stock in exchange for 105,265 shares of Series E convertible preferred
stock. Mr. Milley, one of our directors, tendered 656,486 shares of common stock
in exchange for 26,259 shares of Series E convertible preferred stock.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K

DOCUMENTS FILED AS PART OF REPORT

(A) 1. FINANCIAL STATEMENTS

The following financial statement schedule is filed as part of this report
as page F-30;

Schedule IX -- Valuation and Qualifying Accounts.

All other schedules are omitted because they are not applicable, or not
required, or because the required information is included in the Consolidated
Financial Statements or notes thereto.

(A) 3. EXHIBITS

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

* SEC File No. 0-935

(B) REPORTS ON FORM 8-K

The Company filed a Current Report on Form 8K dated September 17, 2001
reporting, under Item 2, the acquisition of assets as a result of the completion
of a merger transaction by and among AccuMed International, Inc. ("AccuMed"),
AccuMed Acquisition Corp. ("Acquisition Sub"), and the Company, pursuant to
which AccuMed merged with and into Acquisition Sub, which is a wholly owned
subsidiary of the Company.

The Company filed a Current Report on Form 8K dated December 31, 2001
reporting, under Item 5, that Leonard R. Prange tendered his resignation on
December 31, 2001, as President, Chief Operating Officer, Chief Financial
Officer and Secretary of the Company. The Company's Board of Directors appointed
Peter P. Gombrich, the Chairman of the Board of Directors, to fill the vacancy
in those offices until a successor is hired.

(C) SEE ITEM 14 (A)3 ABOVE

(D) THE FINANCIAL STATEMENTS SCHEDULES ARE FILED (AS A SEPARATE SECTION OF
THIS REPORT)

39

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.

MOLECULAR DIAGNOSTICS, INC.

BY: /s/ PETER P. GOMBRICH
------------------------------------
Peter P. Gombrich
Chairman of the Board, and
Chief Executive Officer

Date: April 11, 2002

Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

40

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders of
Molecular Diagnostics, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Molecular
Diagnostics, Inc. and Subsidiaries, formerly Ampersand Medical Corporation, as
of December 31, 2001 and 2000, and the related statements of operations, changes
in stockholders' equity (deficit) and cash flows for each of the three years in
the period ended December 31, 2001. Our audits also included the financial
statement schedule listed in the index at item 14. These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Molecular Diagnostics, Inc.
and Subsidiaries as of December 31, 2001 and 2000 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related financial statement
schedule when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.

The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the financial statements, the Company has incurred substantial net losses
from operations and has limited financial resources. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans with regard to these matters are described in Note 1. The
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.

/S/ ERNST & YOUNG, LLP

Chicago, Illinois
April 8, 2002

F-1

PART I -- FINANCIAL INFORMATION

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

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

F-2

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

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

F-3

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)

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

F-4

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
(DOLLARS IN THOUSANDS)

See Note 3 for noncash transaction related to the acquisition of AccuMed.

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

F-5

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS)

F-6

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES

(FORMERLY AMPERSAND MEDICAL CORPORATION)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) -- (CONTINUED)

(DOLLARS IN THOUSANDS)

F-7

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES

(FORMERLY AMPERSAND MEDICAL CORPORATION)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) -- (CONTINUED)

(DOLLARS IN THOUSANDS)

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

F-8

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001

NOTE 1. THE COMPANY AND BASIS OF PRESENTATION

Molecular Diagnostics, Inc, which may also be referred to as "MDI" was
incorporated as Ampersand Medical Corporation in Delaware on December 15, 1998,
as the successor to Bell National Corporation ("Bell National"). Bell National
was incorporated in California in 1958.

On September 25, 2001, the Company changed its corporate name to Molecular
Diagnostics, Inc. in order to better represent its operations and products. The
name change was effected by a merger with a wholly-owned subsidiary. Molecular
Diagnostics, Inc. has retained its Certificate of Incorporation, except as
amended to reflect the new name, bylaws and capitalization.

On December 4, 1998, Bell National (then a shell corporation without any
business activity) acquired InPath, LLC, a development-stage company engaged in
the design and development of medical instruments and related tests. In the
acquisition, Bell National issued 4,288,790 shares of common stock and warrants
to purchase 3,175,850 shares of common stock to the members of InPath in
exchange for their units of membership interest in InPath and the senior
executives of InPath assumed management control of MDI.

Based upon the terms of the acquisition agreement, for financial reporting
and accounting purposes the acquisition was accounted for as a reverse
acquisition whereby InPath is deemed to have acquired Bell National. However,
Bell National was the continuing legal entity and registrant for both Securities
and Exchange Commission filing purposes and income tax filing purposes, until
its merger into MDI in May 1999. Because Bell National was a non-operating
public shell company with nominal assets and InPath was a private operating
company, the acquisition was recorded as the issuance of stock for the net
monetary assets of Bell National, accompanied by a recapitalization and no
goodwill or other intangible assets were recorded.

On September 17, 2001, Molecular Diagnostics, Inc. completed an acquisition
transaction whereby AccuMed International, Inc. was merged into a wholly-owned
subsidiary of MDI. The value of the transaction was approximately $14,178,000.
Accordingly, the consolidated financial statements presented hereunder include
the operations of InPath from March 16, 1998 (inception), the operations of Bell
National and Molecular Diagnostics, Inc. from December 4, 1998, and the
operations of AccuMed International, Inc. from September 17, 2001.

Molecular Diagnostics, Inc. is focused on the design, development and
marketing of the InPath System. 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.

Molecular Diagnostics, Inc. has 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 designs,
develops, and markets web-enabled software based systems for image analysis,
image capture, and image transmission and management for clinical and industrial
applications. Samba is also developing software used in the InPath System. A
majority of reported revenues since inception of Molecular Diagnostics, Inc.
have been generated by Samba.

Molecular Diagnostics, Inc. 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 its plans and its ability to continue as a going concern
depend upon its securing substantial additional financing. Management's plans
include substantial efforts to obtain additional capital. If Molecular
Diagnostics, Inc. is unable to obtain adequate additional financing or generate
profitable sales revenues, management may be required to curtail its product
development and other activities and may be forced to cease operations.

F-9

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation. The consolidated financial statements include
Molecular Diagnostics, Inc. and its wholly owned subsidiaries. All intercompany
balances and transactions have been eliminated.

New Accounting Standards. On June 29, 2001, the Financial Accounting
Standards Board (FASB) approved its proposed Statements of Financial Accounting
Standards No. 141 (FAS 141), Business Combinations, and No. 142 (FAS 142),
Goodwill and Other Intangible Assets.

FAS 141 supercedes Accounting Principles Board Opinion No. 16 (APB 16),
Business Combinations. The most significant changes made by FAS 141 are: (1)
requiring that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001, and (2) establishing specific
criteria for the recognition of intangible assets separately from goodwill.

FAS 142 supercedes APB 17, Intangible Assets. FAS 142 primarily addresses
the accounting for goodwill and intangible assets subsequent to their
acquisition (i.e., the post-acquisition accounting). The provisions of FAS 142
will be effective for 2002.

The most significant changes made by FAS 142 are (1): goodwill and
indefinite lived intangible assets will no longer be amortized, (2) goodwill
will be tested for impairment at least annually at the reporting unit level, (3)
intangible assets deemed to have an indefinite life will be tested for
impairment at least annually, and (4) the amortization period of intangible
assets with finite lives will no longer be limited to forty years.

The Company adopted FAS 141 effective July 1, 2001 and will adopt FAS 142
effective January 1, 2002. These standards only permit prospective application
of the new accounting; accordingly, the adoption of these standards will not
affect previously reported financial information. The effect of adopting FAS 142
will not be material.

The FASB recently issued FAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. This statement addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. FAS 144 retains
and expands upon the fundamental provisions of existing guidance related to the
recognition and measurement of the impairment of long-lived assets to be held
and used and the measurement of long-lived assets to be disposed of by sale.
Generally, the provisions of FAS 144 are effective for financial statements
issued for fiscal years beginning after December 15, 2001. Earlier application
is encouraged.

Use of Estimates. The preparation of the financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.

Revenue Recognition. Molecular Diagnostics, Inc. recognizes revenue upon
shipment of product to customers and no remaining Company obligations or
contingencies exist, or in the case of sales of software by its wholly owned
subsidiary Samba, upon shipment if 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 twelve months. 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. Samba calculates 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. Implementation and installation services are generally completed
within 120 days.

F-10

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

Cash and Cash Equivalents. Molecular Diagnostics, Inc. considers all
highly liquid investments with a maturity of three months or less at the time of
purchase to be cash equivalents.

Inventory of Instruments and Component Parts. Inventory of instruments and
component parts consists of AcCell instruments and component parts necessary to
manufacture AcCell instruments. The manufacturing process is carried out in the
facilities of a third-party contractor. Inventory is stated at the
lower-of-cost-or-market cost is determined by the first-in-first-out (FIFO)
method. The Company has established a policy for reserving obsolete and excess
inventory, generally any non-usable, damaged, or non-salable inventory or
inventory with little or no demand for the product in excess of one year.

Property and Equipment. Property and equipment are stated at cost and are
depreciated using the straight-line method over the assets' estimated useful
lives. Principal useful lives are as follows:

Normal maintenance and repairs are charged to expense as incurred,
significant improvements are capitalized.

License, Patents, and Technology. License, patents, and purchased
technology are recorded at their acquisition cost. Costs to prepare patent
filings are capitalized when incurred. Costs related to abandoned or denied
patent applications are written off at the time of abandonment or denial.
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 seventeen years. The Company assesses licenses, patents, &
technology quarterly for impairment.

Goodwill. Amortization expense for 2001, 2000 and 1999 related to goodwill
was approximately $141,000, $146,000 and $167,000 respectively. As described in
New Accounting Standards above, the Company has adopted FAS 141 and will adopt
FAS 142, effective January 1, 2002. FAS 142 sets forth guidelines for
discontinuing periodic goodwill amortization costs in results of operations and
for establishing an annual goodwill impairment review and related net realizable
value asset write-down methodology.

Research and Development Costs. Research and development costs are charged
to operations as incurred. Molecular Diagnostics, Inc. 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 Molecular
Diagnostics, Inc.'s foreign operations is the local currency. Accordingly, all
assets and liabilities are translated into United States dollars using year-end
exchange rates, and all revenues and expenses are translated using
weighted-average exchange rates during the year. The amount of foreign currency
translation is not material to the results of operations and the financial
position of Molecular Diagnostics, Inc.

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

F-11

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

Loss Per Share. Basic loss per share is calculated based on the
weighted-average number of outstanding common shares. Diluted loss per share is
calculated based on the weighted-average number of outstanding common shares
plus the effect of dilutive potential common shares. Molecular Diagnostics,
Inc.'s calculation of dilutive net loss per share excludes potential common
shares as the effect would be antidilutive. Cumulative and deemed dividends on
convertible preferred shares totaled approximately $2,495 through December 31,
2001. There were no preferred dividends in 2000 or 1999. Loss per share for
common shareholders as of December 31, 2001 is $0.60. Potential common shares
include stock underlying convertible notes, convertible preferred stock, stock
options, and warrants. The weighted-average number of options and warrants to
purchase common stock using the treasury stock method for 2001 and 2000 was
19,575,547 and 4,936,000 shares, respectively.

Income Taxes. MDI follows the liability method in accounting for income
taxes. Under this method, deferred tax assets and liabilities are determined
based on differences between financial reporting and tax bases of assets and
liabilities and are measured using tax rates and laws that are expected to be in
effect when the differences are expected to reverse. Valuation allowances are
provided against deferred tax assets if it is more likely than not that the
deferred tax assets will not be realized.

Stock Compensation. As permitted by the Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), Molecular
Diagnostics, Inc. uses the intrinsic value method to account for stock options
as set forth in Accounting Principles Board No. 25, Accounting for Stock Issued
to Employees (APB 25).

Reclassification. Certain amounts reported in 2000 consolidated financial
statements have been reclassified to conform with 2001 presentation.

Impairment. At each 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.
An impairment loss is recognized if the amount of undiscounted cash flows is
less than the carrying amount of the asset in which case the asset is written
down to fair value. The fair value of the asset is measured by either quoted
market prices or the present value of estimated expected future cash flows using
a discount rate commensurate with the risks involved.

NOTE 3. ACQUISITION

On September 17, 2001, Molecular Diagnostics, Inc. acquired AccuMed by
issuing 3,911,245 shares of its common stock to holders of all of the
outstanding common stock of AccuMed, and 218,438 shares of its Series A
convertible preferred stock to holders of all of the outstanding Series A
convertible preferred stock of AccuMed.

As a result of the acquisition, MDI (1) assumed AccuMed's outstanding stock
options and warrants, (2) forgave a note receivable due from AccuMed, (3)
wrote-off unamortized license fees and prepaid royalties previously paid under a
licensing agreement with AccuMed and, (4) received 192,088 shares of its common
stock that was held by AccuMed.

The value of the transaction was approximately $14,178,000 and was
determined based on the market price of MDI's common stock over the period of a
few days before and after February 7, 2001, the date the merger was agreed to
and announced. The acquisition was recorded as a purchase business combination
in accordance with Statement of Financial Accounting Standards No. 141, Business
Combinations. Molecular Diagnostics, Inc. is consolidating the results of
AccuMed operations from the date of acquisition.

F-12

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

A summary of the purchase price is as follows (in thousands):

Fair value of 3,911,245 common shares issued................ $ 6,649
Fair value of 218,438 Series A preferred shared issued...... 162
Fair value of 1,128,198 AccuMed warrants assumed............ 1,918
Fair value of 356,655 AccuMed stock options assumed......... 606
Note receivable due from AccuMed, including accrued
interest.................................................. 1,595
Unamortized license fees and prepaid royalties previously
paid to AccuMed........................................... 1,423
Fair value of 192,088 MDI common shares held by AccuMed..... (326)
AccuMed liabilities assumed................................. 1,455
Direct acquisition costs incurred by MDI.................... 696
-------
Total purchase price.............................. $14,178
=======

The purchase price was allocated to AccuMed's acquired assets based on
their respective fair market values, as follows (in thousands):

Cash and cash equivalents................................... $ 43
Inventories................................................. 290
Other current assets........................................ 49
Fixed assets................................................ 115
Deferred compensation....................................... 75
Technology license agreements:
MDI license agreement..................................... 7,230
Dianon license agreement.................................. 260
Goodwill.................................................... 6,116
-------
Total purchase price.............................. $14,178
=======

In allocating the purchase price, MDI obtained an appraisal to determine
the fair market values of the acquired technology license agreement and
inventories. Acquired technology license agreements are being amortized over the
remaining life of the respective agreements; seventeen years for the MDI license
agreement and two years for the Dianon license agreement.

The following selected unaudited pro forma consolidated results of
operations are presented as if the acquisition had occurred on January 1, 2000.
This information is presented for illustrative purposes only and is not
necessarily indicative of the operating results that would have been achieved if
the acquisition had been completed as of January 1, 2000, nor are they
necessarily indicative of the future operating results of Molecular Diagnostics,
Inc. The pro forma data does not give effect to any cost savings or
restructuring and integration costs that might result from the integration of
the companies' operations.

Pro forma results for the fiscal years ended December 31 (in thousands):

F-13

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

At December 31, 2001, management determined several factors, principally
that certain contracts being negotiated by AccuMed failed to materialize,
indicating that the carrying value of goodwill relating to the AccuMed
acquisition was impaired. Based on this evaluation, MDI recognized an impairment
charge of $5,833,000.

NOTE 4. NOTES AND ACCOUNTS RECEIVABLE -- RELATED PARTY

On April 28, 2000, Molecular Diagnostics, Inc. sold 1,333,333 shares of
common stock to Seaside Partners, LP, a hedge fund, at $1.50 per share, or total
proceeds of $2,000,000. Dr. Denis M. O'Donnell, a director of MDI, is a member
and manager of Seaside Advisors, L.L.C., which provides investment management
services to Seaside Partners, L.P. The sale was in conjunction with the private
offering of common stock of Molecular Diagnostics, Inc. (See Note 13). In lieu
of cash, MDI agreed to accept payment in the form of a $2,000,000 promissory
note due July 27, 2000 and bearing interest at the rate of 8% per annum. The
note provisions allow for prepayment at anytime and the due date may be extended
by mutual agreement. MDI agreed to extend the due date of the note until
November 30, 2000. Seaside Partners, L.P. made principal payments amounting to
$1,550,000 during 2000 and the remaining $450,000 in principal was repaid during
2001 along with all accrued interest. At December 31, 2000 the unpaid principal
of the note was classified as a reduction of stockholders equity.

As of December 31, 2001, the Chairman of the Board and Chief Executive
Officer, Peter Gombrich, owes the Company approximately $50,000. The Company
considers this receivable to be collectible in the ordinary course of business.

NOTE 5. NOTES RECEIVABLE

On September 17, 2001, Molecular Diagnostics, Inc. completed the
acquisition of AccuMed. As a result, loans made to AccuMed prior to the
completion of the merger, $1,270,000 and $330,000 in 2001 and 2000 respectively,
and accrued interest receivable due on the notes, approximately $80,000 and
$10,000 respectively, were reclassified to intercompany accounts and eliminated
in the consolidated financial statements as of December 31, 2001 and 2000 in
accordance with accounting principles generally accepted in the United States.

NOTE 6. PREPAID ROYALTIES

On June 9, 2000, Molecular Diagnostics, Inc. executed an amendment to a
Patent and Technology License Agreement originally dated September 4, 1998,
between InPath and AccuMed. The amendment assigned the Patent and Technology
License Agreement directly to MDI, eliminated a minimum royalty payment required
by the original License, and reduced the royalty rate to 4%. As consideration
for this amendment, MDI paid $500,000 cash, issued a convertible note payable in
the principal amount of $100,000 and issued 128,571 shares of MDI common stock,
with a fixed value of $450,000, to AccuMed. The convertible note was paid in
full during December 2000. The $1,050,000 combined consideration paid to AccuMed
was recorded as prepaid royalty and was being charged to royalty expense based
on the recognition of revenues by MDI. As a result of the completion of the
merger of AccuMed into a wholly-owned subsidiary of MDI, the unamortized prepaid
royalty amount was eliminated in purchase accounting. During 2001 and 2000, MDI
recognized $36,000 and $44,000, respectively, as royalty expense prior to the
completion of the merger.

F-14

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

NOTE 7. FIXED ASSETS

Fixed assets consist of the following at December 31 (in thousands):

NOTE 8. LICENSES, PATENTS, AND TECHNOLOGY

Licenses, patents, and technology include the following at December 31 (in
thousands):

During the fourth quarter of 2001, management performed an assessment of
the development of the MDI's pending patent portfolio. As a result of the
developmental nature of the portfolio and significant uncertainty surrounding
the ultimate issuance of the related patents, MDI recorded an impairment loss of
$274,000 for the full amount of the carrying value of its pending patent
portfolio.

NOTE 9. DEPOSITS

On December 17, 2000, Molecular Diagnostics, Inc. received $500,000 from
Monsun, AS, a potential investor in a private offering of equity securities of
MDI. The final terms and conditions of the offering were not finalized at
December 31, 2000 and the funds were subject to return. The deposit was applied
to the purchase price of 125,000 shares of Series B convertible preferred stock
in a private offering, as evidenced by a subscription agreement signed by
Monsun, AS in February 2001.

F-15

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

NOTE 10. ACCRUED EXPENSES

Accrued expenses includes the following December 31 (in thousands):

MDI is currently delinquent in filing Federal and State Income Tax returns
for 1999 and 2000, and is actively attempting to remedy this matter. MDI also is
delinquent in paying Federal and State 1999 and 2000 employee and employer
payroll taxes. As of December 31, 2001, the Company owed $540,000 in past-due
payroll taxes, including $110,000 in assessed statutory penalties and interest.
MDI is currently in process of communicating through counsel with the Internal
Revenue Service. At this time, MDI believes it is not possible to determine the
impact, if any, upon the Company's financial condition. The amount was included
in accrued payroll costs in the accompanying balance sheet.

NOTE 11. NOTES PAYABLE -- RELATED PARTIES

Long-term debt for related parties at December 31 consisted of:

On August 6, 2001, Molecular Diagnostics, Inc. issued a promissory note to
Northlea Partners, Ltd. in exchange for $25,000 in cash. John Abeles, a director
of MDI, is the general partner of Northlea Partners, Ltd. The note was due on
September 22, 2001 and bears interest at the rate of 15% per annum. As
additional consideration for this note, MDI issued a five-year warrant to
Northlea Partners, Ltd. entitling the holder to purchase 62,500 shares of common
stock at an exercise price of $1.00 per share. The closing market price of the
common stock on the issue date of the warrant was $0.73 per share. MDI
determined the fair value of the

F-16

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

warrant to be $1,411 using the fair value interest rate method. This value was
charged to interest expense during the third quarter. The note and related
accrued interest remain outstanding as of December 31, 2001.

In August 2001, Molecular Diagnostics, Inc. agreed to issue a five-year
warrant to Azimuth Corporation, a company controlled by Alexander M. Milley, a
director and significant stockholder, entitling the holder to purchase 500,000
shares of common stock at an exercise price of $1.00 per share. In conjunction
with the issuance of this warrant, Azimuth agreed to relinquish the conversion
rights granted to it under the terms of the convertible promissory note
described in the preceding paragraph. The closing market price of our common
stock on the issue date of the warrant was $0.73 per share. MDI determined the
fair value of the warrant to be $25,000 using the fair value interest rate
method. This value was charged to interest expense during the third quarter of
2001.

On September 20, 2001, Molecular Diagnostics, Inc. issued a promissory note
to Northlea Partners, Ltd. in exchange for $15,000 in cash. The note was due on
December 20, 2001 and bears interest at the rate of 9% per annum. Also on
September 20, 2001 MDI issued a promissory note to Robert Shaw, a director of
MDI, in exchange for $25,000 in cash. The note was due December 20, 2001 and
bears interest at the rate of 9% per annum. The notes remain outstanding as of
December 31, 2001.

On September 22, 2000, MDI issued a convertible promissory note to Azimuth
Corporation in exchange for $500,000 in cash. The note bore interest at the rate
of 15% per year and was due twelve months from the date of issue. The note was
convertible into common stock of MDI any time after the expiration of the first
180 days of the loan term, at a conversion price of $1.00 per share. The
conversion price was less than the market price of the common stock of MDI at
the date of issuance of the note and therefore, the holder is considered to have
a beneficial conversion feature. MDI determined the value of this beneficial
conversion feature to be $125,000. This value was recorded as a reduction to the
debt and was amortized as additional interest expense over the life of the note.
During 2001 and 2000, MDI recorded $91,000 and $34,000 respectively, to interest
expense.

On December 4, 2000, Molecular Diagnostics, Inc. issued a promissory note
to Azimuth Corporation in exchange for $200,000 in cash. The note bore interest
at the rate of 12% per year and was due December 31, 2000. As additional
consideration for the note MDI issued Azimuth a warrant to purchase 50,000
shares of common stock of MDI at a price of $0.937 per share, the approximate
market price of the common stock at the time. Since the note was not repaid
until February 20, 2001, MDI was required to pay a 3% increase in the rate of
interest from January 1, 2001 until the date of repayment. As a further penalty,
MDI was also required to issue Azimuth two warrants, each to purchase 12,500
shares of MDI's common stock, at an exercise price of $0.01 per share. The value
of these warrants was determined to be $1,184 and the amount was charged to
interest expense during 2001.

On December 11, 2000, Molecular Diagnostics, Inc. issued a promissory note
to Azimuth Corporation in exchange for $100,000 in cash. The note bore interest
at the rate of 12% per year and was due 180 days from date of issue. As
additional consideration for the note MDI issued Azimuth a warrant to purchase
1,000,000 shares of its common stock at a price of $1.25 per share, an
approximate 15% premium to the market price of the common stock at the date of
issuance. The proceeds of this note were used to repay a convertible promissory
note to AccuMed due on March 29, 2001. The prepayment was made in conjunction
with ongoing negotiations to acquire AccuMed.

On February 20, 2001, Molecular Diagnostics, Inc. repaid the principal
amounts and accrued interest on the two December notes.

Molecular Diagnostics, Inc. determined the value of the warrants issued in
conjunction with the December 4, 2000 and December 11, 2000 notes to be $84,000.
This amount was charged to interest expense during 2000.

F-17

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

The carrying amount of notes payable approximates fair value at December
31, 2001 and 2000.

NOTE 12. NOTES PAYABLE

Long-term debt for unrelated parties at December 31 consisted of:

On May 15, 2001, MDI issued a convertible promissory note to NeoMed
Innovations III in exchange for $500,000 in cash. The note bears interest at the
rate of 12% per year and is due twelve months from the date of issue. The note
is convertible into common stock of MDI, any time after the expiration of the
first 180 days of the loan term, at a conversion price of $1.00 per share. The
conversion price of the note was less than the market price of the common stock
of MDI at the date of issuance of the note and therefore, the holder is
considered to have a beneficial conversion feature. MDI determined the value of
this beneficial conversion feature to be $50,000. This value was recorded as a
reduction to the debt and will be amortized as additional interest expense over
the life of the note. During 2001, MDI recorded $31,000 of interest expense
including amortization of the debt discount.

In conjunction with the acquisition of AccuMed International, Inc. on
September 17, 2001, MDI assumed the $180,663 unpaid principal amount of an
outstanding Canadian dollar convertible promissory note payable to Xillix
Technologies. The note is due on demand, bears interest at a rate of 6% over the
Canadian prime rate, and is convertible into the common stock of MDI at a
conversion price of $2.18 per share. Through December 31, 2001, MDI made cash
principal payments against the note amounting to $27,467. MDI also made cash
interest payments of $2,533 during the period ended December 31, 2001.

On October 31, 2001 Monsun, AS and MDI agreed to extend the due date of the
convertible promissory note until January 31, 2002. As consideration for the
extension agreement, MDI issued a three-year warrant to Monsun, as entitling the
holder to purchase 100,000 shares of common stock of MDI at an exercise price of
$0.60 per share. A fair value of $25,000 for the warrant was calculated using
the fair value method and was recorded as additional interest expense during
2001.

In July 1999, Molecular Diagnostics, Inc.'s wholly owned subsidiary, Samba,
negotiated a Revolving Credit Line ("Revolver") with the Banc National de Paris
(BNP). The terms of the Revolver provide that Samba may borrow, in the form of
an advance on payment against monthly billings, up to a maximum of 200,000
Euros, approximately $178,920. The terms of the Revolver require Samba to pay
interest at Euribor plus 2.5%, (5.9% at December 31, 2001) on advances
outstanding under the Revolver and grant BNP a security interest in Samba
accounts receivable. The Revolver was renewed in January 2002. As of December
31, 2001 the amount outstanding under the Revolver was approximately $177,000.

F-18

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

On November 1, 2000, Molecular Diagnostics, Inc. issued a convertible
promissory note to Monsun, AS in exchange for $500,000 in cash. The note bears
interest at the rate of 15% per year and was due twelve 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. The conversion price of the note was less than the market price of common
stock at the date of issuance of the note and therefore, the holder is
considered to have a beneficial conversion feature. MDI determined the value of
this beneficial conversion feature to be $125,000. This value was recorded as a
reduction to the debt and was amortized as additional interest expense over the
life of the note. During 2001 and 2000, MDI recorded $104,000 and $21,000
respectively to interest expense.

On November 1, 2001 MDI issued a Convertible Promissory Note to Schwarz,
Cooper, Greenberger & Krauss ("SCGK") in exchange for $500,000 in legal
services. The Note bears interest at the rate of 12% per year and is due in five
installments. The Note is convertible into Common Stock of MDI upon issuance of
the Note at a conversion price equal to the stock price on the conversion date.

In accordance with Promissory Note provisions, SCGK forgave the final
installment on the note which was due February 28, 2002. Therefore, MDI did not
include the final payment in its debt balance as of December 31, 2001.

The carrying amounts of notes payable approximates fair value at December
31, 2001 and 2000.

NOTE 13. STOCKHOLDERS' EQUITY

SALE OF EQUITY

Summary of the Company's preferred stock capital table as of December 31,
2001 is as follows:

During January 2000, Molecular Diagnostics, Inc. sold 1,712,120 shares of
common stock under a December 1999 private offering for $0.33 per share.

On various dates between February 7, 2000 and April 30, 2000, Molecular
Diagnostics, Inc. sold 3,588,330 shares of its common stock in a Private
Placement Offering to accredited private investors at a price of $1.50 per
share. MDI received total gross proceeds from this offering of $5,329,000.

In October 1999, MDI issued a warrant to The Research Works, as
consideration for the preparation of an investment research report on MDI,
entitling the holder to purchase 70,000 shares of common stock at $0.33 per
share. In April 2000, MDI received $23,100 in proceeds from the exercise of The
Research Works warrant.

During 2000, Molecular Diagnostics, Inc. received cash proceeds of $17,000
from the sale of 21,989 shares of its common stock to employees in accordance
with the terms of the Employee Stock Purchase Plan.

In September 2001, MDI issued 218,438 shares of Series A convertible
preferred stock to AccuMed in conjunction with the acquisition.

F-19

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

In October 2000, the Board of Directors authorized Molecular Diagnostics,
Inc. to raise additional new equity to support current and future operations. In
February 2001, MDI sold 1,333,856 shares of Series B convertible preferred stock
to accredited investors in a private offering. The Series B preferred stock has
a stated value of $4.00 per share, an annual dividend rate of 10%, and is
convertible into common stock at a conversion price equal to $1.00 per share.
MDI received net cash proceeds from the February 2001 offering of $5,176,000,
including $500,000 received during December 2000. Proceeds from the offering
were used to complete the acquisition of AccuMed, repay some outstanding
indebtedness, fund clinical studies and trials of MDI's products, and general
working capital. Upon issuance of the preferred stock, the Company determined
the fair value of its Common Stock to be $1.35 per share. The $1,867,398 was
considered a deemed dividend for loss per share purposes. The 347,000 shares of
Common Stock and 533,542 warrants issued to advisors were recorded as Common
Stock at the par value per share of $0.001, or $374. The balance of the value
determined for the shares, $572,000, and the fair value of the warrants of
$817,000 were recorded as additional paid in capital. The cash payment of
$159,000 made to advisors and the fair value of the Common Stock and warrants,
$572,000 and $817,000 respectively, were recorded as a debit to additional paid
in capital to reflect the cost of raising equity.

In May 2001, Molecular Diagnostics, Inc. sold the remaining 166,000
authorized shares of Series B convertible preferred stock to an accredited
foreign investor to complete the February 2001 private offering. MDI received
net cash proceeds of $664,000. Upon issuance of the preferred stock, the Company
determined the fair value of its Common Stock on May 15, 2001 to be $1.10 per
share. The $66,400 was considered a deemed dividend for loss per share purposes.
The 66,400 shares of Common Stock issued to the advisory group were recorded as
Common Stock at the par value per share of $0.001, or $66. The balance of the
value determined for the shares, $81,000, and the fair value of the warrants of
$81,000 were recorded as additional paid-in-capital. The fair value of the
Common Stock and the warrants, $81,000 each, were recorded as a debit to
additional paid-in-capital to reflect the cost of raising equity.

In November 2001, the Company received $3,635,000 in net proceeds from the
private sale of 1,331,499 shares of Series C Convertible Preferred Stock, to a
limited number of accredited investors. The Series C preferred stock has a
dividend rate of 10% and is convertible into the Common Stock of the Company at
a conversion rate equal to $0.60 per share.

Also in November 2001, the Company received $1,750,000 in proceeds from the
sale of 175,000 shares of Series D Convertible Preferred Stock in a private sale
to Ventana Medical Systems, Inc ("Ventana"). The Series D preferred stock has a
dividend rate of 10% and is convertible into the Common Stock at a conversion
rate of $1.00 per share. The Company also issued a three-year warrant to Ventana
entitling the holder to purchase 1,750,000 shares of the Common Stock of the
Company at an exercise price of $1.15 per share.

In December 2001, the Company completed a tender offer to exchange 1/25 of
a share of Series E convertible preferred stock, par value $0.001 per share, for
each common share of Molecular Diagnostics, par value $0.001 per share, up to a
maximum of 20,000,000 shares of common, or a maximum of 800,000 Series E
preferred stock. As of December 31, 2001, 10,859,688 common shares have been
tendered for 434,388 preferred shares under the terms of this offering and is
valued at $9,557,000.

F-20

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

ISSUANCE OF PREFERRED STOCK

SERIES A CONVERTIBLE PREFERRED STOCK
$4.50 per share
Liquidation Value:
$10.3034 per share
Conversion Price:
0.4367 -- Liquidation Value divided by Conversion Price
($4.50/$10.3034)
Conversion Rate:
None
Voting Rights:
None
Dividends:
Any time -- 3 years
Conversion Period:

SERIES B CONVERTIBLE PREFERRED STOCK
$4.00 per share
Liquidation Value:
$1.00 per share
Conversion Price:
4.00 -- Liquidation Value divided by Conversion Price
($4.00/$1.00)
Conversion Rate:
None
Voting Rights:
10% -- Quarterly -- Commencing March 31, 2001
Dividends:
Any time
Conversion Period:
Cumulative dividends in arrears at December 31, 2001 were $35,000

SERIES C CONVERTIBLE PREFERRED STOCK
$3.00 per share
Liquidation Value:
$0.60 per share
Conversion Price:
5.00 -- Liquidation Value divided by Conversion Price
($3.00/$0.60)
Conversion Rate:
None
Voting Rights:
10% -- Quarterly -- Commencing March 31, 2002
Dividends:
Any time
Conversion Period:

SERIES D CONVERTIBLE PREFERRED STOCK
$10.00 per share
Liquidation Value:
$1.00 per share
Conversion Price:
10.00 -- Liquidation Value divided by Conversion Price
($10.00/$1.00)
Conversion Rate:
None
Voting Rights:
10% -- Quarterly -- Commencing April 30, 2002
Dividends:
Any time -- After April 1, 2002
Conversion Period:

SERIES E CONVERTIBLE PREFERRED STOCK
$22.00 per share
Liquidation Value:
$0.80 per share
Conversion Price:
27.50 -- Liquidation Value divided by Conversion Price
($22.00/$0.80)
Conversion Rate:
Equal in all respects to holders of common shares
Voting Rights:
10% -- Quarterly -- Commencing May 31, 2002
Dividends:
Any time -- After December 1, 2002
Conversion Period:

F-21

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

ISSUANCE OF RESTRICTED SHARES FOR SERVICES

In August 1999, Molecular Diagnostics, Inc. awarded 50,000 restricted
shares of common stock to a non-employee consultant for services. The award was
originally scheduled to vest over three years. The award was made as partial
consideration for consulting services to be performed under a three-year
consulting agreement. The consultant was required to maintain the consulting
relationship with MDI, except in the case of change of control or termination
MDI, during the entire vesting period. MDI and the consultant agreed to an early
termination, without cause, of the agreement as of July 1, 2000. This
termination resulted in the immediate vesting of the shares. A fair value of
$181,000 was calculated at the July 1, 2000 for the 50,000 shares. MDI charged
the remaining $175,000 in unamortized fair value to consulting expense during
2000.

Also in August 1999, Molecular Diagnostics, Inc. awarded an additional
50,000 restricted shares of common stock to a non-employee consultant under an
agreement for consulting services with terms similar to those outlined in the
preceding paragraph. The measurement date of these shares had not been
determined as of December 31, 2001, and therefore the value of these shares will
be based on the market value of the common stock at the end of each interim
period until the measurement date is determined. A fair value of $45,000 was
calculated at December 31, 2001, using the Black-Scholes valuation model. During
2001 and 2000, MDI recorded $13,000 and $19,000 respectively, as consulting
expense related to these shares.

During 2000, Molecular Diagnostics, Inc. issued additional awards of
restricted shares of common stock to non-employee consultants for services. The
awards total 100,000 shares, and were issued under agreements for consulting
services with terms similar to those outlined in the preceding paragraphs. The
measurement date of these shares had not been determined as of December 31, 2001
and therefore the value of these shares will be based on the market value of
common stock at the end of each interim period until the measurement date is
determined. A fair value of $91,000 was calculated at December 31, 2001 using
the Black-Scholes valuation model. During 2001 and 2000, MDI recorded $30,000
and $10,000 respectively, as consulting expense.

ISSUANCE OF STOCK OPTIONS TO NON-EMPLOYEES FOR SERVICES

Molecular Diagnostics, Inc. issued an option to purchase 50,000 shares of
common stock, at an exercise price of $0.406 per share, to a non-employee
consultant during 1999. The option was issued under a consulting agreement for
services to be performed over three years resulting in a three-year vesting
period. In July 2000, MDI and the consultant agreed to an early termination,
without cause, of the consulting agreement. The early termination resulted in
the immediate vesting of all the options and established a measurement date. A
fair value $181,000 was calculated on the date the options were vested using the
Black-Scholes valuation model. MDI charged the remaining unamortized fair value
of $171,000 to consulting expense during 2000.

Molecular Diagnostics, Inc. issued options to purchase 200,000 shares of
common stock to non-employee consultants during 1999. The options vest over a
period of time, ranging from the date of grant to three years, and have exercise
prices of $0.394 and $0.406 per share. MDI issued these options to consultants
as consideration for consulting services that commenced during 1999 and will be
completed through 2002. Services provided under several consulting agreements
ceased during 2001 and 2000, resulting in the cancellation of 45,000 and 46,666
options, respectively. The measurement date of the remaining outstanding options
had not been determined at December 31, 2001. A fair value of $95,000 was
calculated for the remaining options outstanding at December 31, 2001, using the
Black-Scholes valuation model. This value is charged to consulting expense over
the term of the consulting agreements. The amount of expense to be ultimately
recognized will vary depending on the market value of the common stock at the
end of each period. During 2001 and 2000, MDI recorded $16,000 and $32,000
respectively, as consulting expense related to the remaining outstanding
options.

F-22

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

In January 2000, Molecular Diagnostics, Inc. issued an option to purchase
25,000 shares of common stock at an exercise price of $0.921 per share for
services completed by a non-employee consultant. Accordingly, MDI determined a
fair value of $34,000 using the Black-Scholes valuation model. MDI charged the
amount to selling, general, and administrative expense in 2000.

During 2000, Molecular Diagnostics, Inc. issued an additional 270,000
options to purchase common stock to non-employees for consulting services. The
options vest over a time period, ranging from the date of grant to three years,
and have exercise prices from $1.75 to $2.875 per share. MDI issued these
options to consultants as consideration for consulting services that commenced
during 2000 and will be completed through 2003. As the measurement date of these
options had not been determined as of December 31, 2001, the value of these
options will be determined at the end of each interim period until the
measurement date is determined. A fair value of $144,000 was determined as of
December 31, 2001, using the Black-Scholes valuation model. This value is
charged to consulting expense over the term of the agreements. The amount of
expense to be ultimately recognized will vary depending on the market value of
the common stock at the end of each period. During 2001 and 2000, MDI recorded
$37,000 and $33,000 respectively as consulting expense.

ISSUANCE OF COMMON STOCK FOR SERVICES

During 2000, Molecular Diagnostics, Inc. issued 40,000 shares of common
stock in exchange for medical consulting and financial advisory services. The
services had a fair value of $60,000. During 2001 and 2000, the Company charged
$4,000 and $56,000 respectively, to medical consulting and investor-relations
expenses.

ISSUANCE OF WARRANTS FOR SERVICES

In November 2000, Molecular Diagnostics, Inc. issued warrants to purchase a
total of 200,000 shares of common stock, at an exercise price of $1.00 per
share, to non-employees as compensation for financial services to be provided
under agreements covering a one-year period. The warrants vest in equal amounts
each month over the period. MDI may terminate the agreements upon thirty days
written notice, and any unvested options as of the date of termination would be
cancelled. The measurement date of these warrants was determined as of December
31, 2001. A fair value of $98,000 for these warrants was calculated at December
31, 2001, using the Black-Scholes valuation model. During 2001 and 2000, MDI
recorded $81,000 and $17,000 respectively, as selling, general, and
administrative expense.

In January 2001, Molecular Diagnostics, Inc. issued warrants to purchase
80,000 shares of common stock, at an exercise price of $1.00, and 100,000 shares
of common stock, at an exercise price of $.50, to a non employee as compensation
for financial services to be provided under agreements covering January through
April, 2001 and May through December 2001 respectively. The warrant vested in
equal amounts each month. A fair value of $111,000 for these warrants was
calculated in 2001 using Black-Scholes. The agreements were replaced on October
1, 2001 with a new agreement covering a fifteen month period ending on December
31, 2002. In accordance with the terms of the new agreement all of the
outstanding warrants were immediately vested and MDI issued a new warrant to
purchase 150,000 shares of common stock at an exercise price of $0.50. The new
warrant vests in equal amounts each month as services are provided. A fair value
of $120,000 was calculated for these warrants as each months services were
completed and vesting took place, using the Black-Scholes valuation model. MDI
recorded $24,000 as selling, general, and administrative expense in 2001 to
cover the vested warrants.

During 2001, several advisory groups, contracted to assist Molecular
Diagnostics, Inc. in completing the Private Placement Offering of Series B
Convertible Preferred Stock in 2001 were compensated through the payment of
$159,000 in cash, the issuance of 440,692 shares of common stock, and the
issuance of warrants to purchase 533,542 shares of common stock at an exercise
price of $1.20 per share.

F-23

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

ISSUANCE OF WARRANTS TO PURCHASE ASSETS

In June 2000, the Company entered into a License and Technology Agreement
(the "Agreement") with Invirion and Dr. Bruce Patterson, M.D., Ph.D., its
principal, granting the Company exclusive rights to certain medical technology
for the detection of oncogenic (cancer causing) types of the Human Papilloma
Virus ("HPV"). The Agreement provides for $500,000 in cash payments and the
issuance of warrants to purchase 400,000 shares of our Common Stock at an
exercise price of $0.01, based on the delivery of milestones. The first two
milestones were met in 2000 which required us to pay $400,000 and issue 250,000
warrants. The third milestone was reached during 2001 and the Company paid
$34,000 in cash and issued 50,000 warrants. The Company used the Black-Scholes
valuation model to determine a fair value for the warrants issued in 2001 and
2000 of $49,000 and $530,000, respectively, and recorded the amount as license
fees.

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 6% for 2001 and
2000, a volatility factor of 90% for 2001 and 216% for 2000, and a fair value of
the underlying common shares of closing market price on the date of the grant.
The expected life equaled the term of the warrants, options, or restricted
shares.

WARRANTS

At December 31, 2001, the Company had the following outstanding warrants to
purchase shares of Common Stock:

F-24

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

STOCK APPRECIATION RIGHTS

At December 31, 2000, and 1999, MDI had 450,000 stock appreciation rights
(SARs) outstanding. These SARs, issued in 1989, have an exercise price of $0.30
and could be exercised through November 20, 2001. These SARs are deemed
automatically exercised on November 20, 2001 if not done so at the option of the
holder. In general, each SAR entitles the holder to receive upon exercise an
amount equal to the excess, if any, of the market value per share of Common
Stock at the date of exercise over the exercise price of the SAR, plus any
dividends or distributions per share made by MDI prior to the exercise date. In
lieu of making cash payments, MDI may elect and intends, to issue shares of
Common Stock. MDI has recorded compensation expenses of $91,395 and $230,625 for
the years ended December 31, 2000 and 1999, respectively, and a reversal of
compensation expense of $79,020 in 2001, to reflect the difference between the
closing market price of MDI's common stock at November 20, 2001, December 31,
2000 and December 31, 1999 and the exercise price of the SARs.

NOTE 14. LEASES

The Company currently leases approximately 5,700 square feet of space for
its Chicago, Illinois corporate headquarters and research laboratory and offices
under an operating type lease expiring in 2006. The Company's wholly owned
subsidiary, Samba Technologies SARL, leases approximately 300 square meters of
office space in a suburb of Grenoble, France under an operating type lease
expiring in 2008. Samba has the option to terminate the lease at the end of each
three year term. Total rental expense, including expenses related to the
Company's previous headquarters location, Samba's previous temporary office
space, and AccuMed's leased facilities prior to vacating the leased facility
during the years ended December 31, 2001, 2000 and 1999 was $231,000, $90,000
and $61,000, respectively.

F-25

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

Future minimum annual lease payments under these leases as of December 31,
2001 are (in thousands):

Following completion of MDI's merger with AccuMed, management decided to
vacate AccuMed's leased facility and consolidate its operations into MDI's
headquarters facility. Management expects to enter into negotiations with
AccuMed's landlord in order to reach a settlement arrangement relating to the
remaining minimum lease payments. Since MDI has 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.

NOTE 15. INCOME TAXES

Significant components of deferred income taxes consist of the following at
December 31 (in thousands):

At December 31, 2001, the Company had domestic net operating loss
carryforwards aggregating approximately $57,995,000. For financial reporting
purposes, this entire amount of deferred tax assets related principally to the
net operating loss carryforwards has been offset by a valuation allowance due to
uncertainty regarding the realizations of the assets. The valuation allowance
increased by $23,381,000 and 2,315,000 for the year ended December 31, 2001 and
2000, respectively.

F-26

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

The net operating loss carryforwards and Research and Development credit
carryforwards may not be available to offset future taxable income of MDI due to
statutory limitations based on the changes of ownership and other statutory
restrictions.

The net operating loss carryforwards begin to expire in 2006. The Research
and Development credit carryforwards expire from 2002 to 2014.

NOTE 16. EQUITY INCENTIVE PLAN AND EMPLOYEE STOCK PURCHASE PLAN

On May 25, 1999, stockholders approved the establishment of the 1999 Equity
Incentive 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 to recipients
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 in the Plan
from 2,000,000 shares to 3,000,000 shares.

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

MDI applies APB Opinion No. 25 and related interpretations in accounting
for options granted to employees under the Equity Incentive Plan. No
compensation cost was recorded during 2001, 2000 or 1999 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 FAS 123, the Company's net loss for the years ended December 31,
2001 and 2000 would have been $20,950,000 and $7,639,000 respectively on a pro
forma basis, and a net loss per share for the years ended December 31, 2001 and
2000 of $0.65 and $0.27 on a pro forma basis.

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 6% for 2001 and 2000; dividend yields
of zero for both years; volatility factors of the expected market price of the
Company's common stock of 90% for 2001 and 216% for 2000 and a weighted average
expected life of the options of 2.5 - 5 years.

F-27

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

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

At the Annual Meeting on May 25, 1999, the stockholders also approved the
Employee Stock Purchase Plan. The Plan offers employees the opportunity to
purchase shares of our common stock of MDI through a payroll 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 Plan is
200,000.

NOTE 17. COMMITMENTS AND CONTINGENCIES

At December 31, 2001, MDI was contractually committed to pay approximately
$2,600,000 to scientists, researchers, universities, and other independent third
parties for services to be performed during 2002. MDI may unilaterally cancel
these contracts with thirty days written notice or for non-performance.

On October 11, 2001, MDI obtained a 30% investment in Cell Solutions, LLC.
Cell Solutions was formed for the purposes of developing and improving slide
preparation systems. As consideration, MDI provides Cell Solutions five-year
warrants to purchase 172,120 shares of common stock with an exercise price of
$0.82. These warrants were valued using Black-Scholes and determined to have a
value of $127,000. MDI has included the value of these warrants as an investment
at December 31, 2001. MDI determined the fair value of the investment to be
impaired at December 31, 2001. The investments was written down to zero as a
result of the uncertainty of future benefit or revenue stream.

In conjunction with the Cell Solutions investment, BioTec Ventures (BTV)
has executed a consulting agreement with MDI that guarantees Mr. Knesel, BTV
owner and manager, three years of annual salaries starting at $60,000 per year
and ending with $100,000 in third and final year. At December 31, 2001 $13,000
was included in consulting expense in conjunction with this agreement.

F-28

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

MDI is contractually committed to issue a total of 1,549,086 warrants with
the same terms based upon delivery of certain products by Cell Solutions. As of
December 31, 2001, Cell Solutions had not delivered these products and MDI was
not liable for the issuance of the warrants.

NOTE 18. QUARTERLY DATA (UNAUDITED)

The following table represents unaudited quarterly operating results for
the two years ended December 31, 2001 and, 2000. The Company prepared this
information on a basis consistent with the Company's audited financial
statements. In management's opinion, the quarterly operating results include all
adjustments necessary (which are of a normal and recurring nature) for the fair
presentation of the results of the interim periods presented. Basic loss per
share for each quarter is computed using the weighted-average number of shares
outstanding during that quarter. Basic loss per share for the full year is
computed using the weighted-average number of shares outstanding during the
year. Thus, the sum of the four quarters' basic loss per share may not equal the
full-year basic loss per share. In addition, due to rounding of each quarters'
operating results, the full-year operating results disclosed in the consolidated
financial statements may not equal the sum of each quarters' operating results
shown below.

NOTE 18. SUBSEQUENT EVENTS

Officer Resignation. On December 31, 2001, Leonard R. Prange tendered his
resignation from his positions as President, Chief Operating Officer, Chief
Financial Officer and Secretary of the Company. MDI's Board of Directors
appointed Peter P. Gombrich, the Chairman of the Board of Directors, to fill the
vacancy in those offices until a successor is hired. On April 1, 2002, MDI
contracted with Michael A. Brodeur, a partner of Tatum CFO Partners, LLP and for
the purpose of hiring Mr. Brodeur as MDI's President, Chief Operating Officer,
Chief Financial Officer, Treasurer and Secretary.

Bridge Financing. On March 19, 2002, the Company issued a convertible
promissory note to NeoMed Innovations III, L.P. for the principal amount of
$500,000 in cash. The note bears interest at the rate of 7% per year and is due
June 15, 2002. The note is convertible into shares of our common stock at
anytime after issuance at a conversion rate of $1 per share, subject to
adjustment or the note may be converted into shares of common stock on the same
terms as the price per share of common stock offered in a proposed private
placement. As additional consideration for the note, the Company issued NeoMed a
warrant to purchase 150,000 shares of our common stock at an exercise price of
$1 per share.

REIMBURSEMENT OF LEGAL FEES

SpectRx Litigation Settlement. On February 1, 2002, the Company reached an
out-of-court settlement with SpectRx. Under the settlement, SpectRx paid a lump
sum cash payment of $150,000 to MDI and the

F-29

MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(FORMERLY AMPERSAND MEDICAL CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 -- (CONTINUED)

Company has granted SpectRx an option to license certain of the Company's
technology. Additional terms of the settlement were confidential. Under the
settlement, neither party admitted any liability or wrongdoing.

From time to time, MDI has been a party to routine pending or threatened
legal proceedings and arbitrations. MDI insures some, but not all, of its
exposure with respect to such proceedings. Based upon information presently
available, and in light of legal and other defenses available to MDI, management
does not consider the liability from any threatened or pending litigation to be
material to MDI. MDI has not experienced any significant environmental problems.

F-30

EXHIBIT INDEX

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K

DOCUMENTS FILED AS PART OF REPORT

1. FINANCIAL STATEMENTS

2. FINANCIAL STATEMENT SCHEDULES

The following financial statement schedule is filed as a part of this
report as page F-30.

Schedule IX -- Valuation and Qualifying Accounts.

All other schedules are omitted because they are not applicable or not
required, or because the required information is included in the
Consolidated Financial Statements or notes thereto.

Schedule IX -- Valuation and Qualifying Accounts

F-31

3. EXHIBITS

F-32

F-33

F-34

F-35

F-36

F-37

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

* SEC File NO. 0-935

F-38