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                                  UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  For the Fiscal Year ended December 31, 1997.
                           COMMISSION FILE NO.0-12850

                     DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC.
                 (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)

                    DELAWARE                          13-3152648
         (State or other jurisdiction of           (I.R.S. Employer
         incorporation or organization)           Identification No.)

    200 N. Westlake Boulevard, Suite 202, Westlake Village, California, 91362
               (Address of principal executive offices) (Zip Code)

         Issuer's telephone number, including area code: (805) 381-2700

                    Securities Registered Pursuant To Section
                           12(b) of the Exchange Act:
                                      None

                    Securities Registered Pursuant To Section
                           12(g) of the Exchange Act:

                 Redeemable Common Stock Purchase Warrants, and
                          Common Stock, $0.01 Par Value
                                (Title of class)


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

Check if there is no disclosure of delinquent filers in response to Item 405 of
regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]

The issuer's revenues for the fiscal period ended December 31, 1997 were
$16,087,208.

At March 24, 1998, the issuer had 5,115,777 shares of Common Stock, $0.01 par
value, issued and outstanding.

The aggregate market value of the outstanding voting and non-voting common
equity held by non-affiliates of the issuer computed by reference to the average
bid and asked price of such common equity as of March 24, 1998 was $42,022,997.
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                       DOCUMENTS INCORPORATED BY REFERENCE

Items 9-12 of Part III of this Report incorporate by reference portions of the
Registrant's definitive Proxy Statement with respect to its 1998 Annual Meeting
of Stockholders.

Transitional Small Business Disclosure format:  YES    NO   X
                                                   ---     ---

         When used in this Form 10-KSB or future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or stockholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "will likely
result," "are expected to," "will continue," "is anticipated," "estimate,"
"project," "believe" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company wishes to caution readers that all
forward-looking statements are necessarily speculative and not to place undue
reliance on any such forward-looking statements, which speak only as of the date
made, and to advise readers that various risks and uncertainties, including
regional, national and international economic conditions, competitive and
regulatory factors, could affect the Company's financial performance and could
cause the Company's actual results for future periods to differ materially from
those anticipated or projected. The risks highlighted herein should not be
assumed to be the only things that could affect future performance of the
Company.

         The Company does not undertake, and specifically disclaims any
obligation, to publicly release the result of any revisions which may be made to
any forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.



                                     PART I

ITEM 1.  DESCRIPTION OF BUSINESS.


    Prior History and Activities. Dental/Medical Diagnostic Systems, Inc.
("Company") designs, develops, manufactures and sells high technology dental
equipment. The Company was organized in New York in 1981 under the name Edudata
Corporation and reincorporated in Delaware in 1983. The Company was initially
organized to provide education in the use of personal computers, to market
software programs developed by others, and to provide a broad range of advisory
services to businesses in conjunction with both computer and non-computer
related management issues. From 1988 to early 1996, the Company's operations
were limited to exploring opportunities to acquire or to become an operating
business.

    On March 1, 1996, the Company acquired all the outstanding securities of
Dental/Medical Diagnostic Systems LLC, a California limited liability company
("DMD"), and Bavarian Dental Instruments, Inc., a California close corporation
("BDI"), in exchange for the issuance by the Company of a total of 1,706,626
restricted shares of its Common Stock. As a result of these transactions, the
former members of DMD and former stockholders of BDI gained a majority of the
Company's voting securities and the management control of the Company was
transferred to the former management of DMD and BDI. For accounting purposes
these transactions were treated as a recapitalization of DMD and BDI, with DMD
and BDI combined as the acquiror (reverse acquisition). As a result, the
combined historical financial statements of DMD and BDI became the financial
statements of the Company. Further, since the Company's assets at February 29,
1996 consisted solely of approximately $660,000 in cash and cash equivalents and
the Company had no operations in the seven years prior to the transactions, for
accounting purposes these transactions were recorded by the Company as the
issuance of Common Stock for cash held by the Company.

    BDI, a subsidiary of the Company, distributes and markets reusable diamond
dental burs pursuant to certain agreements with Russian manufacturers. On July
9, 1996, the Company determined to focus future strategic development primarily
upon high value added dental/medical products and technology and, accordingly,
decided to discontinue the dental bur product line, comprised of low-margin
low-technology products, as extrinsic to the Company's strategic goals.


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    On October 2, 1997, the Company purchased the assets of S.E.D. Gerant
("S.E.D."), a company organized under the laws of France, for $120,000. As part
of this asset purchase, the Company paid an additional $106,850 for development
costs associated with S.E.D.'s "Biotron" curing and whitening device products.
S.E.D. is a developer and manufacturer of medical and dental devices. The
Company purchased the rights to all of the technology and the intellectual
property, including patents, developed by S.E.D. including the Biotron products.
The Company commenced marketing a curing and whitening device in Europe and
internationally incorporating this technology in March of 1998 under the brand
name "Apollo 95E." S.E.D. will manufacture the Apollo 95E for the Company
pursuant to an oral agreement between the Company and S.E.D. The Company has
also entered into a consulting agreement with Dr. Francios Duret, President of
S.E.D. Dr. Duret will oversee the manufacture by S.E.D. of the Apollo 95E for
sale by the Company into the international marketplace and will develop new
products as directed from time to time by the Company.

    On September 17, 1997, the Company issued 50,000 shares of Common Stock to
DMD NV, the Company's licensed exclusive distributor of the TeliCam system in
Europe, in exchange for termination of DMD NV's exclusive distribution rights in
Europe. The closing market price of the Common Stock on the date of issuance was
$256,250.

    On February 2, 1988 the Company formed "DMDS, Ltd." a wholly-owned
subsidiary created under the laws of the United Kingdom. DMDS, Ltd. will hold
the assets acquired from S.E.D. In addition, the Company currently plans to
market certain of its new products internationally through DMDS, Ltd.

INDUSTRY OVERVIEW

    The results of a recent study commissioned by the American Dental
Association ("ADA") indicate that the number of US dental visits has grown, from
360 million in 1975, to 534 million in 1995; and that the total expenditure for
dental care in the US in 1995 was approximately $43.2 billion. According to
industry estimates, during 1995 there were approximately 130,000 active dentists
serving the United States marketplace in about 100,000 dental practices.

    In 1994, the US dental medical/surgical equipment market was estimated by
the ADA to be a $2.5 billion annual industry, with a projected annual growth
rate of between 6% and 8%, reaching $3.5 billion annually by the year 2000. The
ADA reports that the average annual purchase of dental supplies and equipment in
1995 was approximately $19,000 per dentist. Factors contributing to this growth
include the general aging of the population, technological advances, increasing
regulatory requirements relating to infection control, and the proliferation of
dental insurance coverage. In addition to the domestic market for dental
supplies and equipment, the ADA findings indicate that there is a multi-billion
dollar annual market for such items in Europe and Asia.

GROWTH STRATEGY

    The Company's goal is to be a leading manufacturer and distributor of high
technology dental products. The Company believes that its focus on the following
business strategies will help it to achieve this goal:

        Delivery of Innovative, Value-Oriented Products. The Company seeks to
    provide innovative products that offer a strong price-value relationship to
    its customers. The Company endeavors to deliver products that offer, or will
    offer, greater or differentiated operating features at competitive prices.

        Commitment to Product Development. From inception (October 23, 1995)
    through December 31, 1997, the Company has devoted approximately $ 2.1
    million to product development activities, including approximately $1.2
    million in fiscal 1997. The dental market is highly competitive, the Company
    believes that its focus on new and improved technologies is essential if the
    Company is to continue to grow and to maintain a competitive position in the
    marketplace.

        Growth Through Acquisitions and Licensing Agreements. The Company
    anticipates that it will complement its internal growth, both in number of
    products and sales, through acquisitions and licensing agreements and a
    focus on developing and marketing new technologies for the dental practice.
    The Company believes that acquisitions and licensing agreements present an
    effective means of obtaining technical personnel and obtaining or expanding
    technologies, products and markets. The Company continually evaluates
    opportunities for acquisitions and licensing agreements.

        Expansion of Domestic and International Sales. Although both the
    domestic and international dental supply markets are highly competitive, the
    Company believes that the size of these markets provides an excellent
    opportunity for growth. The Company intends


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    to increase its domestic sales through the planned introduction of new
    products, such as a composite curing and tooth whitening device and the
    TeliCam Elite. See "-- Product Development." The Company also hopes to
    increase its international sales through entry into additional distribution
    agreements with foreign distributors and the introduction of the Apollo 95E
    curing and tooth whitening device internationally. The Company intends to
    capitalize on its experienced management and sales team to increase its
    domestic and international sales. The Company is developing products
    incorporating digital x-ray technology for sale in the dental market both
    domestically and internationally.

PRODUCTS

         Current Products. The Company's primary existing product emphasis is on
the manufacture and sale, of an intraoral camera system, known as the "TeliCam
II System," and a multi-operatory intraoral camera system, known as the
InTELInet, for use in connection with the TeliCam II System. The Company's
TeliCam II System was introduced to update its "TeliCam I System." The Company
has discontinued marketing its TeliCam I System. The Company is developing an
updated version of its intraoral camera system, the "TeliCam Elite" and plans to
introduce the updated camera in the second quarter of fiscal year 1998.

         Most traditional intraoral dental cameras consist of: (i) a handpiece,
the end of which contains the camera lens and light source; (ii) a camera chip
("CCD chip"), with a camera chip processing unit ("CCU processor"), which
interprets the camera's video signals; (iii) video and light source cables which
connect the handpiece to the CCU processor, and (iv) an external capture device,
such as a video recorder or printer so that the dentist and patient can view the
video image. The primary distinguishing feature of the TeliCam System is its
ability to capture and "freeze" video images and display multiple images
simultaneously without an external capture device. The heart of the TeliCam II
System's image capture capabilities is the Teli CCU processor which is
incorporated therein. The Teli CCU processor, which was designed specifically
for intraoral dental camera use, has a built-in image capturing mechanism or
"frame grabber" computer chip. This gives the dental professional the ability to
capture from one to four images with the touch of a button on the handpiece or
the use of a foot pedal, and eliminates the need for network installation and
the hardwiring of external capture devices. Additionally, the Teli CCU
processor's frame grabber incorporates an automatic light intensity control
which eliminates reflection and glare from the fiberoptic illumination for
clearer video images. The Company has exclusive world-wide rights to market the
Teli CCU processor to the dental market.

         Another feature of the TeliCam II System is its 1/3 inch camera with
near-focus capabilities as close as two millimeters and magnification
capabilities of up to 120 times the actual image, all available without the
necessity of changing lenses. The Company believes that this functionality is
only available in significantly more expensive competing models. Additionally,
the TeliCam System features an ergonomically designed, easy-to-use monocoil
cable, which connects the camera's handpiece to the CCU processor. To the extent
permanent images may be required by insurance companies, auxiliary printing
systems are available from the Company.

         The TeliCam II System displays close-up color video images of dental
patients' teeth and gums. These TeliCam images assist dentists in displaying
dental health and hygiene problems to patients and, as a result of such display,
promote patient acceptance of treatment plans. The TeliCam II System offers
dentists the ability to capture and display multiple video images without an
expensive external capture device such as a video cassette recorder or color
printer, thereby providing a low-cost alternative to the more expensive
traditional intraoral dental camera systems. For this reason, the Company
believes that the TeliCam II System should be particularly attractive to the
overseas market because printed copies of dental images are not generally
required by foreign insurance companies. The Company commenced shipments of
TeliCam I Systems to customers in February 1996, and TeliCam II Systems in the
second quarter of 1997. Through December 31, 1997, the Company had sold 4,511
TeliCam I and TeliCam II Systems to dentists throughout the United States, as
well as to several dental schools, and 2,406 TeliCam I and II Systems
internationally. See "Cautionary Statements and Risk Factors -- Substantial
Dependence on Third Parties -- Suppliers."

         The Company believes that the market for intraoral cameras is a
maturing market where the Company will encounter increasing price competition;
potential revenue growth will in the future be dependent upon the ability of the
Company to add incremental technological improvements and/or reduce pricing.

         In November 1996, the Company introduced its InTELInet Video Monitoring
System ("InTELInet") which generally includes two TeliCam systems, a printer, a
video-cassette monitor, cabling and installation. InTELInet creates a
video-electronic information link between the different operatories of the
dental office. InTELInet is different from most other intra-office networking
systems known to the Company in that it enables simultaneous use of two or more
intraoral cameras, which allows dentists and their staffs to conduct more than
one patient examination at a time using two or more intraoral cameras
simultaneously. InTELInet is thus designed to be a cost-


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effective solution to the problems generally associated with standard networking
of various intraoral cameras in multiple operatories within a single dental
practice. With most traditional intraoral camera networks, each camera must be
wired to a centralized printer or other storage device in order to capture and
store the desired image, which must then be relayed back to the camera's monitor
for viewing the image, and back to the printer for ultimate printout. These
requirements result in substantial and expensive wiring. As a result, most
competing systems require a separate color video printer or other image storage
device to capture the video images from each intraoral camera that is in use.
The color printer or other image storage device is typically the second most
expensive element of an intraoral camera systems. Also, most competing intraoral
cameras require networking implementations which do not permit the simultaneous
use of multiple cameras unless a costly printer is attached to each camera.
Consequently, this traditional type of network requires the dental practice to
make a significant expenditure for cabling and installation and on-site printers
in every operatory. Because the TeliCam has its own microprocessor video capture
device built in, its design facilitates the need for only one central video
printer regardless of the number of cameras being used at the same time. The
InTELInet requires significantly less cabling and eliminates the need for
purchasing multiple printers because of the built-in image capture capabilities
of the TeliCam System. The Company emphasizes the savings to dental practices
and the ease of use of the InTELInet in its marketing campaigns. The InTELInet
is being marketed by the Company only in the US due to the general absence of
multiple operatory practices outside of the United States. The InTELInet
facilitates simple network expansion and is only compatible with intraoral
dental cameras marketed by the Company. While there can be no assurance that
digital x-ray technology will be developed, the Company has designed the
InTELInet system to be compatible with the digital x-ray technology the Company
is currently developing with Suni Imaging Microsystems, Inc. See "--Product
Development." From the time of its first introduction in late November 1996,
through December 31, 1997, 385 InTELInet multiple operatory networking systems
have been sold by the Company.

         Product Development. Consistent with the Company's strategy, the
Company's intends to grow and expand through new product development and
introduction and by updating its current products to respond to competitive
pressures. The Company anticipates introducing several new and enhanced products
in fiscal 1998.

         The Company is currently completing the development of its TeliCam
Elite intraoral camera. This system, designed for the medium-priced dental
market, is distinguished from the Company's current TeliCam II System by
features such as increased portability, expanded memory, a wall mount
capability, an automatic on/off built into the mouth piece, extended life of the
lamp, and aesthetic modifications. The TeliCam Elite, when introduced, may also
be used with the InTELInet network. The Company plans to introduce the TeliCam
Elite in the second fiscal quarter of 1998. No assurances can be given that the
TeliCam Elite will achieve market success.

         The Company has signed an exclusive distribution agreement with Ion
Laser Technology, Inc. ("ILT") for the rights to distribute ILT's composite
curing and whitening system to the dental market in the US and Canada. The
Company is currently working with ILT to produce a device that meets the
Company's specifications. As of March 27, 1998, no devices had yet been shipped
by ILT which met the Company's specifications. While the Company believes an
acceptable device will be developed, no assurance can be given that ILT will be
able to produce a device which meets the Company's specifications or will
otherwise be able to meet the Company's manufacturing requirements. If the
device is successfully developed, the Company will market the device as the
"Apollo 9500(TM)." ILT has retained the right to market its own tooth whitening
system, which uses the same high power non-laser light incorporated into the
Company's Apollo 9500. The Apollo 9500 utilizes a high energy, high pressure
ionized gas in the presence of an electrical current to create a laser-type
light to effect teeth whitening. The Company believes that the teeth whitening
system can produce faster results at a lower cost than currently available teeth
whitening systems. Currently, the leading laser system for teeth whitening in
the dental office requires more than two hours of the dentist's time. Based on
initial testing, the Company believes the Apollo 9500 will whiten teeth in a
dentist's office in less than one hour. The Apollo 9500 procedure can be
performed by a dental hygienist or assistant instead of the dentist. The
procedure involves the compatibility of the light source with catalytic
chemicals to produce effective and rapid teeth whitening. The Apollo 9500 also
functions as a curing system for curing composites, adhesives and sealants used
in dental bonding and repair. Currently available light curing systems can
achieve similar curing results to those produced by the Apollo 9500.
However, those light systems take substantially longer to achieve the same
curing result. The Company will also market the chemical composite and whitening
materials supplied by ILT to be used with this product. See "Cautionary
Statements and Risk Factors -- Substantial Dependence on Third Parties --
Distribution and Licensing Relationships."


         The Company has entered into an agreement with Suni Imaging
Microsystems, Inc. ("Suni") to develop digital x-ray technology for
incorporation into systems for the dental market. The Company has obtained
exclusive rights to market products to the dental market incorporating certain
digital x-ray technology developed by Suni. Suni will retain the rights to
developed microchip technology underlying the x-ray system it develops for the
Company. Digital x-ray systems, including those currently on the market, reduce
radiation exposure compared to conventional x-ray systems and allow dentists to
view x-ray images in real-time without the time-


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consuming process of film development and eliminate the need to use and dispose
of chemicals required to develop conventional x-ray film. This technology, if
successfully developed for the Company by Suni, would provide improved image
quality and a more comfortable sensor for the patient at a lower price point
than competitive systems. Digital x-ray systems, including those currently on
the market, reduce radiation exposure compared to conventional x-ray systems and
allow dentists to view x-ray images in real-time without the time-consuming
process of film development and eliminate the need to use and dispose of
chemicals required to develop conventional x-ray film. This technology also is
designed to allow database storage and recall of images for comparison purposes.
The development of the technology will be done by Suni and funded by the
Company. No assurance can be given that digital x-ray technology will be
successfully developed, or if the technology is developed, that the Company will
be able to commercially exploit it. Additionally, the Company believes that any
products it may develop incorporating the digital x-ray technology will require
FDA approval prior to marketing, and as a consequence, the timing of the
domestic introduction of such product is uncertain. The Company will determine
whether or not to proceed with the marketing of such product based upon the
results of the development.

         The Company introduced a curing and whitening device, the Apollo 95E,
in March of 1998 to markets outside of the US and Canada. The Company has
entered into a consulting agreement with Dr. Francois Duret, president of S.E.D.
S.E.D. will manufacture the Apollo 95E for the Company pursuant to an oral
agreement between the Company and S.E.D. Dr. Duret will oversee manufacture of
the 95E product for the Company by S.E.D., and will render consulting and
research services to the Company, including obtaining regulatory approval of any
new version of the Company's Apollo 95E products. The Company believes that the
Apollo 95E produces faster results than products currently available in that
market place. This product is designed to cure composite material in three
seconds or less, and to produce teeth whitening in a dental operatory in less
than one hour. The Company will also market the chemical composite and whitening
materials to be used with both these products. See "Cautionary Statements and
Risk Factors -- Substantial Dependence on Third Parties -- Suppliers."

         The Company expended $1,213,766 and $322,467 for research and
development of its products for the twelve months ended December 31, 1997 and
from March 2, 1996 to December 31, 1996, respectively.

MANUFACTURING AND COMPONENT PARTS

         The Company assembles and tests the TeliCam II System, as well as
develops new products, at its facility located in Irvine, California. With the
exception of the camera's CCU processor, the Company believes that there are
multiple sources from which it may purchase the components of the TeliCam
System. The Company anticipates that it will obtain the CCU processor component
of the TeliCam System from a single source. Although the Company believes it
will be able to negotiate satisfactory alternative supply arrangements, failure
to do so may have a material adverse effect on the Company. Furthermore, there
can be no assurance that suppliers will dedicate sufficient production capacity
to satisfy the Company's requirements within scheduled delivery times or at all.
Failure or delay by the Company's suppliers in fulfilling its anticipated needs
may adversely affect the Company's ability to market the TeliCam System.

         Effective October 1, 1996, the Company amended its distribution
agreement ("BMC Distribution Agreement") with Boston Marketing, a licensed
distributor of the Teli manufactured CCD chip which includes the Teli CCU
processor. Pursuant to the BMC Distribution Agreement, the Company has the
exclusive right (i) to market certain Teli manufactured CCD chip assemblies with
CCU processors (model numbers CS6110 S/B with Frame Grabber, CS6110 P S/B with
Frame Grabber and the CS6110 S/B without Frame Grabber (each a "Teli Unit" and
collectively the "Teli Units")) to the dental market, and (ii) to use the
"TeliCam" trademark. The Teli Units are key components of the Company's
intraoral digital cameras. The BMC Distribution Agreement has a five-year
initial term. The Company has agreed to purchase a minimum of 2,500 Teli Units
per year for each of the five years, at an initial price of $750 per Teli Unit,
subject to increase after October 1, 1998. The Company has the option to cancel
the BMC Distribution Agreement if any price increase is unacceptable. The Boston
Market Distribution Agreement is terminable by Boston Marketing if the Company
fails to meet its annual minimum purchase obligation. The term of the BMC
Distribution Agreement may be extended by mutual agreement of the Company and
Boston Marketing for an additional five year term. Management believes that, if
necessary, other CCD chips, CCU processors and frame grabbers could be obtained
from third-party suppliers on comparable terms, although a disruption in
supplies of components could extend for up to six months, which would materially
adversely affect the Company's operating results.

         Under the Company's development and distribution agreement with ILT,
ILT will manufacture ILT's composite curing and teeth whitening system for the
Company, which the Company will market as the Apollo 9500. The Company will also
market the chemical composite and whitening materials supplied by ILT to be used
exclusively with this product. The Company is currently working with ILT to
produce a device that meets the Company's specifications. As of March 27, 1998,
no devices had yet been shipped by ILT which met the Company's specifications.
While the Company believes an acceptable device will be developed, no assurance
can be given that



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ILT will be able to produce a device which meets the Company's specifications or
will be able to meet the Company's manufacturing requirements. If ILT is unable
to deliver a product which meets the Company's specifications, or is otherwise
unable to perform its obligations, the Company intends to introduce its Apollo
95E product for sale into the US and Canadian markets. The Company believes that
it would experience a four to six month delay in shipments while it obtained
regulatory approval of its Apollo 95E product for sale in the US and Canada. See
"-- Government Regulation." If the contract with ILT is otherwise terminated,
or if for some reason the Apollo 95E cannot be introduced, the Company believes
that it would experience significant delays in its ability to market whitening
and curing devices. In the event the Company is unable to obtain alternate
sources of supply to replace this planned product line, the Company's operations
may be materially adversely effected. See "Cautionary Statements and Risk
Factors -- Substantial Dependence on Third Parties -- Distribution and Licensing
Relationships."

         The Company's Apollo 95E product will be initially manufactured in
France for the Company under an oral agreement with S.E.D. If S.E.D. is
unable to meet the Company's requirements, Management believes that alternative
manufacturing sources for its Apollo 95E product could be obtained rapidly, on
comparable terms without causing significant delays in production or shipment.
In the event the Company is unable, however, to quickly obtain an alternate
manufacturing source, this could have an adverse effect on the Company's
operations.

BACKLOG

         The Company generally does not operate with significant order backlog
and a substantial portion of its revenues in any quarter is derived from orders
booked in that quarter.

MARKETING AND SALES

         US Sales and Distribution. The Company's domestic sales are made by
four full-time employees who are based at corporate headquarters, and a national
field force of independent sales representatives under the supervision of 14
independent Regional Managers. The Company's full time sales employees are
generally experienced in the business of marketing and distribution of intraoral
cameras to the dental industry. The Company markets its products through direct
mail solicitations, professional publications advertising, and attendance at
dental conferences. During 1997 and 1996 the Company ran advertisements in
various publications for the dental industry on a monthly basis and attended in
excess of 70 dental conferences and trade shows in 1996 and in excess of 75
dental conferences and trade shows in 1997. In addition, the Company has sold
TeliCam Systems to five dental schools including the University of Chicago,
Tufts University and the University of Louisville. The Company believes that
these and anticipated future dental school sales will generate additional
interest in, as well as familiarity with, the Company's products at the initial
stages of a dental professional's career. In the US dental marketplace, the
Company's marketing campaign has focused on the advantages of the intra-office
networking capabilities and the significantly lower price of the TeliCam System.
The Company plans to distribute the Apollo 9500, and products it is currently
developing such as the TeliCam Elite and any product incorporating digital x-ray
technology through its existing distribution network.

         International Sales and Distribution. In the international market, the
Company sells the TeliCam System through independent dealers and distributors.
Presently, the Company has nine contracts with independent distributors, which
agreements cover key international markets including, the Middle East, the Far
East, Russia, Australia, Canada and South America. On September 17, 1997 the
Company repurchased distribution rights for its products in the European market
from an independent distributor for 50,000 shares of its Common Stock. The
Company's international distributors provide important support, including
customer support and product service, to customers in each of their respective
countries. The Company had an agreement with Hiroki Umezaki, a former officer,
director and principal stockholder of the Company, pursuant to which he was to
receive a 15% commission on all sales made by the Company in Asia, except Japan,
in which his commission was to be 12%. This agreement has been amended to
provide that Mr. Umezaki shall receive a 12% commission on sales made in Japan
only. This oral agreement is currently being documented with these changed terms
and the Company believes that the new agreement will be signed with the new
terms as described above. Furthermore, Olympus Camera Company of Japan
("Olympus") has commenced purchases and has signed a letter of intent with the
Company relating to Olympus becoming the exclusive distributor of the TeliCam
System in Japan. The Company is continuing to negotiate with Olympus; however,
no assurance can be given that the parties will enter into a distribution
agreement. The Company's international sales, which commenced in April 1996,
aggregated approximately $6,100,000 through December 31, 1997. Since printed
copies of dental images are not generally required by foreign insurance
companies, the Company believes that the TeliCam System Frame-grabber image
capturing mechanism, which enables dental professionals to avoid the costs of
external capture devices, and their requisite networking demands, makes the
TeliCam System particularly attractive in international markets. The Company
currently does not intend to market the InTELInet network outside the United
States. The Company plans to market the Apollo 95E through its wholly-owned
subsidiary, DMDS, Ltd. and through its existing network of international
distributors.


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TRAINING, CUSTOMER SUPPORT AND PRODUCT SERVICE

    Management believes that operating the Company's TeliCam System Products
requires very little training. Nevertheless, as part of the Company's customer
service program, the sales representative or international distributor
responsible for the sale of the TeliCam System schedules an installation and
training appointment when the system is delivered. In addition, the Company
provides a TeliCam System operating manual to its customers which provides
answers to frequently asked questions about the product's operations. The
Company's technical support personnel, and internationally, the support
personnel of the Company's distributors, are also available to answer customers
telephone inquiries during normal business hours. All TeliCam Systems come with
a one-year complete parts and labor warranty and extended warranties are also
available. InTELInet installation and maintenance is provided through
independent installers retained by the Company. Customer support for the TeliCam
Elite will be provided by the existing TeliCam System support system. The
Company is currently developing a program for training, customer support and
service for the products it hopes to introduce in 1998.


PATENTS AND PROPRIETARY RIGHTS

    The patents pertaining to the various components of the TeliCam System are
all owned by third parties. Pursuant to an agreement with Boston Marketing
Company, Ltd. ("Boston Marketing") the Company has the exclusive right to market
TeliCam's CCD processor unit ("Teli Units") to the dental market ("Boston
Marketing Distribution Agreement"). Also pursuant to this agreement, the Company
has the rights to use the "TeliCam" trademark.

    Certain technology incorporated into the Company's Apollo 9500 system is
protected by patents owned by ILT. The Company has an exclusive right to
distribute the Apollo 9500 curing and whitening system in the US and in Canada.
ILT has retained the right to market its own tooth whitening system in the US
and Canada that incorporates the same high power non-laser light technology as
is incorporated into the Company's Apollo 9500. As part of the asset purchase
from S.E.D., the Company purchased the technology rights, including patent
rights, to certain technology incorporated into its Apollo 95E product. See
"Cautionary Statements and Risk Factors -- Substantial Dependence on Third
Parties."

    The Company's success and ability to compete is dependent in part upon its
proprietary technology. The Company's proprietary technology for the TeliCam is
not protected by any patents. Consequently, the Company relies primarily on
trademark, trade secret and copyright laws to protect this technology. Also, the
Company has implemented a policy that all employees and third-party developers
sign nondisclosure agreements. However, there can be no assurance that such
precautions will provide meaningful protection from competition or that
competitors will not be able to develop similar or superior technology
independently. Also, the Company has no license agreements with the end users of
its TeliCams, so it may be possible for unauthorized third parties to copy the
Company's products or to reverse engineer or otherwise obtain and use
information that the Company regards as proprietary. If litigation is necessary
in the future to enforce the Company's intellectual property rights, to protect
the Company's trade secrets or to determine the validity and scope of the
proprietary rights of others, such litigation could result in substantial costs
and diversion of resources and could have a material adverse effect on the
Company's business, operating results and financial condition. Ultimately, the
Company may be unable, for financial or other reasons, to enforce its rights
under intellectual property laws. In addition, the laws of certain countries in
which the Company's products are or may be distributed may not protect the
Company's products and intellectual property rights to the same extent as the
laws of the United States.

    The Company believes that its products do not infringe upon any valid
existing proprietary rights of third parties. Although the Company has received
no communication from third parties alleging the infringement of proprietary
rights of such parties, there can be no assurance that third parties will not
assert infringement claims in the future. Any such third party claims, whether
or not meritorious, could result in costly litigation or require the Company to
enter into royalty or licensing agreements. There can be no assurance that the
Company would prevail in any such litigation or that any such licenses would be
available on acceptable terms, if at all. If the Company were found to have
infringed upon the proprietary rights of third parties, it could be required to
pay damages, cease sales of the infringing products and redesign or discontinue
such products, any of which alternatives, individually or collectively could
have a material adverse effect on the Company's business, operating results and
financial condition.


                                       8
<PAGE>   9
GOVERNMENT REGULATION

         The products which the Company sells are considered to be medical
devices and the Company is considered to be a medical device manufacturer and is
subject to control by, among other governmental entities, the FDA and the
corresponding agencies of the states and foreign countries in which the Company
sells its products. These regulations govern the introduction of new medical
devices, the observance of certain standards with respect to the manufacture and
labeling of medical devices, the maintenance of certain records and the
reporting of potential product problems and other matters. A failure to comply
with such regulations could have material adverse effects on the Company.

         The Federal Food, Drug and Cosmetic Act ("FDC Act") regulates medical
devices in the United States by classifying them into one of three classes based
on the extent of regulation believed necessary to ensure safety and
effectiveness. Class I devices are those devices for which safety and
effectiveness can reasonably be ensured through general controls, such as device
listing, adequate labeling, premarket notification and adherence to good
manufacturing practices ("GMP") as well as medical device reporting ("MDR")
labeling and other regulatory requirements. Class II devices are those devices
for which safety and effectiveness can reasonably be ensured through the use of
special controls, such as performance standards, post-market surveillance and
patient registries, as well as adherence to the general controls provisions
applicable to Class I devices. Class III devices are devices which generally
must receive premarket approval by the FDA pursuant to a premarket approval
("PMA") application to ensure their safety and effectiveness. Generally, Class
III devices are limited to life sustaining, life supporting or implantable
devices; however, this classification can also apply to novel technology or new
intended uses or applications for existing devices.

         Before they can be marketed, most medical devices introduced to the
United States market are required by the FDA to secure either clearance of a
pre-market notification pursuant to Section 510(k) of the FDC Act (a "510(k)
Notification") or approval of a PMA. Obtaining approval of a PMA application can
take several years. In contrast, the process of obtaining 510(k) Notification
clearance generally requires a submission of substantially less data and
generally involves a shorter review period. Most Class I and Class II devices
enter the market via the 510(k) Notification procedure, while new Class III
devices ordinarily enter the market via the more rigorous PMA procedure. In
general, clearance of a 510(k) Notification may be obtained if a manufacturer or
seller of medical devices can establish that a new device is "substantially
equivalent" to a predicate device other than one that has an approved PMA. The
claim for substantial equivalence may have to be supported by various types of
information, including clinical data, indicating that the device is as safe and
effective for its intended use as its legally marketed equivalent device. The
510(k) Notification is required to be filed and cleared by the FDA prior to
introducing a device into commercial distribution. Market clearance for a 510(k)
Notification submission may take 3 to 12 months or longer. If the FDA finds that
the device is not substantially equivalent to a predicate device, the device is
deemed a Class III device, and a manufacturer or seller is required to file a
PMA application. Approval of a PMA application for a new medical device usually
requires, among other things, extensive clinical data on the safety and
effectiveness of the device. PMA applications may take years to be approved
after they are filed. In addition to requiring clearance or approval for new
medical devices, FDA rules also require a new filing and review period prior to
marketing a changed or modified version of an existing legally marketed device
if such changes or modifications could significantly affect the safety or
effectiveness of that device. The FDA also prohibits an approved device from
being promoted or marketed for unapproved applications.

         Over time, the FDA has adopted classification regulations for certain
medical devices and has designated some of these devices as Class I, while
exempting certain of them from the 510(k) Notification requirements. The dental
burs sold by the Company's BDI subsidiary have been classified by the FDA as
Class I devices and are exempt from the 510(k) Premarket Notification
requirements. They are not exempt from GMP, medical device reporting, labeling
and other regulatory requirements. The Company has decided to discontinue its
dental bur business. In December 1997 the Company was notified by the staff of
the FDA that in the FDA's view a 510(K) will be required on all intraoral
cameras sold in the United States including the Company's TeliCam product. The
staff of the FDA also orally confirmed that the Company may continue to sell the
TeliCam domestically and internationally pending clearance of the product.
Although the Company believes that the marketing and sales of the TeliCam
intraoral dental camera does not require filing or clearance of a 510(K)
Notification and would vigorously challenge any enforcement action based upon
such a contention, the Company has determined to promptly comply with the
staff's direction since there will be no negative affect on the sales or
operations of the Company. The Company and its regulatory experts believe that
the obtaining of the 510(K) Notification for the camera will be a relatively
easy process and should be completed in the next two to three months.

         The Company believes that it will be required to obtain FDA approval or
clearance prior to introduction of any digital x-ray products, if such products
are, in fact, developed. ILT has obtained 510(K) approval of the curing and
whitening device the Company will market as the Apollo 9500. If ILT is unable
to perform its obligations to deliver a curing and whitening device to
the Company


                                       9
<PAGE>   10
which meets the Company's specifications, the Company believes it would be
required to obtain FDA approval or clearance prior to introduction of its Apollo
95E product, or an alternative product, for sale in the US.

         Pursuant to FDA requirements, the Company has registered its
manufacturing facility with the FDA as a medical device manufacturer, and listed
the medical devices it manufactures. The Company also is subject to inspection
on a routine basis for compliance with FDA regulations. These regulations
include those covering GMP which require that the Company manufacture its
products and maintain its documents in a prescribed manner with respect to
manufacturing, testing and control activities. Further, the Company is required
to comply with other FDA requirements with respect to labeling, and the MDR
regulations which require that the Company provide information to the FDA on
deaths or serious injuries alleged to have been associated with the use of its
products, as well as product malfunctions that are likely to cause or contribute
to death or serious injury if the malfunction were to recur. The Company
believes that it is currently in material compliance with all relevant GMP and
MDR requirements.

         In addition, the Company is required to be licensed as a medical device
manufacturer by the State of California. The Company has applied for such a
license to cover its manufacturing activities. In general, because of the
Company's belief that its products are Class I devices and exempt from 510(K)
Notification, the Company believes that the California Department of Health
Services, Food and Drug Branch ("California DHS") will permit the Company to
continue to manufacture and sell its products prior to the required prelicensing
inspection. Approval of the license generally requires that the Company comply
with the FDA's GMP labeling and MDR regulations, as well any other applicable
regulatory requirements. This State license is not transferable and must be
renewed annually.

         Generally, if the Company is in compliance with FDA and California
regulations, it may market its devices in other states in the United States.
International sales of medical devices are also subject to the regulatory
requirements of each country, and in Europe, the regulations of the European
Union. The Company has obtained applicable regulatory approval of its Apollo 95E
product for sale in the European Common Market. The regulatory review process
varies from country to country. The Company, in general, will rely upon its
distributors and sales representatives in the foreign countries in which it
markets its products to ensure that the Company compiles with the regulatory
laws of such countries. The Company believes that its international sales to
date have been in compliance with the laws of the foreign countries in which it
has made sales. Failure to comply with the laws of such country could have a
material adverse effect on the Company's operations and, at the very least,
could prevent the Company from continuing to sell products in such countries.
Exports of Class I and Class II medical devices are also subject to certain
limited FDA regulatory controls.

PRODUCT LIABILITY AND INSURANCE

         The nature of the Company's present and planned products may expose the
Company to product liability risks. No product liability claims have been
brought against the Company to date. The Company maintains product liability
insurance with coverage limits of $1,000,000 per occurrence and $1,000,000 per
year. While the Company believes that it maintains adequate insurance coverage,
there can be no assurance that the amount of such insurance will be adequate to
satisfy claims made against the Company in the future or that the Company will
be able to obtain insurance in the future at satisfactory rates or in adequate
amounts. Product liability claims or product recalls could have a material
adverse effect on the business and financial condition of the Company. In
addition, the Company is required under certain of its licensing agreements to
indemnify its licensors against certain product liability claims by third
parties.

COMPETITION

         The distribution and manufacture of dental supplies and equipment is
intensely competitive. For example, there are at least twelve companies offering
intraoral camera systems which are competitive with the TeliCam System. The
Company's dental curing and whitening device products, if such products are
introduced, will face competition from existing curing and whitening systems,
including laser systems, and including a tooth whitening system marketed by ILT.
Many of the Company's competitors have greater financial and other resources
than the Company, and, consequently, such entities may be able to develop,
manufacture, market and/or distribute systems which are functionally similar or
superior to the Company's products. Moreover, significant price reductions by
the Company's competitors could result in a similar reduction in the Company's
prices. Any of these competitive pressures may have a material adverse effect on
operating results.

         In the United States, the Company competes with other companies that
sell dental products, distributors and several major manufacturers of dental
products, primarily on the basis of price, customer service and value-added
services and products. The Company's principal domestic competitors for the
TeliCam System are Patterson Dental Co., Henry Schein, Inc., Dentsply and
Ultrak.


                                       10
<PAGE>   11
The Company also faces competition in its international markets, where the
Company competes on the basis of price and product quality against the same
dental product distributors and manufacturers.

EMPLOYEES

    At February 8, 1998, the Company had 57 full-time employees. Of these
employees, 23 were involved in production, 5 were in customer service, 20 were
in administration, 4 were engaged in sales and marketing, and 5 were involved in
engineering and research and development. The Company believes it has a good
relationship with its employees and none of its employees are represented by a
collective bargaining agreement.


ITEM 2.  DESCRIPTION OF PROPERTIES.

    The corporate headquarters and principal offices of the Company are located
in Westlake Village, California, consisting of approximately 3,900 square feet
space under a lease that expires on November 14, 2000 ("Office Lease"). The
Office Lease provides for aggregate minimum monthly rental payments of
approximately $6,200. Further, under a lease that expires on November 1, 1998,
the Company has approximately 5,700 square feet of space in a building in
Irvine, California, where it previously manufactured and distributed the TeliCam
System and conducted research and development activities. The rental payment
under this plant lease is approximately $5,310 per month. The Company is
presently trying to sub-lease this facility. The Company now leases a larger
facility in Irvine of approximately 12,000 square feet, under a lease that
expires in November 1998 at a rental payment of $ 6,750 per month to perform
these functions. All leases require the Company to pay taxes, maintenance fees,
insurance, and periodic rent increases based on a published price index. The
Company does not presently own, and does not have any current plans to invest in
any interests in real property other than through its leases.


ITEM 3.  LEGAL PROCEEDINGS.

    The Company is not involved in any material legal proceedings.

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

    None.


                                       11
<PAGE>   12
                                     PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

    The Common Stock and Redeemable Common Stock Purchase Warrants are currently
traded on the NASDAQ SmallCap Market under the symbols "DMDS" and "DMDSW,"
respectively, and on the Boston Stock Exchange under the symbols "DMD" and
"DMDW," respectively. Prior to May 9, 1997 the Common Stock was quoted on the
OTC Bulletin Board. The following table sets forth the range of the high and low
bid quotations of the Common Stock on the OTC Bulletin Board for 1996, and the
NASDAQ SmallCap Market for 1997 as reported by NASDAQ Trading and Market
Services. These quotations reflect inter-dealer prices, without mark-up,
mark-down or commission, and may not represent actual transactions.

<TABLE>
<CAPTION>
                                                                   1997 REDEEMABLE COMMON
                                                  1997 STOCK       STOCK PURCHASE WARRANTS     1997 STOCK
                                                 HIGH      LOW        HIGH       LOW        HIGH       LOW
                                                 ----      ---        ----       ---        ----       ---
      PERIOD ENDED
<S>                                             <C>        <C>        <C>        <C>        <C>        <C>
March 31, 1997  and June 30, 1996               $4.8       $3.1       $-         $-         $5.8       $ .9
June 30, 1997 and August 31, 1996                7.1        4.1        3.9        3.7        5.4        3.6
September 30, 1997 and  November 30, 1996        6.6        5.4        2.7        2.5        5.8        3.6
December 31, 1997 and 1996                       9.5        5.9        4.0        3.8        5.6        4.3
</TABLE>

On March 4, 1998, the high bid and low ask prices were $7.50 and $6.938,
respectively for the Common Stock and $3.75 and $3.375, respectively, for the
Redeemable Common Stock Purchase Warrants. As of March 4, 1998, there were 62
stockholders of record and approximately 1,324 beneficial holders of the Common
Stock, and 29 stockholders of record and approximately 442 beneficial holders of
the Redeemable Common Stock Purchase Warrants.

                                 DIVIDEND POLICY

The Company has not paid any cash dividends on the Common Stock since its
inception and does not intend to pay any dividends on the Common Stock in the
foreseeable future. The payment of any dividends in the future will depend on
the evaluation by the Company's Board of Directors of such Factors as it deems
relevant at the time and restrictions imposed by the terms of the Company's debt
obligations. The Company bank financing agreements and the purchase agreement
entered into in connection with the Debt Placement impose restrictions on any
payment of dividends. The Board of Directors believe that all the Company's
earnings, if any, should be retained for the development of the Company's
business.

                                  RECENT SALES

         On September 17, 1997 the Company issued 50,000 shares of its Common
Stock to DMD NV, a distributor of the Company's TeliCam system in Europe, in
exchange for cancellation of DMD NV's rights to distribute the TeliCam System in
Europe. The transaction was a private transaction exempt from registration
pursuant to Section 4(2) of the Securities Act of 1933, as amended (the "Act")
and Rule 506 of Regulation D promulgated under the Act. The shares of Common
Stock given to DMD NV in exchange for its distribution rights had an aggregate
value, based on the closing market price on the date of issuance, of
approximately $256,250. A registration statement on Form S-3 with respect to
the shares was filed by the Company in January of 1998.

         On March 3, 1998, the Company entered into an agreement with accredited
investors and institutional purchasers for the private placement (the "Debt
Placement") of its 12% Senior Subordinated Notes due 1999 (the "Notes") and
450,000 warrants (the "Warrants"). The Debt Placement was consummated on March
19, 1998. The Debt Placement was exempt from Registration under Section 4(2) of
the Act and Rule 506 of Regulation D promulgated under the Act. The Warrants are
(i) exerciseable commencing on May 15, 1998, and for five years thereafter for
the purchase of one share of Common Stock per Warrant (the "Warrant Shares");
and (ii) at an exercise price of $5.812 per share. The Company has agreed to
file a registration statement with respect to the Warrant Shares within 45 days
of the date the Warrants were issued. The Notes (i) bear interest at a rate of
12% per annum payable semi-annually; (ii) mature on the first anniversary of the
date of issuance; and (iii) may be repaid by the Company prior to maturity at
one hundred and two (102%) percent of the amount of the unpaid principal plus
the interest due as of the date of repayment. If the Notes are unpaid at
maturity, each Note holder has the option to convert the outstanding principal
and interest then due on such Note into Common Stock of the Company (the
"Conversion Shares") at a conversion price equal to eighty (80%) percent of the
average of the five lowest closing bid prices for the


                                       12
<PAGE>   13
twenty consecutive trading days prior to the date of conversion. The unpaid
principal and interest then due on the Notes is convertible into a maximum
aggregate amount of 500,000 shares of Common Stock. Depending on the stock price
at the time of conversion, more than 500,000 shares of Common Stock may be
required to permit conversion of one hundred (100%) percent of the unpaid
principal and interest then due on the Notes into Common Stock. The Company has
agreed to present a proposal to its stockholders at the next annual meeting of
its stockholders to approve issuance of a sufficient number of shares of Common
Stock to permit conversion upon default of one hundred (100%) percent of the
unpaid principal and interest then due on all of the outstanding Notes to Common
Stock. The Company has agreed to file a registration statement with respect to
any Conversion Shares within 45 days of the date the Notes mature, if the Notes
are then unpaid. The Company intends to use the proceeds of the Debt Placement
of approximately $4.2 million, net of commissions and costs, to launch its
Apollo 9500 and Apollo 95E products, for product development and for other
working capital purposes.


                           USE OF PROCEEDS OF OFFERING

         On May 14, 1997, the Company closed a secondary offering (the
"Offering") of 2,070,000 shares of Common Stock. Each share of Common Stock
included one redeemable warrant (the "Redeemable Common Stock Purchase
Warrants") to purchase one share of common stock at a purchase price of $5.00.
The Offering resulted in gross proceeds of $10,350,000, less expenses of
approximately $1,819,628 for net proceeds of approximately $8,530,372.
Approximately $1,600,000 of the net proceeds were used to repay the principal on
the Bridge Notes and an additional $100,000 was used to pay off accrued
interest. The Bridge Notes consisted of secured convertible promissory notes in
the aggregate principal amount of $1,600,000 bearing interest at 10% per annum
and were payable the earlier of May 27, 1998 or consummation of the Offering.
Approximately $224,000 was used to repay loans from related parties. Of the
remaining proceeds net of associated expenses, at December 31, 1997,
approximately $2,937,000 had been used for product development, acquisition,
working capital and general corporate purposes.


ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS.

         The following discussion and analysis should be read together with the
Consolidated Financial Statements of the Company and notes thereto incorporated
elsewhere in this Form 10KSB.

INTRODUCTION

This discussion summarizes the significant factors affecting the consolidated
operating results, financial condition and liquidity/cash flows of the Company
for the twelve and ten month periods ended December 31, 1997 and December 31,
1996. Except for the historical information contained herein, the matters
discussed in this Management's Discussion and Analysis are forward looking
statements that involve risks and uncertainties and are based upon judgments
concerning various factors that are beyond the Company's control. Actual results
could differ materially from those projected in the forward looking statements
as a result of, among other factors, the factors set forth under the caption
"Cautionary Statements and Risk Factors" below.

         Dental Medical Diagnostic Systems, Inc. ("Company") designs, develops,
manufactures and sells high technology dental equipment. The Company was
organized in New York in 1981 under the name Edudata Corporation and
reincorporated in Delaware in 1983. The Company was initially organized to
provide education in the use of personal computers, to market software programs
developed by others, and to provide a broad range of advisory services to
businesses in conjunction with both computer and non-computer related management
issues. From 1988 to early 1996, the Company's operations were limited to
exploring opportunities to acquire or to become an operating business.

         On March 1, 1996, the Company purchased all of the outstanding
membership interests of Dental/Medical Diagnostic Systems, LLC ("DMD") and all
of the outstanding capital stock of Bavarian Dental Instruments, Inc. ("BDI").
Immediately subsequent to the transaction, the former members of DMD and
stockholders of BDI owned approximately 66.6% of the Company's outstanding
common stock and management control of the Company was transferred to the former
management of DMD and BDI. Accordingly, for accounting purposes the acquisition
was treated as a recapitalization of DMD and BDI with DMD and BDI combined as
the acquiror (reverse acquisition). As a result, the combined historical
financial statements of DMD and BDI became the financial statements of the
Company.


                                       13
<PAGE>   14
         DMD was formed in October 1995 and has been primarily involved in
designing, developing, manufacturing, and marketing intra-oral camera systems
referred to as "TeliCam Systems". The first shipments to customers of the
TeliCam System commenced in early February 1996. BDI was formed in November 1995
and has been primarily involved in the marketing and distribution of dental burs
imported from Russia. The first sales of burs commenced in March 1996. On July
9, 1996, the Company determined to focus future strategic development primarily
upon high value added dental/medical products and technology and, accordingly,
decided to discontinue the dental bur product line, comprised of low-margin,
low-technology products.

         On November 27, 1996, the Company raised $1,314,766, net of issuance
costs of $285,234, through a private placement of 32 Units to certain accredited
investors. Each Unit consisted of a secured promissory note in the principal
amount of $50,000 (a "Bridge Note") and a warrant (a "Bridge Warrant") to
purchase 18,750 shares of Common Stock at a purchase price of $2.67 per share.
The Bridge Notes accrued interest at a rate of 10% per annum and the principal
and all accrued interest were repaid by the Company from the proceeds of the
Company's May 1997 Offering. As a result of the Bridge Warrant issuance, the
Bridge Notes were discounted by $259,103, which amount was amortized over the
term of the Bridge Notes. The Bridge Warrants were converted into 1,600,000
Redeemable Common Stock Purchase Warrants upon closing of the Company's Offering
on May 14, 1997.

         On January 13, 1997 the Company changed its name from Edudata
Corporation to Dental/Medical Diagnostics Systems, Inc. On February 5, 1997, the
Company changed its fiscal year end from a fiscal year ending on the nearest
Saturday to February 28th to a December 31 fiscal year end. On January 13, 1997
the Company effected a one-for-2.197317574 reverse stock split and on March 24,
1997 the Company's stockholders approved an additional one-for-1.33333333
reverse stock split. All information in this Report has been adjusted to
reflect both stock splits.

         On May 14, 1997, the Company closed a secondary offering (the
"Offering") of 2,070,000 shares of Common Stock. Each share of Common Stock
included one redeemable warrant (the "Redeemable Common Stock Purchase
Warrants") to purchase one share of common stock at a purchase price of $5.00.
The Offering resulted in gross proceeds of $10,350,000, less expenses of
approximately $1,819,628 for net proceeds of approximately $8,530,372.
Approximately $1,600,000 of the net proceeds were used to repay the principal on
the Bridge Notes and an additional $100,000 was used to pay off accrued
interest. The Bridge Notes consisted of secured convertible promissory notes in
the aggregate principal amount of $1,600,000 bearing interest at 10% per annum
and were payable the earlier of May 27, 1998 or consummation of the Offering.
Approximately $224,000 was used to repay loans from related parties. The
remaining proceeds net of associated expenses have or will be used for product
development, acquisition, and to repay the remaining loans from related parties,
and working capital and general corporate purposes.

         On October 2, 1997, the Company purchased the assets of S.E.D. Gerant
("S.E.D."), a company organized under the laws of France, for $120,000. As part
of this asset purchase, the Company paid an additional $106,850 for development
costs associated with S.E.D.'s "Biotron" curing and whitening device product.
S.E.D. is a developer and manufacturer of medical and dental devices. The
Company purchased the rights to all of the technology and the intellectual
property, including patents, developed by S.E.D. The Company anticipates that it
will commence marketing a curing and whitening device in Europe and
internationally incorporating this technology during the second fiscal quarter
of 1998 under the brand name "Apollo 95E." S.E.D. will manufacture the Apollo
95E for the Company pursuant to an oral agreement between the Company and
S.E.D. The Company has also entered into a consulting agreement with Dr.
Francois Duret, the president of S.E.D. Dr. Duret will oversee the manufacture
of the Apollo 95E for sale by the Company into the international marketplace and
will develop new products as directed by the Company.

         On September 17, 1997, the Company issued 50,000 shares of Common Stock
to DMD NV, the Company's licensed exclusive distributor of the TeliCam system in
Europe, in exchange for termination of DMD NV's exclusive rights. The Common
Stock had an aggregate value, based on the closing market price on the date of
issuance, of $256,250.

         On February 2, 1988 the Company formed "DMDS, Ltd." a wholly-owned
subsidiary created under the laws of the United Kingdom. DMDS, Ltd. will hold
the assets acquired from S.E.D. In addition, the Company currently plans to
market certain of its new products internationally through DMDS, Ltd.

         On March 2, 1998, the Company entered into an agreement with accredited
investors and institutional purchasers for the private placement (the "Debt
Placement") of its 12% Senior Subordinated Notes due 1999 (the "Notes") and
450,000 warrants (the "1998 Warrants"). The Debt Placement was consummated on
March 19, 1998. The 1998 Warrants are (i) exercisable commencing on May 15,
1998, and for five years thereafter for the purchase of one share of Common
Stock per Warrant; and (ii) at an exercise price of $5.812 per share. The Notes
(i) bear interest payable semi-annually at a rate of 12% per annum; (ii) mature
on the first anniversary of the date of


                                       14
<PAGE>   15
issuance; and (iii) may be repaid by the Company prior to maturity at one
hundred and two (102%) percent of the amount of the unpaid principal plus
interest due as of the date of repayment. If the Notes are unpaid at maturity,
each Note holder has the option to convert the outstanding principal and
interest then due on such Note into Common Stock of the Company (the "Conversion
Shares") at a conversion price equal to eighty (80%) percent of the average of
the five lowest closing bid prices for the twenty consecutive trading days prior
to the date of conversion. The unpaid principal and interest then due on the
Notes is convertible into a maximum aggregate amount of 500,000 shares of Common
Stock. Depending on the stock price at the time of conversion, more than 500,000
shares of common stock may be required to permit conversion of one hundred
(100%) percent of the unpaid principal and interest then due on the Notes into
Common Stock. The Company has agreed to present a proposal to its stockholders
at the next annual meeting of its stockholders to approve issuance of a
sufficient number of shares of Common Stock to permit conversion upon default of
one hundred (100%) percent of the unpaid principal and interest then due on all
of the outstanding Notes to Common Stock.

Results of Operations

         For the twelve and ten month periods ended December 31, 1997 and
December 31, 1996 net sales totaled $16,087,208 and $11,673,102 respectively.
The Company incurred an operating loss of $1,648,080 for the twelve months ended
December 31, 1997, and operating income of $304,435 for the ten months ended
December 31, 1996. Included in the results of the year ended December 31, 1997
and the ten month period ended December 31, 1996 are sales of approximately
$35,500 and $235,000, and an operating loss of approximately $15,500 and
$196,000 respectively, related to the Company's discontinued dental bur line.

         Net sales for the twelve and ten month periods ended December 31, 1997
and December 31, 1996 were $16,087,208 and $11,673,102, respectively or an
increase of approximately 38% for the period. This increase is primarily due to
the two month longer period, increased international sales volume and increased
sales volume of the InTELIinet video systems. The sales in the ten month period
ended 1996 were significantly enhanced by an approximate $1,255,000 back order
position from inception to the commencement of sales in the period. Back orders
on hand as of January 1, 1997 amounted to $65,448 in the aggregate. Sales are
comprised primarily of sales of TeliCam Systems and related products.

         Cost of sales for the twelve and ten month periods, ended December 31,
1997 and December 31, 1996 were $10,234,206 or 64% of sales and $6,685,464 or
57% of sales, respectively. Cost of sales increased as a percentage of sales
primarily due to the increased international sales that require price discounts
on sales, partially offset by anticipated reduced warranty and service costs.
International sales and anticipated reduced warranty costs on same are subject
to a number of risks, including the Company's dependence on third party
suppliers for non-defective components and the Company's dependence on foreign
distribution. See "Cautionary Statements and Risk Factors -- Substantial
Dependence on Third Parties," and " -- Reliance on International Sales and
Distributors and General Risks of International Operations." Also contributing
to the increase in cost of sales was the increase in lower margin InTELInet
sales.

         Selling, general and administrative expenses totaled $6,031,066 and
$4,360,736, respectively for the twelve and ten month periods ended December 31,
1997, and December 31, 1996, respectively. The increase in expense is primarily
due to the two addition months included in the period, increased sales
commissions as a result of the increase in sales volume, increased salary and
wages and legal expenses associated with the acquisition of new products. These
expenses are expected to continue to increase as sales volume increases and
increased marketing costs are incurred for the introduction of the new products.
Partially offsetting these increases for the twelve month period ended December
31, 1997 were decreased advertising, show expenses and salaries as a result of
discontinuing the dental bur line.

         Research and development expenses totaled $1,213,766 and $322,467,
respectively for the twelve and ten month periods ended December 31, 1997 and
December 31, 1996. The increase in 1997 is the result of expenditures on the
research and development, primarily the digital x-ray technology. See
"Cautionary Statements and Risk Factors -- Importance of New Product Development
to Common Growth" and " -- Expansion through Undetermined Acquisitions and
Joint-Ventures." Increased expenditures on research and development are expected
to continue into future periods.

         Amortization of debt issuance cost totaled $76,431 for the twelve month
period ended December 31, 1997 and $31,548 for the ten month period ended
December 31, 1996, and is the result of the cost of the sale of the Bridge
Notes, issued in November 1996, being amortized over the term of the Notes. The
Company has repaid such debt out of the proceeds of the Offering.



                                       15
<PAGE>   16
         Interest income totaled $205,818 for the twelve month period ended
December 31, 1997, and is the result of investing the net proceeds of the
Offering in a short term management account through Comerica Securities. These
funds were not available in the prior period.

         Interest expense totaled $138,576 for the twelve month period ended
December 31, 1997 and $57,166 for the ten month period ended December 31, 1996,
and consisted of interest paid on capital lease obligations and interest accrued
on the Bridge Notes and notes payable to related parties. The increase in the
twelve month period is primarily due to the Bridge Notes, which were repaid in
May 1997 with proceeds of the Offering.

         A non-recurring charge of $256,250 was incurred on September 17, 1997
and was the result of the purchase by the Company of the distribution rights
into the European market from DMD NV, an independent distributor, for 50,000
shares of common stock.

         Loss before extraordinary item for the twelve month period ended
December 31, 1997, totaled $1,810,580 or $.42 per share. Income for the ten
month period ended December 31, 1996 totaled $137,151 or $.05 per share.

         Extraordinary loss on early extinguishment of debt totaled $234,149
(net of tax benefit of $143,511) for the twelve month period ended December 31,
1997, and is the result of the payment of the $1,600,000 Bridge Notes with the
proceeds of the Offering. The amount is comprised of the write-off of
unamoritized debt issuance cost and the discount to the Bridge Notes that was
being amortized over the term of the Notes.

Capital Resources and Liquidity

         For the twelve month period ended December 31, 1997, the Company used
net cash of $3,270,929 in operations. Accounts receivable increased by $722,742
to $1,967,614 at December 31, 1997 primarily due to the increase in
international sales during the period. Accounts payable and accrued liabilities
totaling $2,539,585 at December 31, 1997, increased from $1,551,788 at the prior
year-end period primarily due to increased spending on research and development
on the Digital x-ray. Inventory levels increased $1,412,400 primarily due to the
increased sales volume.

         Capital expenditures for the twelve month period ended December 31,
1997 were $284,082. Approximately $49,000 was for the purchase of an exhibit
booth used at dental shows, $79,000 was for a new computer network system and
$60,000 for tooling for the new camera. Cash and cash equivalents on hand at the
end of the period was $3,981,062.

         On July 1, 1997, the Company finalized a credit agreement with Comerica
Bank ("Comerica") extending up to a $2,000,000 line of credit to the Company,
secured by a first priority security interest in the Company's assets and by an
assignment of the Company's rights under the Boston Marketing Distribution
Agreement. The credit facility bears interest at the rate of prime plus .25% per
annum (8.75% at December 31, 1997). All borrowings under the facility are
subject to a formula based, generally, on accounts receivable and inventory. The
Company intends to use the credit facility, when needed, for working capital and
general corporate purposes. No amounts were outstanding under this agreement at
December 31, 1997. On December 10, 1997, the Company finalized a second
agreement with Comerica Bank ("Comerica") extending up to a $500,000 line of
credit to the Company, secured by a first priority interest in the Company's
assets. The credit facility bears interest at a rate of prime plus .5% per annum
(9.0% at December 31, 1997). The line expires on December 10, 1998. The
principal balance will amortize over a thirty six (36) month period. Borrowings
are at 80% of the capital expenditure. No amounts were outstanding under this
agreement at December 31, 1997.

         At present, the expenditures for continued research and development for
products incorporating digital x-ray technology is the only significant future
commitment and will be financed by the remaining proceeds of the May 9, 1997
Offering and the $4.5 million Debt Placement. Based on its current operating
plan, the Company anticipates that in addition to the remaining proceeds of the
Offering, together with the credit facility and proceeds from the Debt
Placement, further capital will be required during the next twelve months to
satisfy the Company's expected increased working capital and research and
development requirements for its new products. The Company is currently
exploring alternatives to fulfill these requirements. No assurance can be given
that additional financing will be available when needed or that, if available,
it will be on terms favorable to the Company or its stockholders. If needed
funds are not available, the Company may be required to curtail its operations,
which could have a material adverse effect on the Company's business, operating
results and financial condition. There can be no assurance that the Company's
working capital requirements during this period will not exceed its available
resources or that these funds will be sufficient to meet the Company's
longer-term cash requirements for operations. See "Cautionary Statements and
Risk Factors -- Need For Additional Financing."


                                       16
<PAGE>   17
Fluctuations in Quarterly Results

         The Company's business is subject to certain quarterly influences. Net
sales and operating profit are generally higher in the fourth quarter due to the
purchasing patterns of dentists in the United States and are generally lower in
the first quarter due primarily to the effect upon demand of increased purchases
in the prior quarter. It is also expected that the Company's business will
experience lower sales in the summer months as a consequence of holiday
vacations and a lesser number of trade shows.

         Quarterly results may be adversely affected in the future by a variety
of other factors, including the possible costs of obtaining capital, as well as
the release of new products and promotions taking place within the quarter. The
Company plans to continue to fund research and development and to increase
working capital requirements for the new products. Also, the expenses of the
Company are to a large extent fixed and not susceptible to rapid reduction. To
the extent that such expenses precede or are not subsequently followed by
increased revenues, the Company's business, operating results and financial
condition will be adversely affected.


CAUTIONARY STATEMENTS AND RISK FACTORS

         Several of the matters discussed in this document contain forward
looking statements that involve risks and uncertainties. Factors associated with
the forward looking statements which could cause actual results to differ
materially from those projected or forecast in the statements that appear below.
In addition to other information contained in this document, readers should
carefully consider the following cautionary statements and risks factors:

Limited Operating History; History of Losses and Accumulated Deficit. While the
Company has been in existence since 1981, its operations between 1988 and its
acquisition of DMD and BDI in March 1996, were limited to the exploration of
acquisition opportunities. Dental/Medical Diagnostic Systems, the division of
the Company which designs and markets the Company's TeliCam II System, and BDI,
a subsidiary of the Company, have only been in operation since October 1995. For
the period from inception (October 23, 1995) to March 2, 1996, the Company
incurred a net loss before extraordinary item of $1,625,213, and for the ten
month period ended December 31, 1996, the Company had net income of $137,151.
For the twelve months ended December 31, 1997 the Company had a net loss after
extraordinary item of $2,044,729. At December 31, 1997, the Company's
accumulated deficit was $3,532,791. The ability of the Company to obtain and
sustain profitability will depend, in part, upon the successful marketing of
existing products and the successful and timely introduction of new products.
There can be no assurance that the Company will be able to generate and sustain
net sales or profitability in the future.

Dependence Upon a Single Product. The TeliCam II System, is currently the
Company's primary product and, together with related products such as the
InTELInet system, will account for a substantial portion of the Company's
revenue until new products are introduced. See " -- Importance of New Product
Development to Growth." There can be no assurance that the TeliCam System will
be more effective than competing products or technologies, or will be
successfully marketed. The Company is still in the early stages of marketing the
TeliCam System and related products, and, consequently, the degree to which the
market will accept this product is still uncertain. If the TeliCam System and
related products cannot be marketed successfully on a sustained basis, it is
likely that the Company's business operations would be substantially and
adversely impacted.

Importance of New Product Development to Growth. The Company's ability to
develop and introduce new products successfully on a timely basis will be a
significant factor in the Company's ability to grow and remain competitive. New
product development often requires long-term forecasting of market trends, the
development and implementation of new designs, compliance with extensive
governmental regulatory requirements and a substantial capital commitment. The
medical and dental device industry is characterized by rapid technological
change. As technological changes occur in the marketplace, the Company may have
to modify its products in order to keep pace with these changes and
developments. The introduction of products embodying new technologies, or the
emergence of new industry standards, may render existing products, or products
under development, obsolete or unmarketable. Any failure by the Company to
anticipate or respond in a cost-effective and timely manner to government
requirements, market trends or customer requirements, or any significant delays
in product development or introduction, could have a material adverse effect on
the Company's business, operating results and financial condition.

Need For Additional Financing. Based on its current operating plan, the Company
anticipates that in addition to the remaining proceeds of the Offering, together
with the credit facility and proceeds of the Debt Placement, further capital
will be required during the next


                                       17
<PAGE>   18
twelve months to satisfy the Company's expected increased working capital and
research and development requirements for its planned new products. The Company
is currently exploring alternatives to fulfill these requirements. No assurance
can be given that additional financing will be available when needed or that, if
available, it will be on terms favorable to the Company or its stockholders. If
needed funds are not available, the Company may be required to curtail its
operations, which could have a material adverse effect on the Company's
business, operating results and financial condition. The Company will need to
raise additional funds through bank borrowings, public or private financings, or
otherwise. If additional funds are raised through the issuance of equity
securities, additional dilution to stockholders may occur. In addition, if
sufficient funds to repay the Notes are not available, the Notes may be
converted to shares of Common Stock and additional dilution to stockholders may
occur. No assurance can be given that additional financing will be available
when needed or that, if available, it will be on terms favorable to the Company
or its stockholders. If needed funds are not available, the Company may be
required to curtail its operations, which could have a material adverse effect
on the Company's business, operating results and financial condition. See
"Management's Discussion and Analysis -- Capital Resources and Liquidity."

Expansion through Undetermined Acquisitions and Joint Ventures. The Company
intends to expand its product lines and domestic and international markets, in
part, through acquisitions. The Company's ability to expand successfully through
acquisitions will depend upon the availability of suitable acquisition
candidates at prices acceptable to the Company, the Company's ability to
consummate such transactions and the availability of financing on terms
acceptable to the Company. There can be no assurance that the Company will be
successful in completing acquisitions. Such transactions involve numerous risks,
including possible adverse short-term effects on the Company's operating results
or the market price of the Common Stock. These acquisitions and joint ventures
may not be subject to approval or review by the Company's stockholders. The
Company does not expect that it will obtain an appraisal by any independent
appraisers with respect to any such acquisition. Certain of the Company's future
acquisitions may also give rise to an obligation by the Company to make
contingent payments or to satisfy certain repurchase obligations, which payments
could have an adverse financial effect on the Company. In addition, integrating
acquired businesses may result in a loss of customers or product lines of the
acquired businesses and also requires significant management attention and may
place significant demands on the Company's operations, information systems and
financial resources. The failure effectively to integrate acquired businesses
with the Company's operations could adversely affect the Company. In addition,
the Company competes for acquisition opportunities with companies which have
significantly greater financial and management resources than those of the
Company. There can be no assurance that suitable acquisition opportunities will
be identified, that any such transactions can be consummated, or that, if
acquired, such new businesses can be integrated successfully and profitably into
the Company's operations. Moreover, there can be no assurance that the Company's
historic rate of growth will continue, that the Company will continue to
successfully expand, or that growth or expansion will result in profitability.

         The Company also intends to expand its product lines and domestic and
international markets through joint ventures. The Company's ability to expand
successfully through joint ventures will depend upon the availability of
suitable joint venture candidates whose terms are acceptable to the Company, the
Company's ability to consummate such transactions and the availability of
financing on terms acceptable to the Company. There can be no assurance that the
Company will be successful in completing joint ventures. Such transactions
involve numerous risks, including possible adverse short-term effects on the
Company's operating results or the market price of the Common Stock. The failure
effectively to integrate joint ventures with the Company's operations could
adversely affect the Company. In addition, the Company competes for expansion
opportunities with companies which have significantly greater financial and
management resources than those of the Company. There can be no assurance that
suitable investment opportunities will be identified, that any such transactions
can be consummated, or that such new businesses can be integrated successfully
and profitably into the Company's operations. Moreover, there can be no
assurance that the Company's historic rate of growth will continue, that the
Company will continue to successfully expand, or that growth or expansion will
result in profitability.

Substantial Dependence on Third Parties

The Company substantially depends upon third parties for several critical
elements of its business including the development and licensing for
distribution of its products.

                  Suppliers. With the exception of the TeliCam System's CCD
processor unit, the Company believes that there are multiple sources from which
it may purchase the components of the TeliCam System. The Company anticipates
that it will obtain certain of the components of the TeliCam System from a
single source or a limited number of sources of supply. Although the Company
believes it will be able to negotiate satisfactory supply arrangements and
relationships, the failure to do so may have a material adverse effect on the
Company. Furthermore, there can be no assurance that suppliers will dedicate
sufficient production capacity to satisfy the Company's requirements within
scheduled delivery times or at all. Failure or delay by the Company's suppliers
in fulfilling its anticipated needs may adversely affect the Company's ability
to market the TeliCam System. Pursuant to the Boston Marketing Distribution
Agreement, the


                                       18
<PAGE>   19
Company has the exclusive right to market Teli Units to the dental market.
Boston Marketing is a licensed distributor of the Teli Units under a separate
agreement with their manufacturer. The agreement between Boston Marketing and
the Teli Units manufacturer obligates Boston Marketing to meet minimum purchase
obligations. If Boston Marketing fails to meet these obligations, Boston
Marketing will be terminated as a licensed distributor. In the event of such
termination, the Company, as a sublicensee subdistributor of Boston Marketing,
may lose its right to purchase the Teli Units. Moreover, in the event the
Company is unable to meet its minimum annual purchase obligations under the
Boston Marketing Distribution Agreement, and, as a consequence, such agreement
terminates, the Company may be required to find an alternative source for the
primary component of its TeliCam System. The Company believes that, in the event
the Company loses its right to sell the Teli Units, replacement components could
be developed by and obtained from third parties, but that this may take more
than six months. The potential delay associated with locating an alternative
source of supply would have a significant adverse effect on the Company's
operating results and financial condition. In addition, there is no guarantee
that an intraoral dental camera system utilizing the replacement components will
be accepted by the dental marketplace. The Company has an oral agreement
with S.E.D. to manufacture its Apollo 95E product for sale internationally. Dr.
Duret, president of S.E.D. will oversee manufacturing of the Apollo 95E for the
Company, and will render consulting services for the Company. If S.E.D. is
unable to meet the Company's requirements, the Company would have to obtain an
alternative manufacturing arrangement. The Company believes that such
manufacturing capability could be developed by the Company or obtained from
third parties, but that developing or obtaining alternative capacities may take
up to four months. The potential delay associated with either developing or
locating an alternative source of supply could have a significant adverse effect
on the Company's operating results and financial condition. See "Description of
Business -- Manufacturing and Component Parts."

         Distribution and Licensing Relationships. The Company has entered into
licensing relationships with ILT and SUNI. The Company is currently working with
ILT to develop a curing and whitening device that meets the Company's
specifications. As of March 27, 1998, no devices had yet been shipped by ILT
which met the Company's specifications. While the Company believes an acceptable
device will be developed, no assurance can be given that ILT will be able to
produce a device that meets the Company's specifications, or will otherwise be
able to meet the Company's manufacturing requirements. If ILT is unable to meet
the Company's specifications, or is otherwise unable to perform its obligations,
the Company intends to introduce its Apollo 95E product for sale in the US and
Canada. The Company believes that it would need to delay product shipments of
the 95E into the US and Canada for four to six months while it obtains FDA
regulatory approval. If the regulatory approval of the 95E product cannot be
obtained, the Company believes an alternative source of supply for curing and
whitening devices could be developed by the Company, or be obtained from third
parties. Developing or locating such an alternative source could result in
substantial delays. Regulatory approval for any such alternative product may
need to be obtained prior to any sale in the US and Canada. If ILT is able to
meet its obligations, under the terms of the Company's agreement with ILT, the
Company will be required to meet substantial minimum purchase and sales goals
during each year of the five year initial term of its license with ILT in order
to retain exclusive rights to sell ILT's tooth curing and whitening devices in
the US and Canada. If the Company is unable to meet its minimum purchase and
sales requirements, ILT may terminate the agreement and license its devices for
sale by the Company's competitors, or may grant exclusive rights to such a
competitor. There can be no assurance that the Company will achieve sufficient
sales to be able to maintain its right to sell ILT products. If ILT licenses the
technology to a competitor, this could have a material adverse effect on the
Company's operating results and financial condition. The initial five year term
of the agreement may be renewed at the option of the Company for ten successive
one year terms, provided that the Company has met its annual purchase and sales
requirements. If the contract with ILT expires, or is terminated except by
reason of ILT's non-performance, the Company has agreed not to sell any product
competitive with the Apollo 9500 into the US or Canadian markets for a period of
one year following termination or expiration of the contract. In the event of
such termination or expiration, the Company would not be able to introduce a
competitive device, including the 95E, into the US or Canadian markets for at
least a year, even if prior regulatory approval of such product is obtained.
Delays associated with regulatory approval, product development, locating an
alternative source of supply, and the Company's inability to sell alternative
devices in the US and Canada for one year following expiration or termination of
the contract, would have a significant adverse effect on the Company's operating
results and financial condition. In addition, there is no guarantee that any
device manufactured by ILT, the Apollo 95E, or a product developed and
manufactured by an alternative supplier, once introduced, will be accepted by
the dental marketplace. Under the Company's licensing and development
arrangements with Suni for the development of digital x-ray technology for the
dental market, the Company has obtained exclusive marketing rights to products
incorporating certain digital x-ray technology developed by Suni. The Company
has paid significant advances to, and is dependent upon Suni to successfully
develop the digital x-ray technology and to commercialize the digital x-ray
technology. There can be no assurance that Suni will be successful in this
endeavor. If Suni should not develop a digital x-ray product acceptable to the
Company or the marketplace, this would have a material adverse effect on the
Company's operating results and financial condition. The agreement with Suni
provides that the Company is obligated to make minimum royalty payments if
products incorporating the developed technology are introduced to the market in
order to maintain exclusivity. There can be no assurance that the Company will
be able to meet the royalty payments required to maintain exclusivity. Suni
would then be able to license the developed technology to the Company's
competitors, or grant an


                                       19
<PAGE>   20
exclusive license to a competitor, which could have a material adverse effect on
the Company's operating results and financial condition. See "Description of
Business -- Growth Strategy" and " -- Products -- Product Development."

Fluctuations in Quarterly Results. The Company's business is subject to certain
quarterly influences. Management's prior experience in the industry would
indicate that net sales and operating profits are generally higher in the fourth
quarter due to the purchasing patterns of dentists and are generally lower in
the first quarter due primarily to increased purchases in the prior quarter and
during the summer months due to a reduced volume of trade shows and increased
unavailability of dentists due to summer vacations. The Company plans to
increase expenses to fund greater levels of research and development and to fund
investments in joint ventures and acquisitions. To the extent that such expenses
precede or are not subsequently followed by increased revenues, the Company's
business, quarterly operating results and financial condition will be adversely
affected. Quarterly results may also be adversely affected by a variety of other
factors, including the timing of acquisitions and their related costs, as well
as the release of new products and promotions taking place within the quarter.
Other factors that may influence the Company's quarterly operating results
include the timing of introduction or enhancement of products by the Company or
its competitors, market acceptance of the TeliCam II, the InTELInet System and
other new products, development and promotional expenses relating to the
introduction of new products or enhancements of existing products, reviews in
the industry press concerning the products of the Company or its competitors,
changes or anticipated changes in pricing by the Company or its competitors, mix
of distribution channels through which products are sold, mix of products sold,
product returns, the timing of orders from major distributors, order
cancellations, delays in shipment and general economic conditions. Due to all of
the foregoing factors, it is also likely that in some future periods the
Company's operating results may be below the expectations of analysts and
investors. In such event, the price of the Company's Common Stock would likely
be materially adversely affected.

Extensive Government Regulation. The Company's products and its manufacturing
practices are subject to regulation by the United States Food and Drug
Administration ("FDA") pursuant to the Federal Food, Drug and Cosmetic Act ("FDC
Act"), and by other state and foreign regulatory agencies. Under the FDC Act,
medical and dental devices, including those under development by the Company
must receive FDA clearance or approval before they may be sold, or be exempted
from the need to obtain such clearance or approval. FDA regulations also require
the Company to adhere to certain "Good Manufacturing Practices" ("GMP")
regulations, which include validation testing, quality control and documentation
procedures. The Company's compliance with applicable regulatory requirements is
subject to periodic inspections by the FDA.

The Company is presently in the process of obtaining 510(k) approval of its
TeliCam system and will need 510(k) approval for any new products which are
developed in the future using digital x-ray technology. The process of obtaining
required regulatory clearances or approvals can be time-consuming and expensive,
and compliance with the FDA's GMP regulations and other regulatory requirements
can be burdensome. Moreover, there can be no assurance that the required
regulatory clearances will be obtained, and those obtained may include
significant limitations on the uses of the product in question. In addition,
changes in existing regulations or the adoption of new regulations could make
regulatory compliance by the Company more difficult in the future. If ILT is
unable to perform its obligations, the Company believes it would have to seek
regulatory approval of its Apollo 95E, or any alternative curing and whitening
device, prior to sale in the US. Although the Company believes that its products
and procedures are currently in material compliance with all relevant FDA
requirements, the failure to obtain the required regulatory clearances or to
comply with applicable regulations could result in fines, delays or suspensions
of clearances, seizures or recalls of products, operating restrictions and
criminal prosecutions, and would have a material adverse effect on the Company.
See "Description of Business -- Government Regulations."

Competition. The manufacture and distribution of medical and dental devices is
intensely competitive. The Company competes with numerous other companies,
including several major manufacturers and distributors. With respect to the
intraoral camera market, the Company has at least five major competitors. Most
of the Company's competitors have greater financial and other resources than the
Company. Consequently, such entities may begin to develop, manufacture, market
and distribute systems which are substantially similar or superior to the
Company's products. See "Description of Business - Competition."

Rapid Expansion of the Company's Business. From inception (October 23, 1995)
through December 31, 1997, the Company has experienced rapid and substantial
growth in revenues and geographic scope of operations. Any future growth may
place a significant strain on management and on the Company's financial
resources and information processing systems. The failure to recruit additional
staff and key personnel, to have sufficient financial resources, to maintain or
upgrade these financial reporting systems, or to respond effectively to
difficulties encountered during expansion could have a material adverse effect
on the Company's business, operating results and financial condition. See
"Description of Business -- Growth Strategy."


                                       20
<PAGE>   21
Reliance on International Sales and Distributors and General Risks of
International Operations. For the twelve-month period ended December 31, 1997,
international sales have accounted for approximately 24% of the Company's net
sales, and the Company expects that international sales may increase as a
percentage of sales in the future. Consequently, the Company is subject to the
risks of conducting business internationally, including unexpected changes in,
or impositions of, legislative or regulatory requirements; fluctuations in the
US dollar which could materially adversely affect US dollar revenues; tariffs
and other barriers and restrictions; potentially adverse taxes; and the burdens
of complying with a variety of international laws and communications standards.
The Company's international sales involve potentially longer payment cycles and
the Company may experience greater difficulty collecting accounts receivable.
The Company currently depends on third party distributors for substantially all
of its international sales. At December 31, 1997, nine of the Company's
international distributors accounted for 60% of the Company's accounts
receivable, and nine of these distributors accounted for approximately
$3,877,000 or 24%, of the Company's total sales for the twelve-month period
ended December 31, 1997. Certain of the Company's third party distributors may
also act as resellers for competitors of the Company and could devote greater
effort and resources to marketing competitive products. The loss of, or other
significant reduction in sales to, certain of these third party distributors
could have a material adverse effect on the Company's business and results of
operations. The Company is also subject to general geopolitical risks, such as
political and economic instability and changes in diplomatic and trade
relationships, in connection with its international operations. There can be no
assurance that these risks of conducting business internationally will not have
a material adverse effect on the Company's business. Further, any failure by the
Company to predict or plan for changes in the international arena could have a
material adverse effect on the Company's business, operating results and
financial condition.

Dependence on Key Personnel. The Company's future performance will depend
significantly upon its Chairman of the Board and Chief Executive Officer, Robert
H. Gurevitch, and upon certain other key employees of the Company. The loss of
service of one or more of these persons could have a material adverse effect on
the Company's business and operations. The Company has entered into Employment
Agreements with Robert H. Gurevitch and Dewey Perrigo, the Company's Vice
President of Sales, pursuant to which they each have agreed to render services
to the Company until October 1, 1999. The Company has obtained "key person" life
insurance on Mr. Gurevitch in the amount of $2,000,000, of which the Company is
the sole beneficiary, but there can be no assurance that the proceeds of such
insurance will be sufficient to offset the loss to the Company in the event of
his death. The Company does not maintain any insurance on the lives of its other
senior management. In addition, the Company's success will be dependent upon its
ability to recruit and retain qualified personnel. Any failure by the Company to
retain and attract key personnel could have a material adverse effect on the
Company's business, operating results, and financial condition.

Limited Proprietary Protection. The Company's success and ability to compete is
dependent in part upon its proprietary technology. The Company's proprietary
technology is not protected by any patents. Consequently, the Company relies
primarily on trademark, trade secret and copyright laws to protect its
technology. Also, the Company has implemented a policy that most senior and
technical employees and third-party developers sign nondisclosure agreements.
However, there can be no assurance that such precautions will provide meaningful
protection from competition or that competitors will not be able to develop
similar or superior technology independently. Also, the Company has no license
agreements with the end users of its products, so it may be possible for
unauthorized third parties to copy the Company's products or to reverse engineer
or otherwise obtain and use information that the Company regards as proprietary.
If litigation is necessary in the future, to enforce the Company's intellectual
property rights, to protect the Company's trade secrets or to determine the
validity and scope of the proprietary rights of others, such litigation could
result in substantial costs and diversion of resources and could have a material
adverse effect on the Company's business, operating results and financial
condition. Ultimately, the Company may be unable, for financial or other
reasons, to enforce its rights under intellectual property laws. In addition,
the laws of certain countries in which the Company's products are or may be
distributed may not protect the Company's products and intellectual property
rights to the same extent as the laws of the United States. See "Business --
Patent and Proprietary Rights."

The Company believes that its products do not infringe upon any valid existing
proprietary rights of third parties. Although the Company has received no
communication from third parties alleging the infringement of proprietary rights
of such parties, there can be no assurance that third parties will not assert
infringement claims in the future. Any such third party claims, whether or not
meritorious, could result in costly litigation or require the Company to enter
into royalty or licensing agreements. There can be no assurance that the Company
would prevail in any such litigation or that any such licenses would be
available on acceptable terms, if at all. If the Company were found to have
infringed upon the proprietary rights of third parties, it could be required to
pay damages, cease sales of the infringing products and redesign or discontinue
such products, any of which alternatives, individually or collectively could
have a material adverse effect on the Company's business, operating results and
financial condition.

Conflict of Interests. Robert Gurevitch, Chairman of the Company, has loaned
money to the Company ("Loan Obligations") and has guaranteed the performance by
the Company under its leases for its Irvine (Technology Drive) and Westlake,
California premises. The


                                       21
<PAGE>   22
Company believes that all of these transactions were on terms no less favorable
than were available from unaffiliated third parties. The Company intends to
attempt to relieve Mr. Gurevitch from his obligations under each of these
guarantees and it is possible that, in order to achieve the release of Mr.
Gurevitch from these guarantees, the Company will be required to post collateral
or provide other concessions to the recipients of the guarantees. The Company
has, in the past, entered into transactions with affiliates and there can be no
assurance that the Company will not enter into transactions with affiliated
parties in the future.

Limitation of Liability and Indemnification. The Company's Amended and Restated
Certificate of Incorporation limits, to the maximum extent permitted by the
Delaware General Corporation Law ("Delaware Law"), the personal liability of
directors for monetary damages for breach of their fiduciary duties as a
director, and provides that the Company shall indemnify its officers and
directors and may indemnify its employees and other agents to the fullest extent
permitted by law. The Company has entered into indemnification agreements with
its directors and executive officers which may require the Company, among other
things, to indemnify such directors against liabilities that arise by reason of
their status or service as directors or officers (other than liabilities arising
from willful misconduct of a culpable nature), to advance their expenses
incurred as a result of any proceeding against them as to which they could be
indemnified, has obtained director's and officer's insurance. The Company has
purchased director's and officer's liability insurance in the amount of $3.0
million. Section 145 of the Delaware Law provides that a corporation may
indemnify a director, officer, employee or agent made, or threatened to be, a
party to an action by reason of the fact that he was a director, officer,
employee or agent of the corporation or was serving at the request of the
corporation against expenses actually and reasonably incurred in connection with
such action if he acted in good faith and in a manner he reasonably believed to
be in or not opposed to the best interests of the corporation, and, with respect
to any criminal action or proceeding, if he had no reasonable cause to believe
his conduct was unlawful. Delaware Law does not permit a corporation to
eliminate a director's duty of care, and the provisions of the Company's Amended
and Restated Certificate of Incorporation have no effect on the availability of
equitable remedies, such as injunction or rescission, for a director's breach of
the duty of care.

Anti-Takeover Provisions. The Company has an authorized class of 1,000,000
shares of preferred stock which may be issued by the Board of Directors on such
terms and with such rights, preferences and designations as the Board of
Directors may determine. Issuance of such preferred stock, depending upon the
rights, preferences and designations thereof, may have the effect of delaying,
deterring or preventing a change in control of the Company. In addition, certain
"anti-takeover" provisions of the Delaware Law, among other things, restrict the
ability of stockholders to effect a merger or business combination or obtain
control of the Company, and may be considered disadvantageous by a stockholder.

Product Liability. Although the Company has not experienced any product
liability claims to date, the sale and support of products by the Company may
entail the risk of such claims, and there can be no assurance that the Company
will not be subject to such claims in the future. A successful product liability
claim or claim arising as a result of use of the Company's products brought
against the Company, or negative publicity attendant to any such claim, could
have a material adverse effect upon the Company's business, operating results
and financial condition. The Company maintains product liability insurance with
coverage limits of $1,000,000 per occurrence and $1,000,000 per year. While the
Company believes that it maintains adequate insurance coverage, there can be no
assurance that the amount of insurance will be adequate to satisfy claims made
against the Company in the future, or that the Company will be able to obtain
insurance in the future at satisfactory rates or in adequate amounts.


                                       22
<PAGE>   23
ITEM 7.  FINANCIAL STATEMENTS.

                     DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>

                                                                                                                           PAGE
                                                                                                                           ----
<S>                                                                                                                        <C>
Report of Independent Accountants.........................................................................................  24
Consolidated Balance Sheets as of December 31, 1997 and December 31, 1996.................................................  25
Consolidated Statements of Operations for  the Twelve month period ended December 31, 1997; the Ten-month period ended
  December 31, 1996 and for the Period from Inception (October 23, 1995) to March 2, 1996.................................  26
Consolidated Statements of Stockholders' Equity for the Twelve month period ended December 31, 1997; the Ten-month
  period ended December 31, 1996 and for the Period from Inception (October 23, 1995) to March 2, 1996....................  27
Consolidated Statements of Cash Flows for the Twelve month period ended December 31, 1997; the Ten-month period
  ended December 31, 1996 and for the Period from Inception (October 23, 1995) to March 2, 1996...........................  28
Notes to Consolidated Financial Statements...............................................................................   29
</TABLE>



                                       23
<PAGE>   24
                        REPORT OF INDEPENDENT ACCOUNTANTS

The Board of Directors and Shareholders of Dental/Medical Diagnostic Systems,
Inc.

         We have audited the accompanying consolidated financial statements of
Dental/Medical Diagnostic Systems, Inc. and Subsidiaries ("the Company") as of
December 31, 1997 and 1996, and the related consolidated statements of
operations, stockholder's equity and cash flows for the twelve month period
ended December 31, 1997, the ten-month period ended December 31, 1996 and for
the period from inception (October 23, 1995) to March 2, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Dental/Medical Diagnostic Systems, Inc. and Subsidiaries as of December 31, 1997
and December 31, 1996 and the consolidated results of their operations and their
cash flows for the twelve month period ended December 31, 1997, the ten-month
period ended December 31, 1996 and for the period from inception (October 23,
1995) to March 2, 1996 in conformity with generally accepted accounting
principles.

/s/ Coopers & Lybrand L.L.P.

Los Angeles, California
February 16, 1998


                                       24
<PAGE>   25
            DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                        AS OF DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
                                                                                                         1997              1996
                                                                                                         ----              ----

                                                      ASSETS

Current assets
<S>                                                                                                 <C>                 <C>
  Cash and cash equivalents ...................................................................     $  3,981,062        $ 1,058,836
  Accounts receivable, less allowance for returns and doubtful accounts of $20,975 and $146,699
     at December 31, 1997 and 1996 ............................................................        1,967,614          1,158,444
  Inventories .................................................................................        2,896,270          1,513,075
  Deferred tax asset ..........................................................................               --             90,000

  Prepaid expenses and other current assets ...................................................          389,061            208,552
                                                                                                    ------------        -----------



    Total current assets ......................................................................        9,234,007          4,028,907
  Property and equipment, net of accumulated depreciation .....................................          553,119            393,578
  Intangible asset, net of accumulated amortization ...........................................           86,950                 --
  Debt issuance costs, net of accumulated amortization ........................................               --            253,686

  Loans to related party ......................................................................          126,000                 --
  Other assets ................................................................................          491,950             42,270
                                                                                                    ------------        -----------
    Total assets ..............................................................................     $ 10,492,026        $ 4,718,441
                                                                                                    ============        ===========



                                       LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Current portion of capital lease obligations ................................................     $     23,356        $    18,468
  Notes payable to related parties ............................................................           45,030                 --
  Accounts payable ............................................................................        1,522,412          1,089,332
  Accrued liabilities .........................................................................        1,017,173            462,456

  Income taxes payable ........................................................................               --            168,570

  Customer deposits ...........................................................................           42,995             33,607
                                                                                                    ------------        -----------
    Total current liabilities .................................................................        2,650,966          1,772,433
  Notes payable ...............................................................................               --          1,355,291
  Notes payable to related parties ............................................................               --            272,966

  Capital lease obligations ...................................................................           39,858             66,028

  Other long term liabilities .................................................................           11,052             14,098
                                                                                                    ------------        -----------
    Total liabilities .........................................................................        2,701,876          3,480,816
                                                                                                    ============        ===========

Commitments and contingencies
Stockholders' equity
  Preferred stock, par value $.01 per share; 1,000,000 shares authorized; none issued
     and outstanding ..........................................................................               --                 --
  Common stock, par value $.01 per share; 20,000,000 shares authorized;
     5,115,777 and 2,985,537 shares issued and outstanding at December 31, 1997
     and  1996 ................................................................................           51,157             29,855
  Additional paid in capital ..................................................................       11,271,784          2,695,832
  Accumulated deficit .........................................................................       (3,532,791)        (1,488,062
                                                                                                    ------------        -----------
Total stockholders' equity ....................................................................        7,790,150          1,237,625
                                                                                                    ------------        -----------
Total liabilities and stockholders' equity ....................................................     $ 10,492,026        $ 4,718,441
                                                                                                    ============        ===========
</TABLE>





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



                                       25
<PAGE>   26
            DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                 FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1997;
                FOR THE TEN MONTH PERIOD ENDED DECEMBER 31, 1996
      AND FOR THE PERIOD FROM INCEPTION (OCTOBER 23, 1995) TO MARCH 2, 1996

<TABLE>
<CAPTION>
                                                            TWELVE MONTHS ENDED  TEN MONTHS ENDED     INCEPTION TO
                                                            DECEMBER 31, 1997    DECEMBER 31, 1996    MARCH 2, 1996
                                                            -----------------    -----------------    -------------
<S>                                                         <C>                 <C>                 <C>
Net sales .............................................       $ 16,087,208        $ 11,673,102       $    220,623
Cost of sales .........................................         10,234,206           6,685,464            202,115
                                                              ------------        ------------       ------------
    Gross profit ......................................          5,853,002           4,987,638             18,508
Selling, general and administrative expense ...........          6,031,066           4,360,736          1,111,391

Research and development expense ......................          1,213,766             322,467            528,426
Non-recurring charge ..................................            256,250                  --                 --
                                                              ------------        ------------       ------------
    Operating income (loss) ...........................         (1,648,080)            304,435         (1,621,309)
Interest income .......................................           (205,818)                 --                 --
Interest expense ......................................            138,576              57,166              3,904
Amortization of debt issuance costs ...................             76,431              31,548                 --
                                                              ------------        ------------       ------------

 Income (loss) before income taxes and extraordinary
    item ..............................................         (1,657,269)            215,721         (1,625,213)
Provision for income taxes ............................            153,311              78,570                 --
                                                              ------------        ------------       ------------
    Income (loss) before extraordinary item ...........         (1,810,580)            137,151         (1,625,213)
Extraordinary loss on early extinguishment of debt (net
  of tax  benefit of $143,511) ........................           (234,149)                 --                 --
                                                              ------------        ------------       ------------
    Net income (loss) .................................       $ (2,044,729)       $    137,151       $ (1,625,213)
                                                              ============        ============       ============

Earnings (loss) per share before
extraordinary item:
   Basic ..............................................       $       (.42)       $        .05       $      (1.57)
   Diluted ............................................               (.42)                .05              (1.57)

Earnings (loss) per share after extraordinary item:
   Basic ..............................................       $       (.47)       $        .05       $      (1.57)
   Diluted ............................................               (.47)                .05              (1.57)

Weighted average number of shares:
   Basic ..............................................          4,341,498           2,893,298          1,035,778
   Diluted ............................................          4,341,498           3,019,213          1,035,778
</TABLE>



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



                                       26
<PAGE>   27
            DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1997;
                    TEN-MONTH PERIOD ENDED DECEMBER 31, 1996
    AND FOR THE PERIOD FROM INCEPTION (OCTOBER 23, 1995) TO DECEMBER 31, 1996

<TABLE>
<CAPTION>
                                                     COMMON STOCK                ADDITIONAL
                                                     ------------                  PAID IN         ACCUMULATED
                                                SHARES           AMOUNT            CAPITAL           DEFICIT             TOTAL
                                                ------           ------            -------           -------             -----

<S>                                        <C>               <C>               <C>               <C>                <C>
Balance, October 23, 1995 (date of
   inception) .......................                --       $         --      $        --       $        --        $        --
Issuance of common stock for cash ...         1,416,500            14,165           617,070                --            631,235
Issuance of common stock for
   services .........................           290,126             2,901           125,216                --            128,117
Issuance of common stock for cash,
   net of issuance costs ............           856,692             8,567           596,962                --            605,529
Net loss ............................                --                --                --        (1,625,213)        (1,625,213)
                                            -----------       -----------       -----------       -----------        -----------
Balance, March 2, 1996 ..............         2,563,318            25,633         1,339,248        (1,625,213)          (260,332)
Issuance of common stock for cash,
   net of issuance costs ............           422,219             4,222         1,050,281                --          1,054,503
Issuance of warrants for cash .......                --                --           259,103                --            259,103
Issuance of stock options to
   nonemployees .....................                --                --            47,200                --             47,200
Net income ..........................                --                --                --           137,151            137,151
                                            -----------       -----------       -----------       -----------        -----------
Balance, December 31, 1996 ..........         2,985,537            29,855         2,695,832        (1,488,062)         1,237,625
Issuance of common stock for cash,
    net of issuance costs ...........         2,120,000            21,200         8,509,192                --          8,530,392
Exercise of stock options ...........            10,240               102             8,910                --              9,012

Amortization of deferred compensation                --                --            57,850                --             57,850

Net loss ............................                --                --                --        (2,044,729)         (2,044,729)
                                            -----------       -----------       -----------       -----------        -----------
Balance, December 31, 1997 ..........         5,115,777       $    51,157       $11,271,784       $(3,532,791)       $ 7,790,150
                                            ===========       ===========       ===========       ===========        ===========
</TABLE>


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



                                       27
<PAGE>   28
            DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1997;
                    TEN-MONTH PERIOD ENDED DECEMBER 31, 1996
      AND FOR THE PERIOD FROM INCEPTION (OCTOBER 23, 1995) TO MARCH 2, 1996

<TABLE>
<CAPTION>
                                                          TWELVE MONTHS ENDED   TEN MONTHS ENDED    INCEPTION TO
                                                           DECEMBER 31, 1997    DECEMBER 31, 1996   MARCH 2, 1996
                                                           -----------------    -----------------   -------------
Cash flows from operating activities:
<S>                                                          <C>                <C>                <C>
Net income (loss) ....................................        $(2,044,729)       $   137,151         $(1,625,213)
  Adjustments to reconcile net income (loss) to net
  cash used by operating activities;
  Depreciation and amortization ......................             92,993            108,047               9,219
  Allowance for returns and doubtful accounts ........            (86,428)            79,123              28,280
  Inventory write down ...............................             29,205             20,822              91,556
  Extraordinary item .................................            377,660                 --                  --
  Amortization of deferred compensation ..............             57,850                 --                  --
  Deferred taxes .....................................             90,000            (90,000)                 --
  Deferred rent ......................................             (3,046)             1,469              12,629
  Common stock and stock options issued for services .                 --             47,200             128,117

  Changes in operating assets and liabilities:
    Accounts receivable ..............................           (722,742)        (1,188,544)            (77,303)
    Inventories ......................................         (1,412,400)          (461,812)         (1,163,641)
    Prepaid expenses and other current assets ........           (180,509)           (55,567)           (152,985)
    Other assets .....................................           (449,680)            (6,230)            (36,040)
    Accounts payable .................................            433,080           (448,316)          1,524,470
    Accrued liabilities ..............................            591,211            272,482             131,991
    Income taxes payable .............................            (52,781)           168,570                  --
    Customer deposits ................................              9,388           (215,738)            249,345
                                                               ----------         ----------            --------
       Net cash used by operating activities .........         (3,270,928)        (1,631,343)           (879,575)
                                                               ----------         ----------            --------


Cash flows from investing activities:
  Loans to related parties ...........................           (126,000)                --                  --
  Purchase of intangible asset........................            (86,950)                --                  --
  Purchase of property and equipment .................           (284,082)          (200,686)           (144,537)
                                                               ----------         ----------           ---------
       Net cash used in investing activities .........           (497,032)          (200,686)           (144,537)
                                                               ----------         ----------           ---------

Cash flows from financing activities:
  (Decrease) increase in book overdraft ..............                 --            (49,906)             49,906

  Accounts payable to related party in excess of terms                 --            (79,218)             79,218

  Issuance of common stock, net of offering costs ....          8,530,392          1,054,503           1,291,113

  Proceeds from exercise of stock options.............              9,012                 --                  --
   Repayment of bridge loan ..........................        (1,600,000)                 --                  --
  Net proceeds from issuance of notes payable ........                 --          1,314,766                  --

  Proceeds from borrowings from related parties ......                 --             25,000             377,015

  Payments on borrowings from related parties ........           (227,936)           (29,049)           (100,000)

  Principal payments on capital lease obligations ....            (21,282)           (11,842)             (6,529)
                                                               ----------         ----------         -----------

       Net cash provided by financing activities .....          6,690,186          2,224,254           1,690,723
                                                               ----------         ----------         -----------
       Net increase in cash and cash equivalents .....          2,922,226            392,225             666,611

Cash and cash equivalents, beginning of period .......          1,058,836            666,611                  --
                                                              -----------        -----------         -----------

Cash and cash equivalents, end of period .............        $ 3,981,062        $ 1,058,836         $   666,611
                                                              ===========        ===========         ===========
Supplemental cash flow information:
Capital lease obligations incurred ...................        $        --        $     5,997         $    96,870
Property and equipment not paid for at period end ....                 --                 --              16,812

Interest paid ........ ...............................            281,693              8,219                  --
Income taxes paid ....................................             50,279                 --                  --
</TABLE>



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


                                       28
<PAGE>   29
            DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. GENERAL

      The Company was organized in New York in 1981 under the name Edudata
Corporation and reincorporated in Delaware in 1983 by Sun Equities Corporation
("Sun") which owned approximately 81 percent of the Company's outstanding common
stock until August 11, 1995. At that time, Sun distributed the shares of the
Company that it owned to its stockholders in the form of a dividend.

      The Company was initially organized to provide education in the use of
personal computers, to market software programs developed by others, and to
provide a broad range of advisory services to businesses in conjunction with
both computer and non-computer related management issues. The Company's original
concept was modified, however, and until 1987, the Company was engaged in the
ownership and operation of technical schools through its subsidiaries, Betty
Owen Secretarial Systems, Inc. and Taylor Business Institute, Inc., and in the
development, construction and sale of single-family homes and commercial
buildings through its majority-owned subsidiary, Lytton & Tolly, Inc. In 1988
the Company disposed of its subsidiaries and their operations and determined to
use the proceeds to acquire another business. From 1988 to early 1996, the
Company's operations were limited to exploring opportunities to acquire or to
become an operating business.

      On March 1, 1996, the Company acquired all the outstanding securities of
Dental/Medical Diagnostic Systems, LLC, a California limited liability company
("DMD"), and Bavarian Dental Instruments, Inc., a California close corporation
("BDI"), in exchange for the issuance by the Company of a total of 1,706,626
restricted shares of its Common Stock. DMD and BDI were initially formed in
October 1995 and November 1995, respectively. As a result of these transactions,
the former members of DMD and former stockholders of BDI gained a majority of
the Company's voting securities and management control of the Company was
transferred to the former management of DMD and BDI. For accounting purposes
these transactions were treated as a recapitalization of DMD and BDI, with DMD
and BDI combined as the acquiror (reverse acquisition). As a result, the
combined historical financial statements of DMD and BDI became the financial
statements of the Company. BDI was formed to import from Russia, distribute and
market dental burs in the United States and elsewhere. The first sales of the
burs commenced in early March 1996. On July 9, 1996, the Company decided to
discontinue the dental bur product line.

      On January 28, 1997 the Company changed its name to Dental/Medical
Diagnostic Systems, Inc. ("DMDS") from Edudata Corporation. Collectively, DMDS
and its wholly owned subsidiaries are referred to as the Company.

      The Company designs, develops, manufactures and sells high technology
dental equipment. The Company's primary emphasis has been on the manufacture and
sale of an intraoral camera system known as the TeliCam II System and a dental
office networking system, known as InTELInet, for use in connection with the
TeliCam II System. The Company commenced shipments of TeliCam Systems to
customers in February 1996 and in November 1996, introduced the InTELInet
networking system for the TeliCam System.

      On October 2, 1997, the Company purchased the assets of S.E.D. Gerant
("S.E.D."), a company organized under the laws of France, for $120,000. As part
of this asset purchase, the Company paid an additional $106,850 for development
costs associated with S.E.D.'s "Biotron" curing and whitening device products.
S.E.D. is a developer and manufacturer of medical and dental devices. The
Company purchased the rights to all of the technology and the intellectual
property, including patents, developed by S.E.D. including the Biotron products.
The Company commenced marketing a curing and whitening device in Europe and
internationally incorporating this technology in March of 1998 under the brand
name "Apollo 95E."

      On September 17, 1997, the Company issued 50,000 shares of Common Stock to
DMD NV, the Company's licensed exclusive distributor of the TeliCam system in
Europe, in exchange for termination of DMD NV's exclusive distribution rights in
Europe. The aggregate price of the Common Stock, based on the closing price on
the date of issuance, was $256,250.

      On February 2, 1998 the Company formed "DMDS, Ltd." a wholly-owned
subsidiary created under the laws of the United Kingdom. DMDS, Ltd. will hold
the assets acquired from S.E.D. In addition, the Company currently plans to
market certain of its new products internationally through DMDS, Ltd.


                                       29
<PAGE>   30
2. BASIS OF PRESENTATION

    On October 23, 1996, the Company authorized an increase in the authorized
number of shares of Common Stock from 10,000,000 shares to 20,000,000 shares.
The Board of Directors also authorized a new class of 1,000,000 shares of
Preferred Stock with a par value of $.01 per share.

    On January 13, 1997, the Company effected a reverse stock split of 1 share
for 2.197317574 shares of its issued and outstanding Common Stock. In addition,
on March 24, 1997 the Company's Stockholders approved a reverse stock split of 1
share for 1.33333333 shares of its issued and outstanding Common Stock. All
share and per share amounts have been retroactively restated to reflect these
reverse splits.

    On February 5, 1997, the Company changed its fiscal year-end from a fiscal
year ending on the nearest Saturday to February 28th to a December 31 fiscal
year-end. The accompanying consolidated financial statements reflect the
operating results of the Company for the twelve -month period from January 1,
1997 through December 31, 1997; for the ten-month period from March 3, 1996
through December 31, 1996 and for the period from inception (October 23, 1995)
through March 2, 1996.

3. ACQUISITION OF DMD AND BDI

    On March 1, 1996, DMDS (formerly Edudata) completed the acquisition of BDI
and DMD. The acquisition was affected pursuant to the terms of the two
Contribution Agreements dated February 29, 1996 ("Contribution Agreements")
between DMDS and BDI and between DMDS and DMD. Pursuant to the Contribution
Agreements the former shareholders of BDI and members of DMD received a total of
1,706,626 shares of newly issued DMDS restricted common stock, then constituting
approximately 66.6% of DMDS' outstanding common stock, taking into consideration
the newly issued shares. As part of the transaction, DMDS' prior Board of
Directors resigned and were replaced by Robert H. Gurevitch, Chief Executive
Officer, director and member/shareholder of DMD and BDI, Hiroki Umezaki,
President of DMD's International Operations, director and member of DMD and two
outside directors. In addition, existing management and security holders of both
DMD and BDI assumed management control of DMDS.

    Accordingly, for accounting purposes the acquisition was treated as a
recapitalization of DMD and BDI with DMD and BDI combined as the acquiror
(reverse acquisition). As a result, the combined historical financial statements
of DMD and BDI became the financial statements of DMDS.

    Further, since DMDS' assets consisted solely of approximately $660,000 in
cash and cash equivalents and had no operations in the seven years prior to the
acquisition, for accounting purposes this transaction was recorded by the
Company as the issuance of common stock for cash held by DMDS. Therefore no
proforma information has been presented.

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

    The consolidated financial statements include the accounts of DMDS and its
wholly owned subsidiaries as of December 31, 1997 and December 31, 1996 and for
the twelve month period ended December 31, 1997; the ten-month period ended
December 31, 1996 and for the period from inception (October 23, 1995) to March
2, 1996. All intercompany balances and transactions have been eliminated.

Use of Estimates

    The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. The significant estimates made in the preparation of the
consolidated financial statements relate to the assessment of the carrying value
of accounts receivable, inventories, and estimated provision for warranty costs.
Actual results could differ from those estimates.


Risks and Uncertainties


                                       30
<PAGE>   31
      The Company buys certain key components from one supplier or from a
limited number of suppliers. Although there are a limited number of suppliers of
the key components, management believes that other suppliers could provide
similar components on comparable terms. Changes in key suppliers could cause
delays in manufacturing and distribution of products and a possible loss in
sales, which could adversely affect operating results.

      The Company has derived substantially all of its revenues from the sale of
one product family. The Company believes that the inability to attract new
customers, the loss of one or more of its major customers, a significant
reduction in business from such customers, or the uncollectibility of amounts
due from any of its larger customers, could have a material adverse affect on
the Company.

Revenue Recognition

      The Company recognizes revenue from the sales of systems and supplies at
the time of shipment and satisfaction of significant vendor obligations, if any,
net of an allowance for estimated sales returns. The Company generally
warranties its systems for one year. A provision for estimated future costs
relating to warranty is recorded when systems are shipped.

Cash and Cash Equivalents

      For purposes of the statement of cash flows, the Company considers all
highly liquid investments purchased with an original maturity of three months or
less to be cash equivalents.

Inventories

      Inventories are carried at standard costs which approximate the lower of
actual cost (first-in; first-out) or market. Such amounts include the cost of
materials and, when applicable, labor and overhead.

Property and Equipment

      Property and equipment are stated at cost, less accumulated depreciation.
Capitalized leases are recorded at the lower of fair market value or the present
value of future minimum lease payments, less accumulated amortization.
Maintenance and repairs are expensed as incurred. The cost and related
accumulated depreciation and amortization of property and equipment sold or
retired are removed from the accounts and the resulting gains or losses are
included in current operations. Depreciation and amortization are provided on a
straight line basis over the estimated useful lives of the related asset, or
with respect to leasehold improvements and capital leases over the primary term
of the lease, whichever is less, as follows:

Equipment and software, including capitalized leases...........  5 years
Furniture and fixtures.........................................  7 years
Leasehold improvements and tooling.............................  3 years

Long-Lived Assets

    The carrying value of long term assets is periodically reviewed by
management, and impairment losses, if any, are recognized when the expected
nondiscounted future operating cash flows derived from such assets are less than
their carrying value.

Advertising and Promotion Costs

    Production costs of future media advertising and costs of dental industry
trade shows are deferred until the advertising or trade show occurs. All other
advertising and promotion costs are expensed as incurred. Total advertising and
promotion expenses incurred for the twelve month period ended December 31, 1997
were $1,528,203; for the ten month period ending December 31, 1996 were
$1,008,879, and for the period from inception (October 23, 1995) through March
2, 1997 were $437,590.


Research and Development Costs


                                       31
<PAGE>   32
    Costs related to research and development are expensed as incurred.

Income Taxes

      The Company accounts for income taxes under the liability method. Under
this method, deferred tax assets and liabilities are determined based on the
differences between the financial statement and tax bases of assets and
liabilities, using enacted tax rates in effect for the year in which the
differences are expected to reverse. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
Income tax expense is the tax currently payable for the period and the change
during the period in deferred tax assets and liabilities.

Stock-Based Employee Compensation Awards

      Statement of Financial Accounting Standards No. 123, "Accounting for the
Awards of Stock-Based Compensation to Employees" ("SFAS No. 123") encourages,
but does not require companies to record compensation cost for stock-based
compensation plans at fair value. The Company has adopted the disclosure
requirements of SFAS No. 123, which involves proforma disclosure of net income
under SFAS No. 123, detailed descriptions of plan terms and assumptions used in
valuing stock option grants. The Company has chosen to continue to account for
stock-based employee compensation awards in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees".

Concentration of Credit Risk and Major Customers

      Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of trade accounts receivable.
Also, at various times throughout the year, cash balances are maintained in
excess of Federally insured deposit limits.

      For the twelve month period ended December 31, 1997 and the ten month
period ended December 31, 1996, nine and five of the Company's customers
accounted for 24% and 21% of sales, respectively. At December 31, 1997 and 1996,
nine and six of the Company's customers accounted for approximately 60% and 75%
of trade accounts receivable, respectively. For the twelve month period ended
December 31, 1997, the Company had export sales of approximately $3,877,000
($1,700,000 Europe; $778,000 Canada; $722,000 Japan; $450,000 Australia and
$227,000 all other). For the ten-month period ended December 31, 1996 the
Company had export sales of approximately $2,200,000 ($1,200,000 Europe;
$400,000 Australia; $310,000 Canada and $290,000 Other). No customer accounted
for more than 10% of revenues and there were no export sales in the period ended
March 2, 1996.

      The Company performs ongoing credit evaluations of its customers'
financial condition and generally does not require collateral. Estimated credit
losses and returns, have been provided for in the financial statements.

      The majority of the Company's current customers consist of dental
professionals. Certain of the dental professionals lease the Company's products
through third party leasing companies. Under the terms of the sales, the leasing
companies have no recourse against the Company.

Fair Value of Financial Instruments

      Statement of Financial Accounting Standards No. 107, "Disclosure About
Fair Value of Financial Instruments", requires disclosure of fair value
information about all financial instruments held by a company except for certain
excluded instruments and instruments for which it is not practical to estimate
fair value. The carrying value of the Company's financial instruments
approximates their fair value.

Recently Issued Accounting Standards

      In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This statement establishes standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income generally represents all changes in
shareholders' equity during the period except those resulting from investments
by, or distributions to, shareholders. SFAS No. 130 is effective for fiscal
years beginning after December 15, 1997 and requires restatement of earlier
periods presented. Management is currently evaluating the requirements of SFAS
No. 130.


                                       32
<PAGE>   33
      In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes standards for
the way that a public enterprise reports information about operating segments in
annual financial statements, and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. SFAS No. 131 is effective for fiscal years beginning after
December 15, 1997 and requires restatement of earlier periods presented.
Management is currently evaluating the requirements of SFAS No. 131.

5.    RELATED PARTY TRANSACTIONS

      From December 1995 through February 1996, Robert H. Gurevitch, Chairman of
the Board and Chief Executive Officer of the Company, and Boston Marketing
Company, Ltd. ("Boston Marketing"), an affiliate of Hiroki Umezaki, a former
Director of the Company, loaned the Company an aggregate of $377,015. The
Promissory Notes evidencing such loans bear interest at 6% per annum and were
originally payable within six months. On February 26, 1996, the Company repaid
$50,000 to each of Mr. Gurevitch and Boston Marketing. In November 1996, Mr.
Gurevitch and Boston Marketing each agreed to extend the term of their
respective notes. On May 23, 1997, Boston Marketing was paid the remaining
principal balance of $150,000 of its loan plus the accrued interest of $3,526.
Mr. Gurevitch was paid $25,000 on July 10, 1997; $26,850 on October 22, 1997;
$5,000 on October 30, 1997; $13,787 on November 1, 1997; and $3,447 on December
1, 1997; leaving approximately $45,030 outstanding.

      On May 27, 1997, the Company loaned Dewey Perrigo, Vice President of Sales
of the Company, and Andrea Niemiec-Perrigo, an employee of the Company, $126,000
for the purpose of buying a home. The Promissory Notes evidencing such loans
bear interest at prime plus .25% (8.75% at December 31, 1997), and are due and
payable on May 27, 1999.



6. INVENTORIES

    Inventories consisted of the following:

<TABLE>
<CAPTION>
                       DECEMBER 31,     DECEMBER 31
                          1997              1996
                          ----              ----
<S>                   <C>              <C>
Raw materials . ....  $1,387,695       $  789,464
Work in process ....     555,049          136,786
Finished goods .....     953,526          586,825
                      ----------       ----------
                      $2,896,270       $1,513,075
                      ==========       ==========
</TABLE>


7. PREPAID EXPENSES AND OTHER CURRENT ASSETS

    Prepaid expenses and other current assets consisted of the following:

<TABLE>
<CAPTION>
                                                       DECEMBER 31,   DECEMBER 31,
                                                         1997           1996
                                                       --------       --------
<S>                                                    <C>            <C>
Prepaid advertising and industry trade show fees       $214,667       $178,281
Other ..........................................        174,394         30,271
                                                       --------       --------
                                                       $389,061       $208,552
                                                       ========       ========
</TABLE>



                                       33
<PAGE>   34
8. PROPERTY AND EQUIPMENT

    Property and equipment consisted of the following:

<TABLE>
<CAPTION>
                                                                          DECEMBER 31,      DECEMBER 31,
                                                                              1997              1996
                                                                              ----              ----

<S>                                                                         <C>              <C>
Equipment and software, including $112,853 and $102,867 of capitalized
  leases at December 31, 1997 and 1996................................      $569,729         $ 342,989
Furniture and fixtures................................................       135,034           116,152
Leasehold improvements................................................        44,222             5,761
                                                                            --------         ---------
                                                                             748,985           464,902
Less accumulated depreciation and amortization, including $22,571 and
  $20,341  relating to capitalized leases at December 31, 1997 and 1996     (195,866)          (71,324)
                                                                            --------         ---------
                                                                            $553,119         $ 393,578
                                                                            ========         =========
</TABLE>


9. ACCRUED LIABILITIES

    Accrued liabilities consisted of the following:

<TABLE>
<CAPTION>
                                                              DECEMBER 31,               DECEMBER 31,
                                                                 1997                       1996
                                                                 ----                       ----
<S>                                                         <C>                      <C>
Accrued commissions..............................           $    223,750             $    257,341
Accrued warranty.................................                 84,730                   56,515
Accrued salaries and wages.......................                 82,112                   42,159
Accrued interest.................................                  5,965                   34,552
Other............................................                620,616                   71,889
                                                            ------------              -----------
                                                            $  1,017,173              $    462,456
                                                            ============              ============
</TABLE>

10.  COMMITMENTS AND CONTINGENCIES

Leases

    The Company leases three facilities under various operating leases which
expire in 1998 and 2000. The leases require the Company to pay taxes,
maintenance fees, and insurance and provide for periodic fixed rent increases
based on a published price index. The Company also leases certain equipment
under capital leases which expire in 2000 and has the right to purchase the
underlying equipment at the termination of the leases for its fair market value.
Rent expense for all operating leases was approximately $132,000; $102,000 and
$38,000 for the twelve month period ended December 31, 1997, the ten-month
period ended December 31, 1996 and for the period from inception (October 23,
1995) to March 2, 1996, respectively. Two non-cancelable leases are guaranteed
by Robert H. Gurevitch, Chief Executive Officer and Chairman of the Board of the
Company.

    The aggregate liability for future rentals under these lease agreements as
of December 31, 1997, is summarized as follows:

<TABLE>
<CAPTION>
     YEAR ENDED DECEMBER 31                     CAPITAL      OPERATING
                                                LEASES        LEASES
                                                ------        ------
<S>                                             <C>          <C>
1998.......................................    $ 28,077     $ 194,592
1999.......................................      25,672        76,308
2000.......................................      22,539        69,949
                                               --------     ---------
                                                 76,288     $ 340,849
                                                            =========

Less amounts representing:
  Interest.................................      13,074
  Current portion..........................      23,356
                                               --------
Long term portion..........................    $ 39,858
                                               ========
</TABLE>



                                       34
<PAGE>   35
Distribution Agreements

    Effective October 1, 1996, the Company amended its distribution agreement
("BMC Distribution Agreement") with Boston Marketing, a licensed distributor of
the Teli manufactured CCD chip which includes the Teli CCU processor. Pursuant
to the BMC Distribution Agreement, the Company has the exclusive right (i) to
market certain Teli manufactured CCD chip assemblies with CCU processors (model
numbers CS6110 S/B with Frame Grabber, CS6110 P S/B with Frame Grabber and the
CS6110 S/B without Frame Grabber (each a "Teli Unit" and collectively the "Teli
Units")) to the dental market, and (ii) to use the "TeliCam" trademark. The Teli
Units are key components of the Company's intraoral digital cameras. The BMC
Distribution Agreement has a five-year initial term. The Company has agreed to
purchase a minimum of 2,500 Teli Units per year for each of the five years, at
an initial price of $750 per Teli Unit, subject to increase after October 1,
1998. The Company has the option to cancel the BMC Distribution Agreement if any
price increase is unacceptable. The Boston Marketing Distribution Agreement is
terminable by Boston Marketing if the Company fails to meet its annual minimum
purchase obligation. The term of the BMC Distribution Agreement may be extended
by mutual agreement of the Company and Boston Marketing for an additional five
year term.


    On October 15, 1997, the Company signed an exclusive distribution agreement
with Ion Laser Technology, Inc. ("ILT") for the rights to distribute ILT's
composite curing and whitening system to the dental market in the US and Canada
(the "ILT Agreement"). The Company is currently working with ILT to produce a
device that meets the Company's specifications. As of March 27, 1998, no devices
had yet been shipped by ILT which met the Company's specifications. If the
device is successfully developed, the Company will market the device as the
"Apollo 9500(TM)." ILT has retained the right to market its own tooth whitening
system, which uses the same high power non-laser light incorporated into the
Company's Apollo 9500. The ILT Agreement has a five-year initial term. The
Company has agreed to purchase a minimum of 15,000 devices over the term of the
Agreement, and to acheive certain sales goal with respect to such devices in
order to maintain its exclusive rights under the agreement. ILT has the option
to cancel the Agreement if the Company is unable to meet its purchase and sales
requirements. The Company has the option to cancel the Agreement if ILT is
unable to deliver acceptable product. The term of the ILT Agreement may be
extended by the Company for up to ten one year terms provided the Company has
met its purchase and sales requirements.

    On October 10, 1997, the Company entered into an agreement with Suni Imaging
Microsystems, Inc. ("Suni") to develop digital x-ray technology for
incorporation into systems for the dental market. The Company has obtained
exclusive rights to market products to the dental market incorporating certain
digital x-ray technology developed by Suni. Suni will retain the rights to
developed microchip technology underlying the x-ray system it develops for the
Company. The Company will determine whether or not to proceed with the marketing
of such product based upon the results of the development. The Company is
required to make certain payments to Suni to fund development.

11.   CAPITAL TRANSACTIONS

    On November 27, 1996, the Company raised $1,314,766, net of issuance costs
of $285,234, through a private placement of 32 Units to certain accredited
investors. Each Unit consisted of a secured promissory note in the principal
amount of $50,000 ("Bridge Note") and a warrant to purchase 18,750 shares of
Common Stock ("Bridge Warrant") at a purchase price of $2.67 per share. The
Notes bore interest at a rate of 10% per annum and the principal and all accrued
interest were payable upon the earliest to occur of: (a) May 27, 1998; (b)
certain change in control events effecting the Company; ( c ) a public offering
of the Company's securities; or (d) the sale by the Company's Chief Executive
Officer of all or substantially all of his holdings of the Common Stock. Upon
the happening of certain events the holders of the Notes had the right to
convert the outstanding balances of their Notes into shares of the Common Stock
at a rate of $2.67 per share. The Warrants were first exercisable on November
27, 1997 and expire on November 27, 2002. As a result of the warrants, these
notes were discounted by $259,104, which amount was being amortized over the
term of the notes.

    On May 14, 1997, the Company closed a secondary offering of 2,070,000 shares
of common stock. Each share of common stock included one redeemable warrant to
purchase one share of common stock at a purchase price of $5.00. This offering
resulted in gross proceeds of $10,350,000 less expenses of approximately
$1,819,608 for net proceeds of approximately $8,530,392. In addition,
approximately $1,600,000 of the net proceeds were used to repay the principal on
the Bridge Notes plus an additional $100,000 was used to pay off accrued
interest. The Bridge Notes consisted of secured convertible promissory notes in
the aggregate principal amount of $1,600,000 bearing interest at 10% per annum
and were payable the earlier of May 27, 1998 or consummation of the offering.



                                       35
<PAGE>   36
Approximately $224,000 was used to repay loans from related parties. The
remaining net proceeds have or will be used for product development,
acquisition, and to repay the remaining loans from related parties, and working
capital and general corporate purposes.

12.  STOCK OPTIONS

    In March, 1997, the Company's Board of Directors approved the "1997 Stock
Incentive Plan". Under the plan, incentive stock options and non-statutory stock
options may be granted to employees, directors, and consultants to purchase a
specified number of shares of common stock at a price not less than the fair
market value on the date of grant and for a term not to exceed 10 years.
Options for employees vest over a period of 5 years.

    SFAS No. 123, "Accounting for Stock-Based Compensation," encourages but does
not require companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Accordingly, no compensation expense
has been recognized for the Company's stock based compensation plans. Had
compensation costs for the Company's stock option and purchase plan (for options
granted in years ended December 31, 1997 and 1996 only) been determined based
upon the methodology prescribed under SFAS No. 123, the Company's net (loss)
would approximate the pro forma amounts below:

<TABLE>
<CAPTION>
Year Ended December 31, 1997:                                 As Reported               Pro Forma
-----------------------------                                 -----------               ---------

<S>                                                           <C>                       <C>
Net income / (loss)                                           $ (2,044,729)             $ (2,180,726)
Net income / (loss) per share                                 $      (.47)              $      (.50)
</TABLE>

<TABLE>
<CAPTION>
Ten Month Period ended December 31, 1996:                     As Reported               Pro Forma
-----------------------------------------                     -----------               ---------

<S>                                                           <C>                       <C>
Net income / (loss)                                           $     137,151             $   (158,129)
Net income / (loss) per share                                 $       .05               $      (.05)
</TABLE>


      The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. SFAS No. 123 does not apply to awards prior to
1996.

      A summary of the status of the Company's stock options as of December 31,
1997 and 1996 and the changes during the year ended December 31, 1997 and the
ten month period ended December 31, 1996, is presented below:

<TABLE>
<CAPTION>
                                                                         Weighted
                                                                          Average            Weighted
                                                        Number of         Option           Average Grant
                                                         Shares       Exercise Price       Date Fair Value
                                                         ------       --------------       ---------------

<S>                                                 <C>               <C>                <C>
Outstanding at March 2, 1996                                   -       $           -     $         -
Granted                                                  139,943               2.63             2.11
Exercised                                                      -                  -                -
                                                    ------------           --------         --------
Options outstanding at December 31, 1996                 139,943               2.63             2.11

Granted                                                  471,691               3.79             2.71
Canceled                                                 (50,513)              2.95                -
Exercised                                                (10,240)               .88                -
                                                         --------           -------         --------
Options outstanding at December 31, 1997                 550,881               3.63             2.62

Options exercisable at year end                          157,392        $      2.26      $
Options available for future grant                        35,700                  -                -
</TABLE>



                                       36
<PAGE>   37
<TABLE>
<CAPTION>
                              Options Outstanding                              Options Exercisable
                              -------------------                              -------------------
                                                 Weighted Average
      Range of         Number Outstanding at        Remaining       Weighted Average    Number Outstanding      Weighted Average
   Exercise Price        December 31, 1997       Contractual Life    Exercise Price    at December 31, 1997      Exercise Price
   --------------        -----------------       ----------------    --------------    --------------------      --------------
<S>                    <C>                       <C>                 <C>                  <C>                    <C>
$   .88  -  2.93                172,190              3.2 years       $          2.32            157,392          $       2.26

$  4.50  -  5.13                378,691              8.8 years       $          5.03                  -                     -
                                -------                                                        --------
                                550,881                                                         157,392
                                =======                                                         =======
</TABLE>


    The fair value of options granted during 1997 and 1996 is estimated as
$1,085,466 and $295,280, respectively, on the dates of grants using the
Black-Scholes option pricing model. The following assumptions were used for 1997
and 1996: (i) risk-free interest rate of 6.33 % and 6.85%, respectively (ii)
expected option life of 5 years, (iii) forfeiture rate of 0, (iv) expected
volatility of 68.73% and 143%, respectively and (v) no expected dividends.


13.  INCOME TAXES

    The income tax expense (benefit) for the twelve-months ended December 31,
1997 and the ten months ended December 31, 1996 is as follows:

<TABLE>
<CAPTION>
                                          1997                 1996
                                          ----                 ----
 Current:
<S>                                 <C>                      <C>
   Federal.....................     $   113,299              $ 132,570
   State.......................          40,012                 36,000
                                    -----------              ---------
                                        153,311                168,570

 Deferred:
   Federal.....................               -                (67,000)
   State.......................               -                (23,000)
                                    -----------              ---------
                     Total.....       $ 153,311              $  78,570
                                    ===========              =========
</TABLE>


    The Company's effective tax rate for the twelve-months ended December 31,
1997 and ten months ended December 31, 1996 differs from the statutory federal
income tax rate as follows:

<TABLE>
<CAPTION>
                                                                 1997             1996
                                                                 ----             ----
<S>                                                              <C>             <C>
Tax provision at the statutory rate...........................   (34)%            34%
Nondeductible expenses........................................     2              10
State taxes, net of federal benefit...........................    (6)             14
Research & development credit.................................    (5)              -
Establishment of valuation allowance..........................    52               -
Reduction in deferred asset valuation allowance...............     -             (27)

Other.........................................................     -               5
                                                                   -             ---
                                                                   9%             36%
                                                                   =             ===
</TABLE>


    There was no tax expense for the period from inception (October 23, 1995)
through March 2, 1996 due principally to DMD being formed as a limited liability
company and, prior to the acquisition by DMDS, having elected to be taxed as a
partnership. Due to the net operating loss incurred, however, treatment as a C
corporation would not have resulted in tax expense for the period from inception
through March 2, 1996.

    The components of the net deferred taxes are as follows:

<TABLE>
<CAPTION>
                                                                         DECEMBER 31,     DECEMBER 31,
                                                                            1997             1996
                                                                            ----             ----

Deferred Tax Assets:
<S>                                                                   <C>               <C>
  Inventory reserves..........................................        $    39,000       $  28,300
  Warranty accrual............................................             33,000          22,600
  Allowance for returns and doubtful                                       20,700          37,900
    accounts.................
  Net operating loss carry forwards...........................          1,029,700               -

</TABLE>

                                       37
<PAGE>   38
<TABLE>
<S>                                                                    <C>              <C>
  Research and development credits............................            100,000               -
  Accrued vacation............................................             24,100               -
  Fixed assets................................................             31,400               -
  Other.......................................................             17,100           1,200
  Valuation allowance.........................................         (1,295,000)              -
                                                                       ----------       ---------
                                                                       $        -       $  90,000
                                                                       ==========       =========
</TABLE>


    As a result of the Company's recent loss history, a valuation allowance has
been recorded for the full amount of the Company's deferred tax asset at
December 31, 1997.

14.  EARNINGS PER SHARE

      In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128 "Earnings per Share" ("SFAS 128"). This statement requires dual
presentation of newly defined basic and diluted earnings per share ("EPS") on
the face of the income statement for all entities with complex capital
structures. The following table provides a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for the year ended
December 31, 1997, the ten month period ended December 31, 1996, and the period
from inception to March 2, 1996:


<TABLE>
<CAPTION>
                                                                           Income               Shares              Per-Share
                                                                        (Numerator)          (Denominator)            Amount
                                                                        -----------          -------------            ------
For the year ended December 31, 1997:
<S>                                                                   <C>                      <C>               <C>
   Basic earnings per share.............                              $  (2,044,729)           4,341,498         $         (.47)
   Effect of dilutive securities - stock options and
      warrants.......................                                             -                    -                      -
                                                                      -------------            ---------         --------------
   Diluted earnings per share ......................                  $  (2,044,729)           4,341,498         $         (.47)
                                                                      =============            =========         ==============


For the ten months ended December 31, 1996:

   Basic earnings per share.............                              $     137,151            2,893,298         $          .05
   Effect of dilutive securities - stock options and
      warrants .......................                                            -              125,915                      -
                                                                      -------------            ---------         --------------
   Diluted earnings per share...........                              $     137,151            3,019,213         $          .05
                                                                      =============            =========         ==============
For the period from inception to March 2, 1996:

   Basic earnings per share............                               $  (1,625,213)           1,035,778         $        (1.57)
   Effect of dilutive securities - stock options and
      warrants .......................                                            -                    -                      -
                                                                      -------------            ---------         --------------
   Diluted earnings per share......................                   $  (1,625,213)           1,035,778         $        (1.57)
                                                                      =============            =========         ==============
</TABLE>

      The computation for diluted number of shares excludes unexercised stock
options and warrants which are anti-dilutive. The number of such shares for the
year ending December 31, 1997, for the ten months ended December 31, 1996 and
for the period ended March 2, 1996 were 4,580,881, 830,395, and none,
respectively.

15. CREDIT FACILITY

     On July 1, 1997, the Company finalized a credit agreement with Comerica
Bank ("Comerica") extending up to a $2,000,000 line of credit to the Company,
secured by a first priority security interest in the Company's assets and by an
assignment of the Company's rights under the Boston Marketing Distribution
Agreement. The credit facility bears interest at the rate of prime plus .25% per
annum (8.75% at December 31, 1997). All borrowings under the facility are
subject to a formula based, generally, on accounts receivable and inventory. The
Company intends to use the credit facility, when needed, for working capital and
general corporate purposes. No amounts were outstanding under this agreement at
December 31, 1997.


                                       38
<PAGE>   39
16. LONG TERM DEBT

     On December 10, 1997, the Company finalized a second agreement with
Comerica Bank ("Comerica") extending up to a $500,000 line of credit to the
Company for capital expenditures, secured by a first priority interest in the
Company's assets. The credit facility bears interest at a rate of prime plus .5%
per annum (9.0% at December 31, 1997). The line expires on December 10, 1998.
The principal balance will amortize over a thirty six (36) month period.
Borrowings are at 80% of the capital expenditure. No amounts were outstanding
under this agreement at December 31, 1997.

17. EXTRAORDINARY ITEM

     On May 14, 1997, the Company repaid the $1,600,000 principal amount Bridge
Notes in connection with the Company's Offering. An extraordinary charge of
$234,149 (net of tax benefit of $143,511) was incurred for the early
extinguishment of those notes.

18. NON-RECURRING CHARGE

     On September 17, 1997, the Company repurchased the exclusive distribution
rights of its products into the European market from an independent distributor
for 50,000 shares of common stock. This resulted in a non-recurring charge of
$256,250.

19. SUBSEQUENT EVENTS (UNAUDITED)


             On March 2, 1998, the Company entered into an agreement with
accredited investors and institutional purchasers for the private placement (the
"Debt Placement") of its 12% Senior Subordinated Notes due 1999 (the "Notes")
and 450,000 warrants (the "Warrants"). The Debt Placement was consummated on
March 19, 1998. The Warrants are (i) exerciseable commencing on May 15, 1998,
and for five years thereafter for the purchase of one share of Common Stock per
Warrant (the "Warrant Shares"); and (ii) at an exercise price of $5.812 per
share. The Company has agreed to file a registration statement with respect to
the Warrant Shares within 45 days of the date the Warrants are issued. The Notes
(i) bear interest at a rate of 12% per annum payable semi-annually; (ii) mature
on the first anniversary of the date of issuance; and (iii) may be repaid by the
Company prior to maturity at one hundred and two (102% ) percent of the amount
of the unpaid principal and interest due as of the date of repayment. If the
Notes are unpaid at maturity, each Note holder has the option to convert the
outstanding principal and interest then due on such Note into Common Stock of
the Company (the "Conversion Shares") at a conversion price equal to eighty
(80%) percent of the average of the five lowest closing bid prices for the
twenty consecutive trading days prior to the date of conversion. The unpaid
principal and interest then due on the Notes is convertible into a maximum
aggregate amount of 500,000 shares of Common Stock. Depending on the stock price
prior to conversion, more than 500,000 shares of common stock may be required to
permit conversion of one hundred (100%) percent of the unpaid principal and
interest then due on the Notes into Common Stock. The Company has agreed to
present a proposal to its stockholders at the next annual meeting of its
stockholders to approve issuance of a sufficient number of shares of Common
Stock to permit conversion upon default of one hundred (100%) percent of the
unpaid principal and interest then due on all of the outstanding Notes to Common
Stock. The Company has agreed to file a registration statement with respect to
any Conversion Shares within 45 days of the date the Notes mature, if the Notes
are then unpaid. The net proceeds of the Debt Placement, estimated to be
approximately $4.2 million, will be used to launch the Company's new products,
current product development activities, and general working capital needs.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.

    None.


                                       39
<PAGE>   40
                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH SECTION 16(a) OF THE EXCHANGE ACT.


    The information required in ITEM 9, is hereby incorporated by reference to
the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission for the 1998 Annual Meeting of its Stockholders ("Proxy
Statement")

ITEM 10. EXECUTIVE COMPENSATION.

    The information required in ITEM 10 is hereby incorporated by reference to
the Registrant's Proxy Statement.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

    The information required in ITEM 11 is hereby incorporated by reference to
the Registrant's Proxy Statement.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

    The information required in ITEM 12 is hereby incorporated by reference to
the Registrant's Proxy Statement.

ITEM 13.     EXHIBITS AND REPORTS ON FORM 8-K.

(a) EXHIBITS.


<TABLE>
<CAPTION>
    EXHIBIT        DOCUMENT
      NO.          DESCRIPTION
      ---          -----------
<S>                <C>
       1.1         Form of Underwriting Agreement (1)

       1.2         Form of Underwriter's Purchase Option granted to M. H. Meyerson & Co., Inc. (1)

       2.l.        Contribution Agreement, dated February 29, 1996, by and among the Registrant and Robert H. Gurevitch,
                   Hiroki Umezaki, Fred Kinley and Dewey Perrigo, as Members of United Medical Diagnostic Systems, LLC.
                   (2).

       2.2.        Contribution Agreement, dated February 29, 1996, by and among the Registrant and Robert H. Gurevitch,
                   Anatoly Borodyansky and Dewey Perrigo, as stockholders of Bavarian Dental Instruments, Inc. (2)

       2.3         Dental/Medical Diagnostic Systems, Inc. 1997 Stock Incentive Plan. (2)

       3.1.        Amended and Restated Certificate of Incorporation of the Registrant. (2)

       3.2.        Bylaws of the Registrant. (2)

       4.1         Specimen Stock Certificate of the Registrant. (1)

       4.2         Form of Warrant Agreement between American Stock Transfer & Trust Company and the Registrant and form
                   of Warrant Certificate. (3)

      10.1         Agency Agreement dated as of October 23, 1996, by and between the Registrant and M.H. Myerson & Co.,
                   Inc. (4)

      10.2         Form Subscription Agreement. (4)

      10.3.        Supplement No. 1 to Confidential Term Sheet, dated November 14, 1996. (4)
</TABLE>



                                       40
<PAGE>   41
<TABLE>
<CAPTION>
    EXHIBIT        DOCUMENT
      NO.          DESCRIPTION
      ---          -----------
<S>                <C>
     10.4          Form of Secured Convertible Promissory Note dated as of November 25, 1996,  issued by the Registrant,
                   and a Schedule of Warrant Holders. (4)

     10.5          Form of Warrant for the Purchase of Shares of Common Stock, dated as of November 25, 1996, issued by
                   the Registrant and a Schedule of Warrant Holders. (4)

     10.6          Form of Lock-Up Agreement Letter, dated January 31, 1997, addressed to M. H. Myerson & Co., Inc. from
                   certain purchasers of Registrant's Common Stock, listed on the Schedule thereto. (2)

     10.7          Form of Registration Rights Agreement Letter, dated January 31, 1997, from Registrant to those certain
                   purchasers of the Registrant's Common Stock listed on the Schedule thereto. (2)

     10.8          Commitment Letter, dated February 13, 1997, from Comerica Bank confirming the existence of a secured
                   line of credit for the Registrant. (2)

     10.9          Security Agreement, dated as of November 25, 1996, entered into by the Registrant. (4)

     10.10         Employment Agreement, dated as of October 1, 1996, entered into by the Registrant and Robert H.
                   Gurevitch. (4)

     10.11         Employment Agreement, dated as of October 1, 1996, entered into by the Registrant and Dewey Perrigo. (4)

     10.12         Letter of Intent, dated August 23, 1996, between the Registrant and Olympus Japan Co., Ltd. (2)

     10.13         Distribution Agreement, dated as of October 1, 1996, between the Registrant and Boston Marketing
                   Company,  Ltd., as amended. (2)

     10.14         Distributor Agreement, dated August 29, 1996, between the Registrant and 479671 BC Ltd. d/b/a/
                   National Dental Direct. (2)

     10.15         Distributor Agreement, dated June 1, 1996, between the Registrant and Michel Van Gerven, Imaging
                   Concepts NV  (2)

     10.16         Distributor Agreement, dated May 23, 1996, between the Registrant and New Image Industries Pty Ltd
                   NII. (2)

     10.17         Distributor Agreement, dated September 19, 1996, between the Registrant and Macana, Inc. d/b/a Florida
                   Dental and Medical Supply. (2)

     10.18         Form of Distributor Agreement, dated May 30, 1996, between the Registrant and David Lok. (2)

     10.19         Sales Representative Agreement, dated October 28, 1996, between the Registrant and Boston Marketing
                   Company,  Ltd. (2)

     10.20         Exclusive Purchase Agreement, dated October 28, 1996, between the Registrant and Fujimi Optics Corp.
                   (2)

     10.21         1996 Systems Integrator/Value Added Integrator Agreement, dated April 1, 1996, between the Registrant
                   and Sony Business & Professional Products Group, Sony Electronics, Inc. (2)

     10.22         Letter of Authorization, dated December 25, 1995, from JV Dentoral in favor of BDI; and Declaration of
                   Exclusive Right, dated December 25, 1995, made by JV Dentoral in favor of BDI. (5)

     10.23         Letter of Authorization, dated January 3, 1996, from NPO Altech in favor of BDI; and Declaration of
                   Exclusive Rights dated December 24, 1995, made by NPO Altech in favor of BDI. (5)
</TABLE>



                                       41
<PAGE>   42
<TABLE>
<CAPTION>
    EXHIBIT        DOCUMENT
      NO.          DESCRIPTION
      ---          -----------
<S>                <C>
     10.24         Promissory Note, dated February 1, 1996, made by the Registrant in favor of Boston Marketing Company,
                   Ltd. (2)

     10.25         Promissory Note, dated February 15, 1996, made by the Registrant in favor of Boston Marketing Company,
                   Ltd.  (2)

     10.26         Promissory Note, dated April 11, 1996, made by the Registrant in favor of Boston Marketing Company,
                   Ltd. (2)

     10.27         Extension of Promissory Note, dated November 5, 1996, between the Registrant and Boston Marketing
                   Company,  Ltd. (4)

     10.28         Promissory Note, dated February 1, 1996, between the Registrant and Robert H. Gurevitch. (2)

     10.29         Promissory Note, dated February 15, 1996, made by the Registrant in favor of Robert H. Gurevitch.(2)

     10.30         Extension of Promissory Note, dated November 5, 1996, between the Registrant and Robert H. Gurevitch.
                   (4)

     10.31         Form of Indemnification Agreement and Schedule of Indemnified Parties. (3)

     10.32         Form of Notice of Vested Stock Option Letter and Schedule of Recipients. (3)

     10.33         Commercial Security Agreement between the Registrant and Hitachi Electronics (America), Inc. (1)

     10.34         Standard Office Lease, dated October 30, 1995, between John Hancock Mutual Life Insurance Company
                   ("John Hancock") and the Registrant, for Suite 202 at 200 North Westlake Boulevard Office; and
                   Guaranty of Lease, dated November 6, 1995, made by Robert H. Gurevitch in favor of John
                   Hancock.(2)

     10.35         Industrial Lease, dated October 23, 1995, between Registrant and The Irvine Company, for One
                   Technology Park Office.(2)

     10.36         Agreement between the Registrant and DMD NV dated as of September 30, 1997. (6)

     10.37         Agreement between the Registrant and Ion Laser Technology, Inc., dated as of October 15, 1997.+

     10.38         Agreement between the Registrant and Suni Imaging Microsystems, Inc. dated October 10, 1997.+

     10.38.1       Extension of automatic termination provisions of agreement between the Registrant and Suni
                   Imaging Microsystems, Inc., dated November 11, 1997.



     10.39         Purchase Agreement by and among the Registrant and the purchasers named therein with respect to
                   the sale and purchase of an aggregate of $4,500,000 aggregate principal amount of the
                   Registrant's 12% Senior Subordinated Notes due 1999, and Warrants dated as of March 2, 1998.+



     10.40         Form of 12% Senior Subordinated Note due 1999.

     10.41         Form of Common Stock Purchase Warrant.

</TABLE>



                                       42
<PAGE>   43
<TABLE>
<CAPTION>
    EXHIBIT        DOCUMENT
      NO.          DESCRIPTION
      ---          -----------
<S>                <C>

     10.42         Revolving Credit Loan and Security Agreement between the Registrant and Comerica
                   Bank-California, dated as of December 10, 1997.+



     10.43         Variable Rate-Single Payment Note of the Company in form of Comerica Bank-California, dated as
                   of December, 10, 1997.+



     10.44         First modification to Variable Rate-Single Payment Note, between the Company and Comerica
                   Bank-California, dated as of December 24, 1997.



     11.1          Statement Re:  Computation of per share earnings.

     21.1          Subsidiaries of the Registrant.

     23.           Consent of Coopers & Lybrand, LLP.

     24.1          Power of Attorney (included in signature page attached to this Form 10-K/SB).

     27.1          Financial Data Schedule.
</TABLE>


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

       +    The Registrant has requested confidential treatment for portions
            of the referenced exhibit.

      (1)   Incorporated by reference to exhibits to Pre-effective Amendment No.
            1 to the Registration Statement on Form SB-2 of the Registrant filed
            on April 7, 1997 (File No. 333-22507).

      (2)   Incorporated by reference to exhibits to the Registrant's
            Registration Statement on Form SB-2 filed on February 28, 1997 (File
            No. 333-22507).


      (3)   Incorporated by reference to exhibits to Pre-effective Amendment No.
            2 to the Registrant's Registration Statement on Form SB- 2 filed on
            April 30 (File No. 333-22507).

      (4)   Incorporated by reference to exhibits to the Registrant's Report on
            Form 10-QSB, dated November 30, 1996.

      (5)   Incorporated by reference from the Registrant's Report on Form 8-K,
            dated March 1,1996.

      (6)   Incorporated by referenced from exhibits to the Registrant's Report
            on Form 10-QSB dated September 30, 1997.



                                       43
<PAGE>   44
 (B) REPORTS ON FORM 8-K.

     In the last fiscal quarter, the Registrant has filed the following Reports
on Form 8-K:

     (1) On November 14, 1997, the Company filed a Form 8-K regarding the
definitive distribution agreement with Ion Laser Technology, ILT., and the
definitive development and licensing agreement with Suni Imaging Microsystems,
Inc.

     (2) On December 18, 1997, the Company filed a Form 8-K announcing that the
staff of the United States Food and Drug Administration had notified the Company
that a 501(K) pre-market notification would be required for connection with the
TeliCam Intra-Oral camera.

     (3) On March 17, 1998, the Company filed a Form 8-K, announcing the
proposed Debt Placement.



                                       44
<PAGE>   45

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized in the City of Los
Angeles and State of California on the 31st day of March 1998.

                                      DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC.

                                      By: /s/    ROBERT H. GUREVITCH
                                         ---------------------------------------
                                         Robert H. Gurevitch
                                         Chairman and Chief Executive Officer

                               POWER OF ATTORNEY

     Each person whose signature appears below constitutes and appoints Robert
H. Gurevitch, and each of them, as his true and lawful attorneys-in-fact and
agents with full power of substitution and resubstitution, for him and his name,
place and stead, in any and all capacities, to sign any or all amendments to
this Annual Report on Form 10-KSB and to file the same, with all exhibits
thereto, and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the foregoing, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or either of them, or
their substitutes, may lawfully do or cause to be done by virtue hereof.

     Pursuant to the requirements of the Securities and Exchange Act of 1934,
this Report has been signed below by the following persons in the capacities and
on the date indicated:

<TABLE>
<CAPTION>
                       SIGNATURE                                    TITLE
                       ---------                                    -----                  DATE
<C>                                                       <S>                          <C>

/s/ ROBERT H. GUREVITCH                                   Chairman, Chief Executive     March 31, 1998
--------------------------------------------------------  Officer, and Director
Robert H. Gurevitch

/s/ JACK D. PRESTON                                       Director                      March 31, 1998
--------------------------------------------------------
Jack D. Preston

/s/ RONALD E. WITTMAN                                     Chief Financial Officer,      March 31, 1998
--------------------------------------------------------  Principal Accounting
Ronald E. Wittman                                         Officer

/s/ MARVIN H. KLEINBERG                                   Director                      March 31, 1998
--------------------------------------------------------
Marvin H. Kleinberg

</TABLE>