<PAGE>
 
================================================================================


                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                  FORM 10-K/A

                                AMENDMENT NO. 1

[X]  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. 1-12461

                            MEDICAL RESOURCES, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


       DELAWARE                                                 13-3584552
(STATE OF INCORPORATION)                                      (IRS EMPLOYER)
                                                            IDENTIFICATION NO.)
 
155 STATE STREET, HACKENSACK, NJ                                   07601
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)                         (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (201) 488-6230
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                    COMMON STOCK (PAR VALUE $.01 PER SHARE)
                              TITLE OF EACH CLASS


     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                    Yes [  ]        No  [X]

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

     At May 26, 1998, 7,641,759 shares of the registrant's Common Stock, par
value $.01 per share, were outstanding and the aggregate market value of the
Common Stock (based upon the NASDAQ closing price of these shares on that date)
held by non-affiliates was $50,920,781.

     The Registrant's Annual Report on Form 10-K for the fiscal year ended 
December 31, 1997, is hereby amended and restated in entirety by this Amendment 
No. 1 on Form 10K/A (as so amended the "Report on Form 10-K"). On July 24, 1998,
the Registrant effected a one-for-three reverse stock split of its Common Stock.
The information set forth in this Form 10-K gives effect to such reverse stock
split.


                      DOCUMENTS INCORPORATED BY REFERENCE

                                Not Applicable.


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<PAGE>
 
ITEM 1. BUSINESS

                                   BUSINESS
 
GENERAL
         
  Medical Resources, Inc. ("Medical Resources" and collectively with its
subsidiaries, affiliated partnerships and joint ventures, the "Company")
specializes in the operation and management of fixed-site outpatient
diagnostic imaging centers, and also provides temporary healthcare staffing
services to acute and sub-acute care facilities. Through its Diagnostic
Imaging division, the Company currently operates 94 outpatient diagnostic
imaging centers located in the Northeast (56), Southeast (24), the Midwest (9)
and California (5), and provides network management services to managed care
organizations. The Company has grown rapidly and has increased the number of
diagnostic imaging centers it operates from 39 at December 31, 1996 to 94 at
September 1, 1998. The Company, through its wholly-owned subsidiary, Dalcon
Technologies, Inc. ("Dalcon"), also develops and markets software products and
systems for the diagnostic imaging industry.          
         
  Until August 1998, the Company, through the Per Diem and Travel Nursing
Divisions of its wholly-owned subsidiaries, StarMed Staffing, Inc. and Wesley
Medical Resources Inc. ("StarMed"), provided temporary healthcare staffing of
registered nurses and other medical personnel to acute and sub-acute care
facilities nationwide. On August 18, 1998, the Company sold the stock of
StarMed to RehabCare Group, Inc. for $33 million (the "StarMed Sale"). Due to
the StarMed Sale, the results of operations of StarMed are herein reflected in
the Company's Consolidated Statements Of Operations as discontinued
operations.            
        
  Diagnostic Imaging Division. The Company's diagnostic imaging centers
provide diagnostic imaging services in a comfortable, service-oriented
outpatient environment to patients referred by physicians. At each of its
centers, the Company provides management, administrative, marketing and
technical services, as well as equipment, technologists and facilities, to
physicians who interpret scans performed on patients. Medical services at the
Company's imaging centers are provided by board certified interpreting
physicians, generally radiologists, with whom the Company enters into
contracts. Of the Company's 94 centers, 82 provide magnetic resonance imaging.
Many of the Company's centers also provide some or all of the following
services: computerized tomography, ultrasound, nuclear medicine, general
radiology, fluoroscopy and mammography.         
 
  The Company's goal is to become the leading operator of fixed-site
outpatient diagnostic imaging centers in the United States. The number of
outpatient diagnostic imaging centers in the United States is estimated to
have grown from approximately 700 in 1984 to approximately 2,500 as of
December 31, 1997. Ownership of fixed-site outpatient diagnostic imaging
centers is highly fragmented, with no dominant national provider. The Company
believes that the environment faced by diagnostic imaging center operators is
characterized by an increased influence of managed care organizations, rising
business complexity, growing control over patient flows by payors, and
continued overall reimbursement pressures, all of which have been and will
continue to require center owners to seek operational efficiencies. In
addition, the Company believes that public and private reforms in the
healthcare industry emphasizing cost containment and accountability will
continue to shift the delivery of imaging services from highly fragmented,
individual or small center operators to companies operating larger multi-
modality networks of centers.
 
  The Company intends, over time, to capitalize on the fragmented nature of
the diagnostic imaging center industry through the acquisition of additional
centers. The Company's strategy has also been to seek to expand the scope and
efficiency of its operations at its existing and acquired facilities by: (i)
leveraging the geographic concentration of its centers; (ii) expanding the
imaging services offered by its centers by upgrading existing technology and
adding new modalities; (iii) applying sophisticated operating, financial and
information systems and procedures; (iv) utilizing targeted local marketing
programs; and (v) developing its network management services to address more
fully the needs of managed care organizations.
 
  Dalcon is a developer and provider of software system applications to
diagnostic imaging center operators. Through its proprietary radiology
information system, ICIS, Dalcon provides the Company's imaging centers, as
well as imaging centers owned and/or operated by third-parties, with
information system development, service
 
                                       1
<PAGE>
 
and support specifically designed for the administration and operation of
imaging centers, including patient scheduling, registration, transcription,
film tracking, billing, and insurance claim processing. The Company purchased
Dalcon in September 1997. As of June 1998, the substantial majority of the
Company's imaging centers had been fully integrated and operating on Dalcon's
ICIS system. In addition, in February 1998, Dalcon entered into a multi-year
agreement with HealthSouth Corporation, pursuant to which Dalcon is to install
its ICIS information system at all of HealthSouth's imaging centers not
currently using it.
                  
  Per Diem and Travel Nursing Divisions. The Company's temporary staffing
business, StarMed, was founded in 1978 and acquired by the Company in August
1994. StarMed's Per Diem staffing division provided registered nurses,
licensed practical nurses, nursing assistants, therapists and medical
transcriptionists on a daily basis to healthcare facilities through 35 offices
located in 16 states as of March 31, 1998. StarMed's Travel Nursing division
operated from a central office in Clearwater, Florida and provided registered
nurses and operating room technicians for periods usually ranging from 8 to 26
weeks. StarMed commenced its Per Diem operations in March 1995 and, since that
time, it had opened 31 offices, acquired 4 staffing companies operating six
additional offices and consolidated the operations of two other offices. Due
to the August 1998 sale of StarMed, the results of operations of StarMed are
herein reflected in the Company's Consolidated Statements of Operations as
discontinued operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of Discontinued
Operations."           
 
  Medical Resources was incorporated in Delaware in August 1990 and has its
principal executive office at 155 State Street, Hackensack, New Jersey 07601,
telephone number (201) 488-6230. Prior to the Company's incorporation, the
Company's operations, which commenced in 1979, were conducted by corporations
which are now among its subsidiaries.
 
DIAGNOSTIC IMAGING SERVICES INDUSTRY
 
OVERVIEW
 
  Imaging centers have played a vital role in the healthcare delivery system
by offering diagnostic services such as Magnetic Resonance Imaging ("MR"),
Computerized Tomography ("CT"), Ultrasound, Nuclear Medicine, Mammography and
X-ray in an outpatient setting. Diagnostic imaging procedures are used to
diagnose diseases and physical injuries through the use of various imaging
modalities. The use of non-invasive diagnostic imaging has grown rapidly in
recent years because it allows physicians to diagnose quickly and accurately a
wide variety of diseases and injuries without exploratory surgery or other
invasive procedures, which are usually more expensive, risky and potentially
debilitating for patients. In addition, diagnostic imaging is increasingly
being used as a screening tool for preventative care. While conventional X-ray
continues to be the primary imaging modality based on the number of procedures
performed, the use of MR and CT procedures has increased due to their more
sophisticated diagnostic capabilities. The Company believes that utilization
will continue to increase because of the growth in demand for diagnostic
imaging services as well as the introduction of new diagnostic imaging
procedures involving new or existing modalities.
 
EQUIPMENT AND MODALITIES
 
  Diagnostic imaging systems are generally based on the ability of energy
waves to penetrate human tissue and generate images of the body which can be
displayed either on film or on a video monitor. Imaging systems have evolved
from conventional x-rays to the advanced technologies of MR, CT, Ultrasound,
Nuclear Medicine and Mammography. The principal diagnostic imaging modalities
used by the Company include the following:
 
  Magnetic Resonance Imaging. MR is a sophisticated diagnostic imaging system
that utilizes a strong magnetic field in conjunction with low energy
electromagnetic waves which are processed by a computer to produce high
resolution images of body tissue. A principal element of MR imaging is that
the atoms in various kinds of body tissue behave differently in response to a
magnetic field, enabling the differentiation of internal
 
                                       2
<PAGE>
 
organs and normal and diseased tissue. Unlike CT and X-rays, MR does not
utilize ionizing radiation which can cause tissue damage in high doses. As
with other diagnostic imaging technologies, MR is generally non-invasive.
 
  Computerized Tomography. CT is used to detect tumors and other conditions
affecting bones and internal organs. CT provides higher resolution images than
conventional X-rays. In a CT, a computer directs the movement of an X-ray tube
to produce multi-cross sectional images of a particular organ or area of the
body.
 
  Ultrasound. Ultrasound has widespread application, particularly for
procedures in obstetrics, gynecology and cardiology. Ultrasound imaging relies
on the computer-assisted processing of sound waves to develop images of
internal organs and the vascular system. A computer processes sound waves as
they are reflected by body tissue, providing an image that may be viewed
immediately on a computer screen or recorded continuously or in single images
for further interpretation.
 
  Nuclear Medicine. Nuclear medicine is used primarily to study anatomic and
metabolic functions. During a nuclear medicine procedure, short lived
radioactive isotopes are administered to the patient by ingestion or
injection. The isotopes release small amounts of radioactivity that can be
recorded by a gamma camera and processed by a computer to produce an image of
various anatomical structures.
 
  General Radiology and Fluoroscopy (X-ray). The most frequently used type of
imaging equipment in radiology utilizes "X-rays" or ionizing radiation to
penetrate the body and record images on film. Fluoroscopy uses a video viewing
system for real time monitoring of the organs being visualized.
 
  Mammography. Mammography is a specialized form of radiology equipment using
low dosage X-rays to visualize breast tissue. It is the primary screening tool
for breast cancer.
 
IMAGING CENTER LOCATION AND OWNERSHIP STRUCTURE
 
  The following table sets forth certain information concerning the imaging
centers operated by the Company as of September 1998. Imaging centers that are
not 100% owned by the Company, through a wholly-owned subsidiary, are typically
owned by limited partnership or other business entities in which a subsidiary of
the Company is the sole general partner or manager. The equity ownership
interest shown includes general and limited partnership interests or other
equity interests owned by the Company. For the centers not wholly owned by the
Company, the Company is generally paid a management fee based on services
provided under management agreements with the imaging center's ownership entity.
 
<TABLE> 
<CAPTION>
                                                    OPERATED
       LOCATION                 NAME               SINCE (1)    OWNERSHIP(2)      MODALITIES(3)
       --------                 ----             -------------- ------------ -----------------------
 <C>                  <S>                        <C>            <C>          <C>
 Northeast Region(56)
  Englewood, NJ...... Englewood Imaging Center   December 1979       100%    MR, CT, US, R, F, M
  Marlton, NJ........ MRImaging of South         July 1984          91.0%    MR
                       Jersey
  Union, NJ.......... Open MRI of Union          August 1984        79.7%    MR
  Morristown, NJ..... MRImaging of Morristown    December 1984      94.2%    MR
  Philadelphia, PA... Academy Imaging Center     January 1986       97.7%    MR, CT, US, NM, R, F, M
  Allentown, PA...... MRImaging of Lehigh        May 1986           95.9%    MR
                       Valley
  Clifton, NJ........ Clifton Medical Imaging    June 1987           100%    MR, CT, US, NM, R, F, M
                       Center
  Yonkers, NY........ Inter-County Imaging       September 1987     65.0%    MR, CT, US, R, F, M
  West Orange, NJ(4). Northfield Imaging         January 1991        100%    MR, CT, US, NM, R, F, M
  Bel Air, MD........ Colonnade Imaging Center   November 1991      62.9%    MR, CT, US, NM, R, F, M
  Jersey City, NJ.... M.R. Institute at          July 1992           100%    MR
                       Midtown
  Brooklyn, NY....... Advanced MRA Imaging       January 1993        100%    MR, CT, US, NM, R, F, M
                       Associates
  Seabrook, MD....... Seabrook Radiological      April 1995         87.1%    MR, CT
                       Center
  Hackensack, NJ..... Hackensack Diagnostic      June 1995           100%    MR, CT, US, R, F, M
                       Imaging
  Bronx, NY.......... Westchester Square         January 1996        100%    MR, CT
                       Imaging
  New York, NY....... MRI-CT Scanning of         January 1996        100%    MR, CT, US, R, M
                       Manhattan
  Centereach, NY..... Open MRI of Centereach     July 1996           100%    MR
  Garden City, NY.... Open MRI at Garden City    November 1996       100%    MR
  East Setauket, NY.. Open MRI at Smith Haven    November 1996       100%    MR
</TABLE>        
 
                                       3
<PAGE>
 
<TABLE>          
<CAPTION>
                                                       OPERATED
        LOCATION                   NAME               SINCE (1)    OWNERSHIP(2)      MODALITIES(3)
        --------                   ----             -------------- ------------ -----------------------
 <C>                     <S>                        <C>            <C>          <C>
                         The MRI Center at
  North Bergen, NJ...... Palisades                  March 1997          9.0%    MR
                         West Hudson MRI
  Kearny, NJ............ Associates                 March 1997         25.0%    MR
                         Cranford Diagnostic
  Cranford, NJ.......... Imaging                    March 1997         75.0%    MR, CT, US, M
  Montvale, NJ.......... Montvale Medical Imaging   March 1997         13.8%    MR, CT, US, R, F, M
  Randolph, NJ.......... Morris-Sussex MRI          March 1997         20.0%    MR
                         Advantage Imaging at
  Totowa, NJ............ Totowa Road                March 1997         15.0%    MR
  Dedham, MA............ MRI of Dedham              March 1997         35.0%    MR
  Seekonk, MA........... RI-MASS MRI                March 1997          5.0%    MR
  Chelmsford, MA........ MRI of Chelmsford          March 1997         65.0%    MR
                         Parlin Diagnostic
  Parlin, NJ............ Imaging                    May 1997            100%    CT, US, R, F, M
  Vineland, NJ.......... South Jersey MRI           May 1997            100%    MR
  Baltimore, MD......... Baltimore Open MRI         May 1997            100%    MR
                         Accessible MRI of
  Silver Springs, MD.... Montgomery Cty             May 1997            100%    MR
                         Accessible MRI of
  Towson, MD............ Baltimore County           May 1997            100%    MR, CT
  Trevose, PA........... Bensalem Open MRI          May 1997            100%    MR
  Philadelphia, PA...... Callowhill Open MRI        May 1997            100%    MR
  Broomall, PA.......... Mainline Open MRI          May 1997            100%    MR
                         Oxford Valley Diagnostic
  Langhorn, PA.......... Center                     May 1997            100%    MR, CT, US, NM, R, F, M
                         Springfield Diagnostic
  Springfield, PA....... Imaging Center             May 1997            100%    MR, CT, US, NM, R, F, M
  Philadelphia, PA...... Lansdowne Medical Center   May 1997            100%    R
  Havertown, PA......... Manoa Radiology            May 1997            100%    CT, US, NM, R, F, M
  Havertown, PA......... Haverford MRI              May 1997            100%    MR
                         Lawrence Park Radiology
  Broomall, PA.......... Center                     May 1997            100%    R
  Philadelphia, PA...... Northeast Imaging          May 1997            100%    MR, CT, US, NM, R, F, M
                         South Philadelphia
  Philadelphia, PA...... Radiology Center           May 1997            100%    MR, CT, US, NM, R, F, M
  Philadelphia, PA...... Union Health Radiology     May 1997            100%    R, M
  Philadelphia, PA...... Juaniata Park              May 1997            100%    R
  Albany, NY............ Albany Open MRI            May 1997            100%    MR
  Syracuse, NY.......... Syracuse Open MRI          May 1997            100%    MR
                         Brooklyn Medical Imaging
  Brooklyn, NY--Ave P... Center                     June 1997           100%    MR, CT, US, NM, R, F, M
                         Brooklyn Medical Imaging
  Brooklyn, NY--Midwood. Center                     June 1997           100%    US, R, F, M
                         Meadows Mid-Queens
  Flushing, NY.......... Imaging Center             June 1997           100%    MR, CT, US, R, M
                         Staten Island Medical
  Staten Island, NY..... Imaging Center             June 1997           100%    MR, CT
  Bronx, NY............. MRI of the Bronx           September 1997      100%    MR, CT
  Flushing, NY.......... MRI of Queens              September 1997      100%    MR
  Philadelphia, PA...... Germantown MRI Center      September 1997      100%    MR
  Philadelphia, PA...... Diamond Radiology          September 1997      100%    R
 Southeast(24)
                         Magnetic Resonance
  St. Petersburg, FL.... Associates                 July 1984          80.2%    MR
  Naples, FL............ Gulf Coast MRI             June 1993           100%    MR
  Fort Myers, FL........ Fort Myers MRI Riverwalk   July 1998            50%    MR, CT, R, M
  Fort Myers, FL........ Fort Myers MRI South       May 1995            100%    MR
  Cape Coral, FL........ Cape Coral MRI             September 1996      100%    MR
  Naples, FL............ Naples MRI                 September 1996      100%    MR
  Titusville, FL........ MRI of North Brevard       September 1996      100%    MR
  Sarasota, FL.......... Sarasota Outpatient MRI
                         & Diagnostic Center        September 1996      100%    MR, CT
  Tampa, FL............. Americare MRI              May 1996            100%    MR
  Tampa, FL............. Americare Imaging          May 1996            100%    CT, US, R, F, M
  Clearwater, FL........ Access Imaging             May 1996            100%    MR, CT
  Melbourne, FL......... South Brevard Imaging      January 1997        100%    MR
                         MRI Center of
  Jacksonville, FL...... Jacksonville               February 1997       100%    MR
  West Palm Beach, FL... The Magnet of Palm Beach   March 1997          100%    MR, CT, US, NM, R, F, M
  Monticello, AR(5)..... Monticello Center          May 1997             (5)    R
  Ocala, FL(5).......... Ocala Center               May 1997             (5)    R
  Miami, FL............. Coral Way MRI              August 1997         100%    MR
  Sarasota, FL.......... Gulf Side Open MRI         August 1997         100%    MR
  Jupiter, FL........... MRI of Jupiter             August 1997         100%    MR, R
                         Magnetic Imaging Center
  Bradenton, FL......... of Manatee                 August 1997         100%    MR
                         Open MRI of South
  Hollywood, FL......... Florida                    August 1997         100%    MR
</TABLE>       
 
                                       4

<PAGE>
 
<TABLE>
<CAPTION>
                                                      OPERATED
        LOCATION                  NAME               SINCE (1)    OWNERSHIP(2)      MODALITIES(3)
        --------                  ----             -------------- ------------ -----------------------
 <C>                    <S>                        <C>            <C>          <C>
  Tampa, FL............ Northside Imaging &
                        Breast Care Center         August 1997         100%    MR
                        Venice Imaging & MRI
  Venice, FL........... Center                     August 1997         100%    MR, CT, US, R, F, M
                        The MRI Center of
  Port Charlotte, FL... Charlotte County           September 1997      100%    MR
 Midwest(9)
  Chicago, IL.......... MRImaging of Chicago       April 1987         87.2%    MR
  Chicago, IL.......... Open MRI of Chicago        June 1992          79.6%    MR, CT, US, NM, R, F, M
                        Oak Lawn MR & Imaging
  Oak Lawn, IL......... Center                     January 1994        100%    MR, CT, US, R, F, M
  Des Plaines, IL...... Golf MRI & Diagnostic
                        Imaging Center             January 1995       75.0%    MR, CT, US, NM, R, F, M
                        Libertyville Imaging
  Libertyville, IL..... Center                     January 1995        100%    MR
  Centerville, OH...... Dayton Open MRI            May 1997            100%    MR
                        Advanced
  Warren, OH........... Radiology/Access MRI       October 1997        100%    MR, CT, US, R, F, M
  Boardman, OH......... Boardman X-Ray/MRI         October 1997        100%    MR, CT, US, R, F, M
                        Western Reserve Imaging
  Youngstown, OH....... Center                     October 1997        100%    CT, US, R, F, M
 California(5)
  Long Beach, CA....... Pacific MRI                January 1997        100%    MR
                        OceanView Radiology
  San Clemente, CA..... Center                     January 1997        100%    MR, CT, US, R, F, M
  Rancho Cucamonga, CA. Grove Diagnostic Imaging   March 1997          100%    MR, CT, US, NM, R, F, M
                        Diagnostic Imaging
  San Jose, CA......... Network                    August 1997          51%    MR, CT, US, NM, R, F, M
  San Jose, CA......... O'Connor MRI               August 1997          60%    MR, CT
</TABLE>
--------
(1) Operated by the Company or NMR of America, Inc. since such date.
(2) Represents the Company's ownership interest in the respective centers.
(3) Modalities are magnetic resonance imaging (MR), computerized tomography
    (CT), ultrasound (US), nuclear medicine (NM), radiology (R), fluorscopy
    (F) and mammography (M).
(4) Includes the operation of the Livingston Breast Care mammography unit
    which is located at the Northfield Imaging Center.
(5) The Company manages the operations of a radiology facility under the terms
    of a management agreement.
 
  Where it deems it economically attractive, the Company may further increase
its ownership of its non-wholly-owned centers by acquiring additional minority
interests in such centers, but there can be no assurance that the Company will
be successful in so doing. The Company has also added new imaging equipment
modalities to certain centers and plans to continue this strategy in those
situations where the Company believes that such additions are economically
justified.
 
  Each center consists of a waiting/reception area and one room per modality,
dressing rooms, billing/administration rooms and radiologist interpreting
rooms. The size of the Company's centers generally ranges from 1,500 to 11,400
square feet.
 
GROWTH STRATEGY AT EXISTING AND ACQUIRED CENTERS
 
  Leveraging Geographic Concentration. The Company has developed clusters of
imaging centers in certain geographic areas that enable it to improve the
utilization of its centers by attracting business from larger referral
sources, such as managed care organizations, due to the Company's ability to
meet the quality, volume and geographical coverage requirements of these
payors. The Company intends, over time, to increase its center concentration
in existing markets to attract additional referrals of this type and to expand
into new geographic areas, through acquisitions, in order to attract
additional managed care and other contracts.
 
  Expanding Imaging Services Offered. The Company expands the imaging services
it offers by upgrading existing technology and adding new modalities at
selected centers. In 1997 and to date in 1998, the Company upgraded technology
and expanded service modalities at 15 centers. The Company's imaging centers
utilize state of the art imaging equipment for which new applications are
continually being developed. New developments and system upgrades frequently
have the ancillary benefit of reducing imaging time and thus increasing
capacity
 
                                      5

<PAGE>
 
of the centers' imaging equipment. The development and improvement of
diagnostic quality "open" MR systems have expanded the public acceptance and
potential market for MR imaging services. The Company currently operates 32
centers that provide MR imaging services using "open" systems and the Company
plans to expand this coverage in markets where it believes such expansion is
economically justified.
        
  Apply Sophisticated Operating, Financial and Information Systems and
Procedures. The Company provides management expertise, financial and operating
controls, and capital resources to its centers in an attempt to optimize their
performance. The financial systems and operating procedures of acquired
centers are, over time, integrated with those of the Company. In that regard,
as of June 1998 the Company completed the installation of the ICIS system
developed by Dalcon in substantially all of its centers. The ICIS system will
enable the Company to standardize reporting of each center and provide
management with on-line access to its centers nationwide. In addition, the
Company is able to achieve economies of scale and provide cost savings in
developing managed care contracts and negotiating group purchasing of goods
and services.         
 
  Utilize Targeted Localized Marketing. The Company develops and coordinates
marketing programs which center managers, sales representatives and affiliated
interpreting physicians utilize to establish referral relationships and to
maximize facility usage and reimbursement yield. The Company's marketing
programs emphasize the capabilities of its imaging equipment, the quality and
timeliness of the imaging results and reports, and the high level of patient
and referring physician service.
 
  Develop Network Management Services. The Company plans to develop and expand
further its network management services business. As a network manager, the
Company enters into contracts with managed care organizations to coordinate
the demand for imaging services and to provide certain administrative
functions related to the delivery of such services. The Company includes
certain of its centers in these networks and believes that the inclusion of
these centers in the networks will increase their utilization. In addition,
the Company believes that its network management services enhance its
relationships with managed care organizations and its ability to enter into
additional contracts with such entities.
 
CENTER OPERATIONS AND IMAGING SERVICES PROVIDED BY THE COMPANY
        
  General. The Company's diagnostic imaging centers provide diagnostic imaging
services in a comfortable, service-oriented environment located mainly in an
outpatient setting to patients referred by physicians. Of the Company's 94
centers, 82 provide magnetic resonance imaging, which accounts for a majority
of the Company's diagnostic imaging revenues. Many of the Company's centers
also provide some or all of the following services: Computerized Tomography,
Ultrasound, Nuclear Medicine, General Radiology and Fluoroscopy and
Mammography.          
 
  Interpreting Physician Arrangements. At each of the Company's centers, all
medical services are performed exclusively by physician groups (the "Physician
Group" or the "Interpreting Physician"), generally consisting of radiologists,
with whom the Company enters into independent contractor agreements. Pursuant
to these agreements, the Company, among other duties, provides to the
Physician Group the diagnostic imaging facility and equipment, performs all
marketing and administrative functions at the centers and is responsible for
the maintenance and servicing of the equipment and leasehold improvements. The
Physician Group is solely responsible for, and has complete and exclusive
control over, all medical and professional services performed at the centers,
including, most importantly, the interpretation of diagnostic images, as well
as the supervision of technicians, and medical-related quality assurance and
communications with referring physicians.
 
  Insofar as the Physician Group has complete and exclusive control over the
medical services performed at the centers, including the manner in which
medical services are performed, the assignment of individual physicians to
center duties and the hours that physicians are to be present at the center,
the Company believes that the Interpreting Physicians who perform medical
services at the centers are independent contractors. In addition, Physician
Groups that furnish professional services at the centers generally have their
own medical practices and, in most instances, perform medical services at non-
Company related facilities. The Company's
 
                                      6

<PAGE>
 
employees do not perform professional medical services at the centers.
Consequently, the Company believes that it does not engage in the practice of
medicine in jurisdictions that prohibit or limit the corporate practice of
medicine. The Company performs only administrative and technical services and
does not exercise any control over the practice of medicine by physicians at
the centers or employ physicians to provide medical services. The Company is
aware of three Interpreting Physicians who own a nominal percentage of three
limited partnerships that are managed and partially owned by the Company.
 
  As part of its administrative responsibilities under the terms of the
Interpreting Physician agreements, the Company is responsible for the
administrative aspects of billing and collection functions at the centers.
Certain third-party payor sources, such as Medicare, insurance companies and
managed care organizations, require that they receive a single or "global"
billing statement for the imaging services provided at the Company's centers.
Consequently, billing is done in the name of the Physician Group because such
billings include a medical component. The Physician Group grants a power of
attorney to the Company authorizing the Company to establish bank accounts
using the Physician Group's name related to that center's collection
activities and to access such accounts. In states where permitted by law, such
as Florida, the Company generally renders bills in the center's name. In such
circumstances, the Physician Group has no access to associated collections.
 
  The Company recognizes revenue under its agreements with Interpreting
Physicians in one of three ways: (I) the Company receives a technical fee for
each diagnostic imaging procedure performed at the center, the amount of which
is fixed based upon the type of the procedure performed; (II) the Company pays
the Interpreting Physicians a fixed percentage of fees collected at the
center, or a contractually fixed amount based upon the specific diagnostic
imaging procedures performed; or, (III) the Company receives from an
affiliated physician association a fee for the use of the premises, a fee per
procedure for acting as billing and collection agent for the affiliated
physician association and for administrative and technical services performed
at the centers and the affiliated physician association pays the Physician
Group based upon a percentage of the cash collected at the center. All of such
amounts and the basis for payments are negotiated between the Physician Group
and the Company.
 
  The fees received or retained by the Company under the three types of
agreements with Interpreting Physicians described above, expressed as a
percentage of the gross billings net of contractual allowances for the imaging
services provided, range from 78% to 93% for the agreements described in item
(I), 80% to 93% for the agreements described in item (II) and 80% to 89% for
the agreements described in item (III). The agreements generally have terms
ranging from one to ten years. For additional information pertaining to the
Company's arrangements with Interpreting Physicians, see Note 1 to the
Company's Consolidated Financial Statements--Revenue Recognition.
 
  Sales And Marketing. The Company develops and coordinates marketing programs
which center managers, sales representatives, affiliated Interpreting
Physicians and corporate managers utilize in an effort to establish and
maintain profitable referring physician relationships and to maximize
reimbursement yields. These marketing programs identify and target selected
market segments consisting of area physicians with certain desirable medical
specialties and reimbursement yields. Corporate and center managers determine
these market segments based upon an analysis of competition, imaging demand,
medical specialty and/or payor mix of each referral from the local market. The
Company also directs marketing efforts at managed care organizations.
 
  Managed care organizations are becoming an increasingly important factor in
the diagnostic imaging industry, and, consequently, the Company places major
emphasis on cultivating and developing relationships with such organizations.
The Company employs industry professionals who have significant experience in
dealing with managed care and other providers. The Company believes that the
geographic concentration of its centers, the presence of multi-modality
centers in all of its regions, its ability to offer cost effective services
and its experience in developing relationships with various managed care
organizations will constitute a competitive advantage with managed care
organizations.
 
                                      7

<PAGE>
 
  Personal Injury Revenue. A significant percentage of the Company's net
service revenues from imaging centers is derived by providing imaging services
to individuals involved in personal injury claims, mainly involving automobile
accidents. Imaging revenue derived from personal injury claims, mainly
involving automobile accidents, represented approximately 24% of the
Diagnostic Imaging business net service revenues for 1997. Due to the greater
complexity in processing receivables relating to personal injury claims with
automobile insurance carriers (including dependency on the outcome of
settlements or judgements for collections directly from such individuals),
such receivables typically require a longer period of time to collect,
compared to the Company's other receivables and, in the experience of the
Company, incur a higher bad debt expense.
 
  While the collection process employed by the Company varies from
jurisdiction to jurisdiction, the processing of a typical personal injury
claim generally commences with the Company obtaining and verifying automobile,
primary health and secondary health insurance information at the time services
are rendered. The Company then generates and sends a bill to the automobile
insurance carrier, which under state law, typically has an extended period of
time (usually up to 105 days) to accept or reject a claim. The amount of
documentation required by the automobile insurance carriers to support a claim
is substantially in excess of what most other payors require and carriers
frequently request additional information after the initial submission of a
claim. If the individual is subject to a co-payment or deductible under the
automobile insurance policy or has no automobile insurance coverage, the
Company generally will bill the individual's primary and secondary health
policies for the uncovered balance. The automobile insurance carrier may
reject coverage or fail to accept a claim within the statutory time limit on
the basis of, among other reasons, the failure to provide complete
documentation. In such circumstances, the Company may pursue arbitration,
which typically takes up to 90 days for a judgment, to collect from the
carrier.
 
  The Company will then pursue collection of the remaining receivable from the
individual. Although the Company attempts to bill promptly after providing
services and typically requests payment upon receipt of invoice, the Company
generally defers aggressive collection efforts for the remaining balance until
the individual's claim is resolved in court, which frequently takes longer
than a year and may take as long as two or three years. Consequently, the
Company's practice is to attempt to obtain a written assurance from the
individual and the individual's legal counsel, under which the individual
confirms in writing his or her obligation to pay the outstanding balance
regardless of the outcome of any settlement or judgment of the claim. If the
settlement or judgment proceeds received by the individual are insufficient to
cover the individual's obligation to the Company, and the individual does not
otherwise satisfy his or her liability to the Company, the Company either (i)
accepts a reduced amount in full satisfaction of the individual's outstanding
obligation, or (ii) commences collection proceedings, which may ultimately
result in the Company taking legal action to enforce its collection rights
against the individual regarding all uncollected accounts. As a result of the
foregoing, the average age of receivables relating to personal injury claims
is greater than for non-personal injury claim receivables.
          
  Managed Care Capitation Agreements. The Company has entered into a number of
"capitated contracts" with third party payors which typically provide for the
payment of a fixed fee per month on a per member basis, without regard to the
amount or scope of services rendered. Because the obligations to perform
service are not related to the payments, it is possible that either the cost
or the value of the services performed may significantly exceed the fees
received, and there may be a significant period between the time the services
are rendered and payment is received. While only approximately 2% of the
Company's 1997 net service revenues were derived from capitated contracts, and
although prior to entering into any such contracts the Company carefully
analyzes the potential risks of capitation arrangements, there can be no
assurances that any capitated contracts to which the Company is or may in the
future become a party will not generate significant losses to the Company.
           
  In addition, certain types of capitation agreements may be deemed a form of
risk contracting. Many states limit the extent to which any person can engage
in risk contracting, which involves the assumption of a financial risk with
respect to providing services to a patient. If the fees received by the
Company are less than the cost of providing the services, the Company may be
deemed to be acting as a de facto insurer. In some states, only certain
entities, such as insurance companies, HMOs and independent practice
associations, are permitted to
 
                                      8

<PAGE>
 
contract for the financial risk of patient care. In such states, risk
contracting in certain cases has been deemed to be engaging in the business of
insurance. The Company believes that it is not in violation of any
restrictions on risk bearing or engaging in the business of insurance. If the
Company is held to be unlawfully engaged in the business of insurance, such
finding could result in civil or criminal penalties or require the
restructuring of some or all of the Company's operations, which could have a
material adverse effect upon the Company's business.
 
  Billings And Collections. Under the Interpreting Physician agreements, the
Company is generally responsible for preparing and submitting bills per
imaging study performed. The preparation and submission of bills is completed
by each center, or by a regional billing office, generally on behalf of and in
the name of the appropriate Interpreting Physician. Prior to 1998, each center
was also responsible for collecting its own receivables and pursuing any
parties that were delinquent in payment of their bills. In February 1998, the
Company commenced a restructuring of its collection efforts for the purpose of
ultimately consolidating all collection activities within four or more
regional collection offices. The restructuring is in response to the need to
improve overall collection results and controls, and to better coordinate
collection efforts previously employed by individual centers (especially where
third parties had been retained to manage the center's collection efforts), as
well as the need to integrate the Company's 1997 acquisitions and to insure
consistent Company-wide collection policies and practices.
 
  Management Information Systems. The Company acquired Dalcon in September
1997. As of June 1998, a substantial majority of the Company's imaging centers
had been fully operating on Dalcon's ICIS radiology information system. The
ICIS radiology information system is designed to, among other things, enhance
the efficiency and productivity of the Company's centers, lower operating
costs, facilitate financial controls, increase reimbursement and assist in the
analysis of sales, marketing and referral data. The ICIS system provides on-
line, real-time information, reporting and access to managers with respect to
billing, patient scheduling, marketing, sales, accounts receivable, referrals
and collections, as well as other matters.
 
  Healthcare Reform and Cost Reduction Efforts. Third-party payors, including
Medicare, Medicaid, managed care/HMO organizations and certain commercial
payors have taken extensive steps to contain or reduce the costs of
healthcare. In certain areas, the payors are subject to regulations which
limit the amount of payments. Discussions within the Federal government
regarding national healthcare reform are emphasizing containment of healthcare
costs. In addition, certain managed care organizations have negotiated
capitated payment arrangements for imaging services. Under capitation
arrangements, diagnostic imaging service providers are compensated using a
fixed rate per member of the managed care organization regardless of the
number of procedures performed or the total cost of rendering diagnostic
services to the members. Services provided under these contracts are expected
to become an increasingly significant part of the Company's business. The
inability of the Company to properly manage the administration of capitated
contracts could materially adversely effect the Company. Although patients are
ultimately responsible for payment of services rendered, substantially all of
the Company's imaging centers' revenues are derived from third-party payors.
Successful reduction of reimbursement amounts and rates, changes in services
covered, delays or denials of reimbursement claims, negotiated or discounted
pricing and other similar measures could materially adversely affect the
Company's respective imaging centers' revenues, profitability and cash flow.
 
  The Company's management believes that overall reimbursement rates will
continue to gradually decline for some period of time due to factors such as
the expansion of managed care organizations and continued national healthcare
reform efforts. The Company enters into contractual arrangements with managed
care organizations which, due to the size of their membership, are able to
command reduced rates for services. The Company expects these agreements to
increase the number of procedures performed due to the additional referrals
from these managed care entities. However, there can be no assurance that the
increased volume of procedures associated with these contractual arrangements
will offset the reduction in reimbursement rate per procedure.
 
                                      9

<PAGE>
 
ACQUIRED CENTERS; COMMON STOCK REPURCHASE OBLIGATIONS
 
  Since 1996, the Company has grown by aggressively acquiring imaging centers
and integrating their operations. The Company has acquired 92 imaging centers
through 27 acquisitions since January 1, 1996. When the Company acquires an
imaging center, it generally acquires assets relating to the provision of
technical, financial, administrative and marketing services which support the
provision of medical services performed by the Interpreting Physicians. Such
assets typically include equipment, furnishings, supplies, tradenames of the
center, books and records, contractual rights with respect to leases, managed
care and other agreements and, in most instances, accounts receivable. Other
than with respect to such accounts receivable for services performed by the
acquired company, the Company does not acquire any rights with respect to or
have any direct relationship, with patients. Patients have relationships with
referral sources who are the primary or specialty care physicians for such
patients. These physicians refer their patients to diagnostic imaging centers
which may include the Company's centers where Interpreting Physicians, under
independent contractor agreements, provide professional medical services. The
Company's acquired imaging centers do not constitute either a radiology,
primary care or specialty care medical practice. In connection with an
acquisition of a center, the Company will generally enter into an agreement,
as described above, with a Physician Group to act as an independent contractor
to perform medical services at the center.
        
  In connection with certain of the Company's 1997 acquisitions in which the
Company issued shares of its Common Stock as consideration, the Company agreed
to register such shares for resale pursuant to the federal securities laws. In
certain of such acquisitions, the Company has granted specific remedies to the
sellers in the event that a registration statement covering the relevant
shares is not declared effective by the Securities and Exchange Commission
(the "SEC") within an agreed-upon period of time, including the right to
require the Company to repurchase the shares issued to such seller. In the
event the Company is unable to register such shares by the required dates, the
Company would become obligated to repurchase the shares issued in connection
with such acquisition. As of September 1, 1998, the Company had not registered
any shares of Common Stock issued in connection with the Company's 1997
acquisitions under a registration statement declared effective by the SEC. As
of December 31, 1997 and June 30, 1998, the Company had reflected $9,734,000
and $5,509,000, respectively, of Common Stock subject to redemption on its
Consolidated Balance Sheets related to shares that the Company may be required
to repurchase. During the first six months of 1998, the Company paid
$3,311,000 to sellers who exercised their rights to have shares of Common
Stock repurchased. In addition, the Company expects to become obligated to pay
an additional $5,509,000 during the remainder of 1998 in connection with the
settlement of certain repurchase obligations of the Company subject to, under
certain circumstances, the consent of the Senior Note holders. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."          
        
  In addition, in connection with certain of such acquisitions, the Company
has agreed with the sellers in such acquisitions to pay to the seller (in
additional shares and/or cash) an amount equal to the shortfall in the value
of the issued shares in the event the market value of such shares at the
relevant effective date of the registration statement or other negotiated date
is less than the market value of such shares as of the closing of the
acquisition or, in other cases, as of the execution of the relevant
acquisition agreement. Based upon the closing sales price of the Company's
Common Stock on September 1, 1998 ($4.00 per share), such shortfall would be
approximately $3,351,000, excluding Price Protection obligations related to
the shares which have repurchase obligations referred to above.         
 
  In connection with certain of the Company's acquisitions, the Company has
also agreed with certain sellers that all or a portion of the consideration
for such acquisitions will be paid on a contingent basis based upon the
profitability, revenues or other financial criteria of the acquired business
during an agreed-upon measurement period following the closing of the
acquisition (usually, one to three years). The specific terms of such
contingent consideration differs for each acquisition. In connection with
certain acquisitions, the Company and the relevant sellers have agreed to a
maximum amount of contingent consideration and in other cases the parties have
agreed that any payment of such contingent consideration may be paid in cash
or shares of Common Stock, or a combination of both.
 
                                      10

<PAGE>
 
  Although the Company has the option, in certain of such cases, to pay
certain of such amounts in shares of Common Stock, payment of significant cash
funds to sellers in the event such remedies or earnout provisions are
triggered could have a material adverse effect on the Company's cash flow and
financial condition. In addition, the Company may be required to finance all
or a portion of any such cash payments from third-party sources. No assurance
can be given that such capital will be available on terms acceptable to the
Company. In addition, the issuance by the Company of shares of Common Stock in
payment of any such owed amounts could be dilutive to the Company's
stockholders.
            
             
COMPETITION
 
  The Company's business is highly competitive. In the Company's diagnostic
imaging business, competition focuses primarily on attracting physician
referrals at the local market level and, increasingly, referrals through
relationships with managed care and physician/hospital organizations. The
Company believes that principal competitors in each of the Company's markets
are hospitals, independent or management company-owned imaging centers,
individual-owned imaging centers and mobile MR units. Many of these
competitors have greater financial and other resources than the Company.
Principal competitive factors include quality and timeliness of test results,
ability to develop and maintain relationships with managed care organizations
and referring physicians, type and quality of equipment, facility location,
convenience of scheduling and availability of patient appointment times.
Competition for referrals can also be affected by the ownership or affiliation
of competing centers or hospitals.
 
GOVERNMENT REGULATION
 
  The healthcare industry is highly regulated at the Federal, state and local
levels. The following factors affect the Company's operation and development
activities:
 
 Certificates Of Need, Licensing And Certification
       
  Many of the states in which the Company currently operates or may operate
have laws that may require a certificate of need ("CON") in certain
circumstances to establish, construct, acquire or expand healthcare facilities
and services or for the purchase, expansion or replacement of major movable
equipment, including outpatient diagnosis imaging centers utilizing MR or
other major medical equipment. At the present time, the CON laws of New York,
Illinois, Florida, Maryland and California pertain to the Company's
activities. In states with CON programs, regulatory approvals are frequently
required for capital expenditures exceeding certain amounts, if such
expenditures relate to certain types of medical services or equipment.       
 
  State CON statutes generally provide that prior to construction of new
facilities or the introduction of new services, a state health planning agency
(a "Planning Agency") must determine that a need exists for those facilities
or services. The CON process is intended to promote comprehensive healthcare
planning, assist in providing high quality health care at the lowest possible
cost and avoid unnecessary duplication by ensuring that only those healthcare
facilities that are needed will be built.
 
  Typically, the provider submits an application to the appropriate Planning
Agency with information concerning the geographic area and population to be
served, the anticipated demand for the facility or service to be provided, the
amount of capital expenditure, the estimated annual operating costs, the
relationship of the proposed facility or service to the overall state health
plan, if applicable, and the cost per patient for the type of care
contemplated. Whether the CON is granted is based upon a finding of need by
the Planning Agency in accordance with criteria set forth in CON statutes,
applicable regulations and applicable state and regional health facilities
plans. If the proposed facility or service is found to be necessary and the
applicant to be an appropriate provider, the Planning Agency will issue a CON
containing a maximum amount of expenditure and a specific time period for the
holder of the CON to implement the approved project.
 
                                      11

<PAGE>
 
  The necessity for these CON approvals serves as a barrier to entry in
certain markets which the Company wishes to service and has the potential to
increase the costs and delay the Company's acquisition, addition or expansion
of centers. A CON program or similar requirement has the potential to curtail
the Company's expansion which could have a material adverse effect on the
Company's future growth.
 
  The Company may also have to comply with Federal certification requirements.
For example, the Company's centers which provide mammography examinations must
be certified by the Federal government. Further, additional certification
requirements may affect the Company's centers, but such certification
generally will follow specific standards and requirements that are set forth
in readily available public documents. Compliance with the requirements often
is monitored by annual on site inspections by representatives of various
government agencies. The Company believes that it currently has obtained all
necessary certifications, but the failure to obtain a necessary certification
could have a material adverse effect on the Company's imaging business.
 
  In addition to the CON programs and Federal certification described above,
the operations of outpatient imaging centers are subject to Federal and state
regulations relating to licensure, standards of testing, accreditation of
certain personnel and compliance with government reimbursement programs. The
operation of these centers requires a number of Federal and state licenses,
including licenses for personnel and certain equipment. Although the Company
believes that currently it has obtained or is in the process of obtaining all
such necessary CON approvals and licenses, the failure to obtain a required
approval could have a material adverse effect on the Company's diagnostic
imaging business. The Company believes that diagnostic testing will continue
to be subject to intense regulation at the Federal and state levels and cannot
predict the scope and effect of such regulation nor the cost to the Company of
such compliance.
 
 Medicare Anti-Kickback Provisions
 
  The Federal Medicare and Medicaid Anti-Kickback Statute (the "Anti-Kickback
Statute") prohibits the offering, payment, solicitation or receipt of any form
of remuneration in return for the referral of patients covered by Medicare,
Medicaid or certain other Federal and state healthcare programs, or in return
for the purchase, lease or order or provision of any item or service that is
covered by Medicare or Medicaid or certain other Federal and state healthcare
programs. Violation of the Anti-Kickback Statute is punishable by substantial
fines, imprisonment for up to five years, or both. In addition, the Medicare
and Medicaid Patient and Program Protection Act of 1987 (the "Protection Act")
provides that persons guilty of violating the Anti-Kickback Statute may be
excluded from the Medicare or Medicaid programs. Investigations leading to
prosecutions and/or program exclusion may be conducted by the Office of
Inspector General ("OIG") of the Department of Health and Human Services
("HHS").
 
  The OIG has issued "safe harbor" regulations which describe practices that
will not be considered violations of the Anti-Kickback Statute. The fact that
a particular arrangement does not fall within a safe harbor does not mean that
the arrangement does not comply with the Anti-Kickback Statute. The safe
harbor regulations simply provide a guarantee that qualifying arrangements do
not violate this federal law. They do not extend the scope of the statutory
prohibitions. Thus, arrangements that do not qualify for safe harbor
protection are in largely the same position as they were prior to the
promulgation of these regulations, meaning that they must be carefully
evaluated in light of the provisions of the Anti-Kickback Statute itself. To
the extent possible, the Company will structure its agreements with referral
sources, such as physicians to comply with applicable safe harbors, but there
are no assurances that it will be able to so with every contract. Further,
these safe harbor regulations have so far been relatively untested in
practice. No assurances can be given that a Federal or state agency charged
with enforcement of the Anti-Kickback Statute and similar laws might not
assert a contrary position or that new Federal or state laws or new
interpretation of existing laws might not adversely affect relationships
established by the Company with healthcare providers, including physicians, or
result in the imposition of penalties on the Company or certain of its
centers. The assertion of a violation, even if successfully defended by the
Company, could have a material adverse effect upon the Company.
 
                                      12
<PAGE>
 
 Corporate Practice Of Medicine And Fee Splitting
 
  The laws of many states prohibit unlicensed, non-physician-owned entities or
corporations from performing medical services or physicians from splitting
fees with non-physicians. The Company is unlicensed for certain of its
services. The Company does not believe however, that it engages in the
unlawful practice of medicine or the delivery of medical services in any state
where it is prohibited, and is not licensed to practice medicine in states
which permit such licensure. Professional medical services, such as the
interpretation of MRI scans, are separately provided by independent contractor
Interpreting Physicians pursuant to agreements with the Company. The Company
performs only administrative and technical services and does not exercise
control over the practice of medicine by physicians or employ physicians to
provide medical services. However, in many jurisdictions, the laws restricting
the corporate practice of medicine and fee-splitting have been subject to
limited judicial and regulatory interpretation and, therefore, there can be no
assurance that, upon review, some of the Company's activities would not be
found to be in violation of such laws. If such a claim were successfully
asserted against it, the Company could be subject to civil and criminal
penalties and could be required to restructure its contractual relationships.
In addition, certain provisions of its contracts with Interpreting Physicians,
including the payment of management fees and restrictive covenants could be
held to be unenforceable. Such results or the inability of the Company to
restructure its contractual relationships could have a material adverse effect
upon the Company.
 
 Stark Law Prohibition On Physician Referrals
 
  The Federal "Stark Law" as amended in 1993 provides that when a physician
has a "financial relationship" with a provider of "designated health services"
(including, among other activities, the provision of MR and other radiology
services which are provided by the Company), the physician will be prohibited
from making a referral of Medicaid or Medicare patients to the healthcare
provider, and the provider will be prohibited from billing Medicare or
Medicaid, for the designated health service. In August 1995, regulations were
issued pursuant to the Stark Law as it existed prior to its amendment in 1993
(when it only applied to clinical laboratories). Draft regulations for the
provisions of the Stark Law applicable to MR and other radiology services were
issued in January, 1998. Submission of a claim that a provider knows, or
should know, is for services for which payment is prohibited under the amended
Stark Law, could result in refunds of any amounts billed, civil money
penalties of not more than $15,000 for each service billed, and possible
exclusion from the Medicare and Medicaid programs.
 
  The Stark Law provides exceptions from its prohibition for referrals which
include certain types of employment, personal service arrangements and
contractual relationships. The Company continues to review all aspects of its
operations and endeavors to comply in all material respects with applicable
provisions of the Stark Law. Due to the broad and sometimes vague nature of
this law, the ambiguity of related regulations, the absence of final
regulations, and the lack of interpretive case law, there can be no assurance
that an enforcement action will not be brought against the Company or that the
Company will not be found to be in violation of the Stark Law.
 
 False Claims Act
 
  A number of Federal laws impose civil and criminal liability for knowingly
presenting or causing to be presented a false or fraudulent claim, or
knowingly making a false statement to get a false claim paid or approved by
the government. Under one such law, the False Claims Act, civil damages may
include an amount that is three times the government's loss plus $5,000 to
$10,000 per claim. Actions to enforce the False Claims Act may be commenced by
a private citizen on behalf of the Federal government, and such private
citizens receive between 15 and 30 percent of the recovery. Efforts have been
made to assert that any claim resulting from a relationship in violation of
the Anti-Kickback Statute or the Stark Law is false and fraudulent under the
False Claims Act. The Company carefully monitors its submissions to HCFA and
all other claims for reimbursement to assure that they are not false or
fraudulent.
 
                                      13
<PAGE>
 
 State Laws
 
  Many states, including the states in which the Company operates, have
adopted statutes and regulations prohibiting payments for patient referrals
and other types of financial arrangements with healthcare providers, which,
while similar in certain respects to the Federal legislation, vary from state
to state. Some states expressly prohibit referrals by physicians to facilities
in which such physicians have a financial interest. Sanctions for violating
these state restrictions may include loss of licensure and civil and criminal
penalties assessed against either the referral source or the recipient
provider. Certain states also have begun requiring healthcare practitioners to
disclose to patients any financial relationship with other providers,
including advising patients of the availability of alternative providers.
 
  The Company continues to review all aspects of its operations and endeavors
to comply in all material respects with applicable provisions of the Anti-
Kickback Statute, the Stark Law and applicable state laws governing fraud and
abuse as well as licensing and certification. Due to the broad and sometimes
vague nature of these laws and requirements, the evolving interpretations of
these laws (as evidenced by the recent draft regulations for the Stark Law),
there can be no assurance that an enforcement action will not be brought
against the Company or that the Company will not be found to be in violation
of one or more of these regulatory provisions. Further, there can be no
assurance that new laws or regulations will not be enacted, or existing laws
or regulations interpreted or applied in the future in such a way as to have a
material adverse effect on the Company, or that Federal or state governments
will not impose additional restrictions upon all or a portion of the Company's
activities, which might adversely affect the Company's business.
            
              
DISCONTINUED OPERATIONS OF STARMED          
          
  Until August 1998, the Company, through the Per Diem and Travel Nursing
Divisions of its wholly-owned subsidiaries, StarMed Staffing, Inc. and Wesley
Medical Resources Inc. ("StarMed"), provided temporary healthcare staffing of
registered nurses and other medical personnel to acute and sub-acute care
facilities nationwide. On August 18, 1998, the Company sold the stock of
StarMed to RehabCare Group, Inc. for $33 million. Due to the StarMed Sale, the
results of operations of StarMed are herein reflected in the Company's
Consolidated Statements Of Operations as discontinued operations.        
       
  StarMed commenced its Per Diem operations in March 1995 and, since that
time, it had opened 31 offices, acquired 4 staffing companies operating six
additional offices and consolidated the operations of two other offices.
StarMed's per diem staffing division provided registered nurses, licensed
practical nurses, nursing assistants, therapists and medical transcriptionists
on a daily basis to healthcare facilities through 35 offices located in 16
states as of March 31, 1998. StarMed's Travel Nursing Division operated from a
central office in Clearwater, Florida and provided registered nurses and
operating room technicians for periods ranging from 8 to 26 weeks.       
 
EMPLOYEES
       
  As of December 31, 1997, the Company had approximately 1,277 full time
employees. This number does not include the healthcare personnel contracted by
StarMed for its Per Diem and Travel Nursing divisions as of such date. The
Company is not a party to any collective bargaining agreements and considers
its relationship with its employees to be good.        
 
INSURANCE
      
  The nature of the services provided by the Company expose the Company to
risk that certain parties may attempt to recover from the Company for alleged
wrongful acts committed by others. As a result of this risk, the Company
maintains workmen's compensation insurance, comprehensive and general
liability coverage, fire, allied perils coverage and professional liability
insurance in amounts deemed adequate by management to cover all potential
risk. There can be no assurance that potential claims will not exceed the
coverage amounts, that the cost of coverage will not substantially increase or
require the Company to insure itself or that certain coverage will not be
reduced or become unavailable.          
 
                                      14
<PAGE>
 
ITEM 2.  PROPERTIES

  The Company leases its 36,133 square foot principal and executive offices
pursuant to two leases with terms of five years and four years, respectively,
remaining. The building also houses the Company's Hackensack imaging center.
The Company's 94 imaging centers range in size from approximately 1,500 to
11,400 square feet. Each center consists of a waiting/reception area and one
room per modality, dressing rooms, billing/administration rooms and
radiologist interpreting rooms. The Company owns the real property in which
certain of its centers operate, and leases its remaining centers under leases
which expire from December 1997 through October 2002 and, in certain
instances, contain options to renew. The Company believes that if it were
unable to renew the lease on any of these facilities, other suitable
facilities would be available to meet the Company's needs. 
    
ITEM 3.  LITIGATION    

  As described below, the Company and certain of its officers and directors
have been named as defendants in several actions filed in state and federal
court arising out of the events also described under "Certain Relationships
and Related Transactions", involving, among other matters, allegations against
the Company with respect to related-party transactions and securities fraud.

  On November 5, 1997, ZPR Investments, Inc., ZP Investments, Inc., Wyoming
Valley Physicians Imaging Center, L.P., Camp Hill Physicians Imaging Center,
L.P., Wexford Radiology, P.C., Sanoy Medical Group, Ltd., Reading Open
Imaging, P.A., Yonas Zegeye, M.D., and Hirut Seleshi, parties who had agreed
to sell to the Company five related imaging centers located in Pennsylvania,
brought action in the Court of Chancery of the State of Delaware, New Castle
County, against the Company and five recently formed subsidiaries of the
Company, seeking specific performance of the acquisition agreements and
unspecified breach of contract damages. The plaintiffs alleged that the
Company and the subsidiaries failed to consummate the acquisition in
accordance with the terms of the acquisitions agreements. The aggregate
purchase price for the acquisitions is $8.4 million in cash and $5.6 million
payable in shares of Company Common Stock based upon the average price for the
five business days preceding September 21, 1997 (approximately 106,666
shares). Pursuant to the acquisition agreement, the shares of Common Stock
issued in connection with such acquisition are subject to price protection of
the issuance price compared to the market price at effectiveness of the
registration statement. In December 1997, the Company entered into an amended
agreement to settle such action and therein agreed to purchase the centers for
$1 million in cash, a promissory note for $7.4 million, plus interest, $5.6
million payable in shares of Company Common Stock, and the payment of certain
fees. The plaintiffs have announced that they do not intend to go forward with
the sale, although they continue to claim that the Company is in breach of the
acquisition agreements. The litigation in the Court of Chancery remains
stayed. 

  On November 7, 1997, William D. Farrell resigned from his position as
President and Chief Operating Officer of the Company and as Director and Gary
I. Fields resigned from his position as Senior Vice President and General
Counsel. On the same date, Messrs. Farrell and Fields, filed a Complaint in
the Superior Court of New Jersey, Law Division, Essex County, against the
Company and the members of the Company's Board of Directors, claiming
retaliatory discharge under the New Jersey Conscientious Employee Protection
Act and breach of contract. On December 17, 1997, the plaintiffs amended their
complaint to add a claim for violation of public policy. The plaintiffs allege
that they were constructively terminated as a result of their objection to
certain related-party transactions, the purported failure of the defendants to
adequately disclose the circumstances surrounding such transactions, and the
Company's public issuance of allegedly false and misleading accounts concerning
or relating to such related-party transactions. The plaintiffs seek unspecified
compensatory and punitive damages, interest and costs and reinstatement of the
plaintiffs to their positions with the Company. On April 8, 1998, the Company
filed its Answer to the Amended Complaint, and asserted a counterclaim against
Messrs. Farrell and Fields for breach of fiduciary duties. The Company intends
to defend vigorously against the allegations. 

  On November 12, 1997, Mr. Gerald Broder, who claims to be a company
stockholder, filed a derivative suit in the Court of Chancery of the State of
Delaware, New Castle County, naming the Company and Stephen M. Davis, Gary L.
Fuhrman, John H. Josephson, Neil H. Koffler, and Gary N. Siegler as defendants.
The complaint alleges that members of the Company's Board of Directors breached
their fiduciary duties owed to the Company and its stockholders by allegedly
engaging in self-dealing transactions that caused the Company financial harm.
The complaint seeks injunctive relief directing such directors to account to the
Company for its damages and their profits from the wrongs complained of therein,
enjoining them from continuing to engage in self-dealing transactions harmful to
the Company and its shareholders, and awarding plaintiff the costs and expenses
incurred in bringing the lawsuit. On April 1, 1998, the plaintiffs amended their
complaint to add additional factual allegations. The Company intends to defend
vigorously against the allegations. 

  On November 14, 1997, Mr. John P. O'Malley III filed a complaint in the
Superior Court of New Jersey, Law Division, Essex County, against the Company
and Gary N. Siegler, Neil H. Koffler, Stephen M. Davis, Gary L. Fuhrman, John
H. Josephson and Lawrence Ramaekers, as defendants, claiming retaliatory
discharge under the New Jersey Conscientious Employee Protection Act and
defamation. Mr. O'Malley alleges that the Company terminated his employment in
retaliation for voicing the concerns of shareholders and senior management
regarding related-party transactions and because the Company did not want to
make full and adequate disclosure of the facts and circumstances surrounding
such transactions. In addition, the plaintiff alleges that the Company
published false and defamatory statements about him. Mr. O'Malley seeks
unspecified compensatory and punitive damages, interest and costs of bringing
the action. On April 8, 1998, the Company filed its Answer to the Complaint,
and asserted a counterclaim against Mr. O'Malley for breach of fiduciary
duties. The Company intends to defend vigorously against the allegations. 

                                      15
<PAGE>
 
  Between November 14, 1997 and January 9, 1998, seven class action lawsuits
were filed in the United States District Court for the District of New Jersey
against the Company and certain of the Company's directors and/or officers. On
November 14, 1997, Joan D. Ferrari, who claims to be a Company stockholder,
filed a lawsuit on behalf of all persons who purchased Common Stock during the
period between May 15, 1997 and November 7, 1997. The Ferrari complaint names
as defendants the Company and Gary N. Siegler, Stephen M. Davis, Gary L.
Fuhrman, John H. Josephson and Neil H. Koffler. On November 18, 1997, Tri-
Masonry Company, who claims to be a Company stockholder, filed a complaint on
behalf of all persons who purchased Common Stock during the period between
March 19, 1997 and November 10, 1997. On November 19, 1997, Yaakov Prager, who
claims to be a Company stockholder, filed a complaint on behalf of all persons
who purchased Common Stock during the period between May 16, 1997 and November
10, 1997. The Tri-Masonry and Prager complaints name as defendants the
Company, William D. Farrell, John P. O'Malley and Gary N. Siegler. On November
20, 1997, Albert Schonert, who claims to be a Company stockholder, filed a
complaint on behalf of all persons who purchased Common Stock during the
period between May 15, 1997 and November 7, 1997. The Schonert complaint names
as defendants the Company and Gary N. Siegler, Stephen M . Davis, Gary L.
Fuhrman, John H. Josephson, Neil H. Koffler and William D. Farrell. On
December 12, 1997, Anne Benjamin, Scott L. Benjamin, Maxine Benjamin, Donald
Benjamin and Andrew M. Schreiber, who claim to be Company stockholders, filed
a complaint on behalf of all persons who purchased Common Stock during the
period between March 31, 1997 and November 10, 1997. The Benjamin complaint
names as defendants the Company and Gary N. Siegler, John P. O'Malley and
William D. Farrell. On December 31, 1997, Allen H. Weingarten, who claims to
be a Company stockholder, filed a complaint on behalf of all persons who
purchased Common Stock during the period between March 19, 1997 and November
10, 1997. The Weingarten complaint names as defendants the Company and William
D. Farrell, John P. O'Malley and Gary N. Siegler. On January 9, 1998, Roselle
Sachs, who claims to be a Company stockholder, filed a complaint on behalf of
all persons who purchased Common Stock during the period between May 15, 1997
and November 10, 1997. The Sachs complaint names as defendants the Company and
Gary N. Siegler, Stephen M. Davis, Gary L. Fuhrman, Neil H. Koffler and William
D. Farrell. 

  The complaints in each action assert that the Company and the named
defendants violated Section 10(b), and that certain named defendants violated
Section 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act"),
alleging that the Company omitted and/or misrepresented material information
in its public filings, including that the Company failed to disclose that it
had entered into acquisitions that were not in the best interest of the
Company, that it had paid unreasonable and unearned acquisition and financial
advisory fees to related parties, and that it concealed or failed to disclose
adverse material information about the Company. The complaints each seek
unspecified compensatory damages, with interest , and the costs and expenses
incurred in bringing the action. On February 9, 1998, the Honorable Joel Pisano,
United States Magistrate Judge, entered an Order consolidating the above-
mentioned class actions for all purposes. On March 31, 1998, the lead plaintiffs
in the consolidated class actions served their Consolidated Class Action
Complaint, asserting that the Company and the named defendants violated Section
10(b) of the Exchange Act, and that certain named defendants violated Sections
20(a) and 20A of the Exchange Act. The Company intends to defend vigorously
against the allegations. 

  As previously disclosed by the Company, the U.S. Attorney for the District
of New Jersey commenced an investigation in connection with the disclosures
regarding the related-party transactions referenced above. In addition as
previously disclosed, the Company has received an inquiry from the SEC, but no
formal proceedings have been commenced by the SEC. The Company has cooperated
fully with these authorities and provided all information requested by them.

  In 1996, Lavina Orsi and Pompeo Orsi brought an action in the Supreme Court
of the State of New York, King's County against Advanced MRA Imaging
Associates in Brooklyn, New York, a wholly owned subsidiary of the Company
("MRA Imaging"), for damages aggregating $12.5 million. The plaintiff alleges
negligent operations, improper supervision and hiring practices and the
failure to operate the premises in a safe manner, as a result of which the
individual suffered physical injury. The Company's general liability and
professional negligence insurance carriers have been notified, and it has been
agreed that the general liability insurance will pursue the defense of this
matter, however such insurers have reserved the right to claim that the scope
of the matter falls outside the Company's coverage. The parties to this matter
are engaged in discovery. 

  On June 2, 1998, Mr. Ronald Ash filed a complaint against the Company,
StarMed, Wesley Medical Resources, Inc., a subsidiary of the Company
("Wesley"), and certain officers and directors of the Company in the United
States District Court for the Northern District of California. The complaint,
among other things, alleges that the defendants omitted and/or misrepresented
material information in the Company's public filings and that they concealed
or failed to disclose adverse material information about the Company in
connection with the sale of Wesley to the Company by the plaintiff. The
plaintiff seeks damages in the amount of $4.25 million or, alternatively,
rescission of the sale of Wesley. The Company believes that it has meritorious
defenses to the claims asserted by plaintiff, and intends to defend itself
vigorously. 
 
  The legal proceedings described above are in their preliminary stages.
Although the Company believes it has meritorious defenses to all claims
against it, the Company is unable to predict with any certainty the ultimate
outcome of those proceedings.
 
  In the normal course of business, the Company is subject to claims and
litigation other than those set forth above. Management believes that such
other litigation will not have a material adverse effect on the Company's
financial position, cash flows or results of operations.
 
                                      16
<PAGE>
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     There were no matters submitted to a vote of security holders during the
last quarter of the year ended December 31, 1997.

                                      17
<PAGE>
 
                                    PART II

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

 Market Information and Stock Price

  The Company's Common Stock had been traded on the National Association of
Securities Dealers Automated Quotation System (NASDAQ) National Market, under
the symbol MRII, since November 3, 1995, and on the NASDAQ SmallCap Market
prior thereto. From April 20, 1998 through June 18, 1998 the Company's Common
Stock traded under the symbol MRIIE to reflect the fact that Nasdaq had
commenced proceedings to determine whether or not the Company's Common Stock
should continue to be traded on the Nasdaq Stock Market as a result of the
Company's failure to file its Annual Report on Form 10-K for the year ended
December 31, 1997 in a timely manner. On May 29, 1998, the Company was advised
that the Panel determined to continue the listing of the Company's Common
Stock on The Nasdaq Stock Market subject to certain conditions. The Company
was required to file its Quarterly Report on Form 10-Q for the quarter ended
March 31, 1998 on or before June 12, 1998, which the Company was able to do,
and to evidence compliance with either Nasdaq's minimum net tangible assets
test or one of Nasdaq's alternative requirements by July 24, 1998. In order to
meet one of Nasdaq's alternative listing requirements, the Company effected a
one-for-three reverse stock split of its Common Stock on July 24, 1998. On
July 28, 1998, the Panel notified the Company that the Company had complied
with Nasdaq's continued listing qualifications and that the Common Stock would
continue to be listed on The Nasdaq Stock Market. Nevertheless, there can be
no assurance that in the future the Common Stock will meet the continued
listing qualifications of The Nasdaq Stock Market. 

  The following table sets forth for the periods indicated below the high and
low sales prices per share of the Common Stock as reported by NASDAQ and gives
effect to the one-for-three reverse stock split of the Common Stock effected
on July 24, 1998: 
 
<TABLE>
<CAPTION>
                                                                 HIGH     LOW
                                                                ------- -------
   <S>                                                          <C>     <C>
   1996
     First Quarter............................................. $19 1/8 $13 7/8
     Second Quarter............................................ $30 3/4 $18 3/8
     Third Quarter............................................. $27 3/4 $18 3/4
     Fourth Quarter............................................ $35 1/4 $21
   1997
     First Quarter............................................. $37 1/2 $28 1/2
     Second Quarter............................................ $53 5/8 $29 5/8
     Third Quarter............................................. $60 3/4 $45 3/4
     Fourth Quarter............................................ $63     $23 1/4
   1998
     First Quarter............................................. $33 3/8 $14 5/8
     Second Quarter ........................................... $19 1/8 $ 6 3/16
     Third Quarter (through September 2, 1998)................. $12 3/4 $ 3 5/8
</TABLE>

  As of the close of business on September 1, 1998, the last reported sales
price per share of the Company's Common Stock was $4.00. 

  There were 435 holders of record of the Company's Common Stock at the close
of business on September 1, 1998. Such number does not include persons, whose
shares are held by a bank, brokerage house or clearing company, but does
include such banks, brokerage houses and clearing companies. 
 
  No cash dividends have been paid on the Company's Common Stock since the
organization of the Company and the Company does not anticipate paying
dividends in the foreseeable future. The payment by the Company of cash
dividends is limited by the terms of the agreement related to its issuance of
the Senior Notes. The Company currently intends to retain earnings for future
growth and expansion opportunities.
 
     The following is a list of securities sold by the Company during the period
covered by this Report on Form 10-K not previously included in the Company's
Quarterly Reports which, pursuant to the exemption provided under Section 4(2)
of the Securities Act of 1933, as amended (the "Securities Act"), were not
registered under the Securities Act:
   
     On November 5, 1997, the Company granted to Jay Alix & Associates ("Jay
Alix") warrants to purchase 8,333 shares of Common Stock with an exercise price
of $54.38 per share, 8,333 shares of Common Stock with an exercise price of
$63.00 per share and 8,333 shares of Common Stock with an exercise price of
$75.00 per    

                                      18

<PAGE>
 
share.  The Warrants have an 18-month term and were granted in connection with
the execution by Jay Alix of an interim management services agreement with the
Company.
    
     On December 29, 1997, the Company entered into a $15 million credit
facility with DVI Financial Services Inc. (the "Facility").  The Facility
provides for two advances to the Company, one for $8 million and the other for
$7 million.  In consideration for making the Facility available to the Company,
the lender received warrants to purchase an aggregate of 33,333 shares of
Common Stock at a exercise price based upon 110% of the average market prices
over a period prior to the issuance of the warrants.  In the event that the
lender refuses to make the second advance, warrants to purchase 15,556 shares of
Common Stock will be canceled.    
   
     On December 30, 1997, the Company issued warrants to acquire 272,333 shares
of Common Stock at an exercise price equal to $34.86 per share to RGC
International, LDC.  The warrants were issued in lieu of certain monetary
penalties incurred by the Company as a result of its failure to comply with the
provisions of a registration rights agreement entered into in connection with
the sale by the Company of $18,000,000 of Series C Convertible Preferred Stock
to RGC International, LDC.  See ITEM 7 - "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - LIQUIDITY AND CAPITAL
RESOURCES."    

ITEM 6. SELECTED FINANCIAL DATA
    
  The following selected consolidated historical financial data of the Company
is derived from the Company's consolidated financial statements for the periods
indicated and, as such, reflects the impact of acquired entities from the
effective dates of such transactions, and reflects StarMed as a discontinued
operation due to its August 1998 sale. The information in the table and the
notes thereto should be read in conjunction with "ITEM 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Company's Consolidated Financial Statements and notes thereto.    
 
<TABLE>
<CAPTION>
                                                                        
                              FOR THE YEARS ENDED DECEMBER 31,            
                         ---------------------------------------------    
                           1997      1996     1995     1994     1993    
                         --------  -------- -------- --------  -------  
                       (IN THOUSANDS EXCEPT SUPPLEMENTAL AND PER SHARE DATA)
<S>                      <C>       <C>      <C>      <C>       <C>      
STATEMENT OF OPERATIONS
 DATA(1)(2):
Net service revenues...  $144,412  $ 64,762 $ 35,860 $ 30,607  $26,934                       
Operating income                                                                             
 (loss)................   (21,297)   13,700    7,194    1,169    1,648                       
Income (loss) from                                                                           
 continuing operations                                                                       
 before extraordinary                                                                        
 item..................   (31,968)    6,983    4,246     (938)    (694)                      
Income (loss) from                                                                           
 continuing operations                                                                       
 per common share:                                                                           
  Basic(4).............     (4.96)     1.86     1.65     (.39)    (.33)                      
  Diluted(4)...........     (4.96)     1.72     1.64     (.39)    (.33)                      
SUPPLEMENTAL DATA(1):                                                                        
Number of consolidated                                                                       
 imaging centers at end                                                                      
 of period.............        98        39       11        8        8                       
Total procedures at                                                                          
 consolidated imaging                                                                        
 centers...............   527,477   209,970  124,302  101,460   86,686                       
BALANCE SHEET DATA:(1)                                                                       
Working capital surplus                                                                      
 (deficit)(3)..........  $(58,174) $ 42,775 $ 10,738 $  5,834  $ 3,365                       
Total assets...........   338,956   164,514   44,136   40,372   40,881                       
Long term debt and                                                                           
 capital lease                                                                               
 obligations (excluding                                                                      
 current portion)......    37,900    21,011   11,157   13,415   19,034                       
Convertible debentures.       --      6,988    4,350      --       --                        
Stockholders' equity...   126,904   106,384   16,966   11,872   12,939                       
</TABLE>
--------

(1) Statement of Operations Data, Supplemental Data and Balance Sheet Data
    reflect the impact of a substantial number of acquisitions during 1997 and
    1996. See Note 14 of the Notes to Consolidated Financial Statements for
    the Year Ended December 31, 1997. 

(2) Statement of Operations Data has been restated to reflect the financial
    results of StarMed as discontinued operations. See Note 16 of the Notes to
    the Consolidated Financial Statements. 

(3) As a result of the Company's default of certain financial covenants under
    the Company's Senior Notes, the Company's Senior Notes and other loans and
    capital leases also subject to acceleration as a result thereof are shown
    as current liabilities as of December 31, 1997. See "Management's Discussion
    and Analysis of Financial Condition and Results of Operations--Liquidity and
    Capital Resources."

(4) Earnings per share amounts for 1997 include charges related to restricted
    common stock and convertible preferred stock of $1,938,000.
 
Earnings per share amounts for prior periods, including related quarters, have
been restated to conform to the requirements of Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings per Share."

                                      19
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
       AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

Revenue Recognition
-------------------

  At each of the Company's diagnostic imaging centers, all medical services
are performed exclusively by physician groups (the "Physician Group" or the
"Interpreting Physician"), generally consisting of radiologists with whom the
Company has entered into independent contractor agreements. Pursuant to these
agreements, the Company has agreed to provide equipment, premises,
comprehensive management and administration, including responsibility for
billing and collection of receivables, and technical imaging services to the
Interpreting Physician.
 
  Net service revenues are reported, when earned, at their estimated net
realizable amounts from patients, third party payors and others for services
rendered at contractually established billing rates which generally are at a
discount from gross billing rates. Known and estimated differences between
contractually established billing rates and gross billing rates (referred to
as "contractual allowances") are recognized in the determination of net
service revenues at the time services are rendered. Subject to the foregoing,
the Company's diagnostic imaging centers recognize revenue under one of the
three following types of agreements with Interpreting Physicians:

    Type I--The Company receives a technical fee for each diagnostic imaging
  procedure performed at a center, the amount of which is dependent upon the
  type of procedure performed. The fee included in revenues is net of
  contractual allowances. The Company and the Interpreting Physician
  proportionally share in any losses due to uncollectible amounts from
  patients and third party payors, and the Company has established reserves for
  its share of the estimated uncollectible amount. Type I net service revenues
  for 1997 were $80,818,000, or 56% of revenues.

    Type II--The Company bills patients and third party payors directly for
  services provided and pays the Interpreting Physicians either (i) a fixed
  percentage of fees collected at the center, or (ii) a contractually fixed
  amount based upon the specific diagnostic imaging procedures performed.
  Revenues are recorded net of contractual allowances and the Company accrues
  the Interpreting Physicians fee as an expense on the Consolidated
  Statements of Operations. The Company bears the risk of loss due to
  uncollectible amounts from patients and third party payors, and the Company
  has established reserves for the estimated uncollectible amount. Type II net
  service revenues for 1997 were $55,016,000, or 38% of revenues.

    Type III--The Company receives from an affiliated physician association a
  fee for the use of the premises, a fee per procedure for acting as billing
  and collection agent and a fee for administrative and technical services
  performed at the centers. The affiliated physician association contracts
  with and pays directly the Interpreting Physicians. The Company's fee, net
  of an allowance based upon the affiliated physician association's ability
  to pay after the association has fulfilled its obligations (i.e., estimated
  future net collections from patients and third party payors less facility
  lease expense and Interpreting Physicians fees), constitutes the Company's
  net service revenues. Since the Company's net service revenues are
  dependent upon the amount ultimately realized from patient and third party
  receivables, the Company's revenue and receivables have been reduced by an
  estimate of patient and third party payor contractual allowances, as well as
  an estimated provision for uncollectible amounts from patients and third party
  payors. Type III net service revenues for 1997 were $8,342,000, or 6% of
  revenues.
 
  Revenues derived from Medicare and Medicaid are subject to audit by such
agencies. The Company is not aware of any pending audits.
 
  The fees received or retained by the Company under the three types of
agreements with Interpreting Physicians described above, expressed as a
percentage of gross billings net of contractual allowances for the imaging
services provided, range from 78% to 93% for the Type I agreements, 80% to 93%
for the Type II agreements and 80% to 89% for the Type III agreements. These
agreements generally have terms ranging from one to ten years.

  Until August 1998, the Company, through the Per Diem and Travel Nursing
Divisions of its wholly-owned subsidiaries, StarMed Staffing, Inc. and Wesley
Medical Resources Inc. ("StarMed"), provided temporary healthcare staffing of
registered nurses and other medical personnel to acute and sub-acute care
facilities nationwide. On August 18, 1998, the Company sold StarMed to
RehabCare Group, Inc. for $33 million (the "StarMed Sale"). Due to the StarMed
Sale, the results of operations of StarMed are herein reflected in the
Company's Consolidated Statements Of Operations as discontinued operations.

  On July 24, 1998, the Company effected a one-for-three reverse stock split
of its Common Stock. The information in this Report on Form 10-K gives effect to
such reverse stock split.

                                      20
<PAGE>
 
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
---------------------------------------------------------------------

  For the year ended December 31, 1997, the Company's net service revenues
increased $79,650,000, or 123%, to $144,412,000 in 1997 from $64,762,000 in
1996, due primarily to revenues of $60,849,000 contributed by centers acquired
during 1997. Revenues at imaging centers acquired during 1996 increased
$20,585,000, or 93%, to $42,617,000 in 1997 from $22,032,000 in 1996 primarily
as a result of the timing of the 1996 acquisitions, partially offset by an
increase of $5,896,000 in the estimated provision for uncollectible amounts
related to Type III centers. Revenues at imaging centers that were operated by
the Company for all of 1997 and 1996 decreased $1,784,000, or 4%, to
$40,946,000 in 1997 from $42,730,000 in 1996, primarily as a result of higher
contractual allowances in 1997 and relatively constant procedure volumes.
 
  Revenues in 1997 were adversely affected by higher contractual allowance
estimates, including a component related to the ultimate collectibility of
amounts related to the Company's Type III revenue. These contractual allowance
estimates are largely dependent upon reimbursement rates from third party
payors, including Medicare, Medicaid and managed care providers. Management
believes that the Company's overall reimbursement rates will continue to
gradually decline for some period of time, due to factors such as the
expansion of managed care organizations and continued national healthcare
reform efforts. The Company will endeavor to mitigate the impact of any
decline in reimbursement rates by decreasing costs and increasing referral
volume. If the rate of decline in reimbursement rates were to increase
materially, or if the Company is unsuccessful in reducing its costs or
increasing its volume, the Company's results could be materially and adversely
affected.
 
  Revenue derived from personal injury claims, mainly involving automobile
accidents, represented approximately 24% of net service revenues for 1997.
Automobile insurance carriers generally pay the non-deductible non-co-pay
portion of the charge, with the remaining balance payable by the individual.
The timing of collection from the individual is partially dependent upon the
outcome and timing of any settlement or judgment of the injury claim.
Accordingly, such receivables typically require a longer period of time to
collect compared to the Company's other receivables, and in the experience of
the Company incur a higher bad debt expense. If the Company were to become
less successful in its efforts in collecting these receivables, the Company's
results could be materially and adversely affected.
 
  Operating costs increased $54,408,000, or 156%, to $89,234,000 in 1997 from
$34,826,000 in 1996, due primarily to operating costs of $35,079,000 related
to centers acquired during 1997. Operating costs at imaging centers acquired
during 1996 increased $18,155,000, or 149%, to $30,325,000 in 1997 from
$12,170,000 in 1996, primarily as a result of the timing of the 1996
acquisitions. Operating costs at imaging centers that were operated by the
Company for all of 1997 and 1996 increased $2,166,000, or 10%, to $23,830,000
in 1997 from $21,664,000 in 1996, primarily as a result of higher payroll and
related costs.
 
  Center operating margins, which represent net service revenue less imaging
center operating costs as a percent of net revenue, decreased in 1997 to 38%
from 46% in 1996 due primarily to higher contractual allowance estimates,
including a component related to the ultimate collectibility of amounts
related to the Company's Type III revenue, as described above, and generally
higher costs.
 
                                      21
<PAGE>
 
  The provision for uncollectible accounts receivable in 1997 was $20,364,000,
or 14% of related net service revenues, compared to the 1996 provision of
$4,705,000 or 7% of related net service revenues. The increase in the
provision for uncollectible accounts receivable was due to the deterioration
during 1997 in the aging of the Company's accounts receivable and a
reassessment by the Company of its expected future collections based upon 1997
collection activity, including analyzing collection experience of its personal
injury receivables. Management believes that the deterioration in the aging of
accounts receivable occurred primarily during the second half of 1997 and was
the result of the Company's substantial acquisition activity in 1997 and the
delay in promptly integrating the billing and collection activities with
respect to such acquisitions. In addition, the Company was without a permanent
President and Chief Financial Officer from October 1997 through February 1998,
which allowed the aging of accounts receivable to continue to worsen since
management resources were not directed at improving billing and collections.
During the fourth quarter of 1997, as the age of the specific bills lengthened,
the ability to research and pursue the old receivables worsened and hence it was
determined that a reserve was required for a substantial number of these older
receivables. Management does not expect further deterioration to occur in 1998
although that will depend on actual collections performance. Accounts receivable
before allowances for uncollectibles aged over one-year increased to
$21,485,000, or 25% of total receivables in 1997, from $7,016,000, or 14% of
total receivables in 1996.

  Management expects its provision for uncollectible accounts receivable as a
percentage of revenues to approximate 8% for 1998. An additional reserve of
approximately 1% of net imaging revenues for uncollectible patient and third
party payors related to the Company's Type III centers is expected to be
reflected as a reduction in net revenues for 1998.

  Corporate general and administrative expense in 1997 was $12,157,000, an
increase of $7,590,000 from the $4,567,000 recorded in 1996. This increase was
primarily due to higher payroll and related costs as a result of the expanded
business development activities and the resulting growth experienced during
the year. In March 1998, the Company announced a workforce reduction and
follow-on attrition program that is expected to result in reduced payroll
costs of approximately $5,000,000 per annum from the levels of the fourth
quarter of 1997. This reduction in workforce is not expected to adversely
impact the ability of the Company to generate future revenue. 
 
  During 1997, the Company recorded $2,536,000 of stock-option based
compensation expense. This non-cash charge was related to stock option grants
to employees and directors during 1996 and early 1997 that were subsequently
approved by the Company's stockholders in May, 1997.
 
  Depreciation and amortization expense in 1997 was $18,733,080, compared to
$6,964,000 in 1996, or an increase of $11,769,000 due primarily to higher
equipment depreciation of $6,585,000 resulting from 1997 acquisitions and
increased goodwill amortization of $4,638,000.

  During 1997, the Company recorded a $12,962,000 loss from the impairment of
goodwill and other long-lived assets. This loss consists of the write-off of
goodwill of $10,425,000, covenants not to compete of $118,000 and fixed assets
of $2,419,000. The write-down of fixed assets primarily relates to imaging
equipment. Substantially all of the impairment relates to eight of the
Company's diagnostic imaging centers which were under performing. The Company
has recorded impairment losses for these centers because the sum of the
expected future cash flows, determined based on an assumed continuation of
current operating methods and structures, does not cover the carrying value of
the related long-lived assets. The operating performance of these centers
declined during 1997 due primarily to declines in referrals and the Company
did not believe that these centers would materially improve in the future.

  During 1997, the Company also recorded $9,723,000 of other unusual charges
consisting of (i) $3,256,000 for the estimated net costs associated with the
resolution of the shareholder and employee lawsuits, (ii) $2,243,000 for
higher than normal professional fees, (iii) $2,169,000 ($2,051,000 of which
was a non-cash charge related to the issuance of 817,000 common stock
warrants) for penalties associated with delays in the registration of the
Company's common stock issued in connection with acquisitions or issuable upon
conversion of convertible preferred stock, (iv) $1,150,000 for the loss on
investment related to a potential acquisition not consummated, (v) $469,000
for costs associated with the investigation of related party transactions and
(vi) $436,000 for management termination benefits and related costs.
 
                                      22

<PAGE>
 
  The Company expects to incur additional unusual charges of at least
$4,500,000 during 1998 primarily related to the estimated net costs associated
with the resolution of the shareholder and employee lawsuits, penalties
associated with delays in the registration of the Company's Common Stock, and
costs associated with the investigation of related party transactions which
was concluded in April 1998. Such additional amounts could be substantially
higher depending upon the outcome of current negotiations regarding penalties
associated with the failure to register the Company's common stock and the
outcome of certain litigation.
 
  Net interest expense for 1997 was $8,814,000 as compared to $2,834,000 for
1996, an increase of $5,980,000. This increase was primarily attributable to
higher outstanding debt, including the issuance of $78,000,000 of Senior Notes
during 1997, notes payable of $36,505,000 and capital lease obligations
totaling $26,612,000 assumed in connection with the Company's acquisitions.
 
  The Company's earnings in 1997 were reduced by $636,000 attributable to
minority interests, as compared to $308,000 in 1996. The increase of $328,000
is primarily due to the acquisition of entities during 1997 that operate
limited partnerships with minority holdings.
 
  The provision for income taxes in 1997 was $1,221,000, as compared to
$3,575,000 in 1996. During 1997, the income tax benefit calculated based upon
the Company's pre-tax loss was reduced by an income tax valuation allowance of
$10,700,000. This valuation allowance was recorded due to uncertainty
regarding the realization of the full amount of the Company's net deferred
income tax assets.
 
  The Company's net loss from continuing operations for 1997 was $31,968,000
compared to net income from continuing operations for 1996 of $6,983,000.
 
  The net loss applicable to common stockholders (used in computing loss per
common share) in 1997 includes charges of $1,938,000 related to Common Stock
subject to redemption and convertible preferred stock. These charges relate to
price protection agreements provided in connection with the Company's 1997
acquisitions of $1,696,000 and the accretion of the Company's preferred stock
of $242,000.
 
 Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
 
  For the year ended December 31, 1996, net service revenues amounted to
$64,762,000 versus $35,860,000 for the year ended December 31, 1995, an
increase of $28,902,000 or 80.6%. Management fee and use revenues for
diagnostic imaging services increased $8,270,000 from $31,174,000 for the year
ended December 31, 1995 to $39,445,000 for the year ended December 31, 1996.
This increase is primarily attributable to an increase of $1,326,000 (4.5%) at
centers which were included in revenue for all of 1996 and 1995; $2,752,000
(169%) in revenue at a center acquired during 1995 and $4,192,000 of revenue
contributed by imaging centers acquired during 1996.
 
  Diagnostic imaging patient service revenues increased $20,631,000 for the
year ended December 31, 1996 to $25,317,000 from $4,686,000 for the year ended
December 31, 1995. This increase is attributable to an increase of $615,000
(19%) at centers which were included in revenue for all of 1995 and 1996;
$2,670,000 (183%) at centers acquired during 1995 and; $22,032,000 of revenue
was contributed by centers acquired during 1996.
 
  Technical services payroll and related costs for the year ended December 31,
1996 amounted to $10,836,000 compared to $6,815,000 for the year ended
December 31, 1995, an increase of $4,021,000 or 59%.
 
  Medical supplies amounted to $4,223,000 for the year ended December 31, 1996
as compared to $2,439,000 for the year ended December 31, 1995, an increase of
$1,784,000 or 73%. Of this increase $1,725,000 or 97% is attributable to
centers acquired during 1995 and 1996.
 
                                      23

<PAGE>
 
  For the year ended December 31, 1996 diagnostic equipment maintenance
increased $1,627,000 or 99% to $3,274,000 from $1,647,000 for the year ended
December 31, 1995. This increase is primarily due to centers acquired during
1995 and 1996.
 
  Independent contractor fees amounted to $1,202,000 for the year ended
December 31, 1996 as compared to $437,000, for the year ended 1995. This
increase of $765,000 or 175% is attributable to the Type II (see Note 1)
centers acquired during 1995 and 1996.
 
  Administrative costs which include facilities rent, marketing costs and
personnel costs of employees whose activities relate to the operations of
multiple centers increased approximately $6,685,000 or 127% from $5,252,000
for the year ended December 31, 1995 to $11,937,000. This increase is
primarily due to costs incurred at imaging centers acquired during 1995 and
1996.
 
  Other costs increased by $1,924,000 or 134% for the year ended December 31,
1996 to $3,354,000 as compared to $1,430,000 in the prior year primarily due
to an increase in accounting, legal and professional fees for the centers.
 
  Provision for uncollectible accounts receivable increased $1,327,000 or 39%
from $3,378,000 from the year ended December 31, 1995 to $4,705,000 for the
year ended December 31, 1996. The 1996 provision for uncollectible accounts
consists of 7.3% of revenue as compared to 9.4% of revenue in 1995. The
decrease in the provision for uncollectible accounts receivable as a
percentage of revenues is due to acquired companies having a more favorable
collection experience due to differences in payor mix.
 
  Corporate general and administrative expense increased by $1,573,000 or 53%
from $2,994,000 for the year ended December 31, 1995 to $4,567,000 for the
year ended December 31, 1996. This increase is primarily due to the expanded
business development activities and the resulting growth experienced during
the year, particularly following the acquisition of NMR of America, Inc.
("NMR").
 
  Depreciation and amortization expense was $6,964,000 for the year ended
December 31, 1996 compared to $4,274,000 for the year ended December 31, 1995
or an increase of $2,690,000 or 63% due primarily to depreciation expense
relating to acquired assets and increased goodwill amortization incurred in
connection with such acquisitions.
 
  Interest expense for the year ended December 31, 1996 was $2,834,000 as
compared to $1,829,000 for the prior year, an increase of $1,005,000 or 55%.
This increase is primarily attributable to an increase in interest on
convertible debentures and lines of credit outstanding during 1996 of $646,000
and increases in interest on debt assumed in acquisitions during 1996 totaling
$764,000 offset by decreases in interest expense relating to scheduled
reductions in outstanding principal balances.
 
  Minority interest amounted to $308,000 for the year ended December 31, 1996
as compared to ($124,000) for the year ended December 31, 1995. The increase
of $432,000 or 348.4% is attributable to increased profitability at the
Company's St. Petersburg, Florida and Yonkers, New York facilities ($383,000)
and the acquisition of the NMR facilities ($49,000).
 
  The provisions for income taxes increased $2,332,000 or 188% for the year
ended December 31, 1996 from $1,243,000 to $3,575,000. This increase is
attributable to the increased profitability of the Company's existing and
acquired businesses during 1996 and an increase in the Company's effective
income tax rate. The Company's provision for income taxes resulted in
effective tax rates of 33.9% in 1996 and 22.4% in 1995, respectively.
 
  The 1996 provision was higher than the statutory rate primarily due to state
and local income taxes, net of the Federal tax effect (6.3%), the impact on
non-deductible goodwill (1.8%) and meals and entertainment, offset by other
items amounting to (8.2%). In 1995, the effective tax rate was lower than the
statutory rate primarily due to a reduction in the deferred tax asset
valuation allowance (27.7%) offset by other items amounting to 16.3%.
 
                                      24

<PAGE>
 
  For the reasons described above, the Company's net income from continuing
operations for the year ended December 31, 1996 increased $2,737,000 or 64.5%
from $4,246,000 for the year ended December 31, 1995 to $6,983,000.

STARMED SALE 

  On August 18, 1998, the Company sold the stock of StarMed to RehabCare
Group, Inc. for gross proceeds of $33,000,000. Due to the StarMed Sale, the
results of operations of StarMed are herein reflected in the Company's
Consolidated Statements of Operations as discontinued operations. 

  Net cash proceeds from the StarMed Sale were used as follows: (i)
$13,786,000 to repay StarMed's outstanding third-party debt (in accordance
with the terms of sale) (ii) $2,000,000 was placed in escrow to be available,
for a specified period of time, to fund indemnification obligations that may
be incurred by the Company (part or all of this amount may be payable to the
Company over time) and (iii) an additional $2,000,000 was placed into escrow
to be applied as a partial repayment of the Company's $78,000,000 of Senior
Notes. The remaining net proceeds of approximately $13,400,000 increased the
Company's consolidated cash balances. For accounting purposes, a pretax gain
from the StarMed Sale of approximately $5,000,000 is expected to be reported
in the third quarter of 1998. 
 
RESULTS OF DISCONTINUED OPERATIONS

 Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
 
  Net service revenues for StarMed increased to $57,974,000 in 1997 from
$29,023,000 in 1996, an increase of $28,951,000 or 100%. Internal growth in
the staffing business, consisting primarily of the opening of new per diem
offices, accounted for $5,442,000 of the increase in revenues. Increased
revenues at per diem offices opened or acquired during 1996 accounted for
$16,861,000 of revenues and revenues of $6,648,000 were contributed by per
diem offices acquired during 1997.
 
  Operating costs for StarMed in 1997 were $46,831,000 compared to $24,238,000
for the year ended December 31, 1996, an increase of $22,593,000 or 93%.
Internal growth in the staffing business, accounted for $4,143,000 of the
increase in operating costs. Increased costs at per diem offices opened or
acquired during 1996 accounted for $11,812,000 of the higher operating costs
and operating costs of $5,646,000 were contributed by per diem offices
acquired during 1997.
 
  Center operating margins for StarMed increased in 1997 to 19% from 16% due
primarily to improved profitability of per diem offices opened or acquired
prior to 1997.

                                      25

<PAGE>
 
  Net earnings related to StarMed increased to $729,000 in 1997 from $271,000
in 1996.
 
 Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
 
  StarMed revenues increased $12,890,000 (80.3%) primarily due to internal
growth and acquisitions. Internal growth in the staffing segment consisting of
the opening of new per diem offices accounted for approximately $3,200,000 of
the increase in staffing revenue. Increased revenues at per diem offices
opened during 1995, related primarily to improved volume as these offices
matured from their start up phase, accounted for approximately $3,400,000 of
the increase in staffing revenues. Per diem staffing businesses acquired
during 1996 contributed approximately $6,300,000 in revenues during the year.
 
  Technical services payroll and related costs for StarMed for the year ended
December 31, 1996 amounted to $24,238,000 compared to $12,711,000 for the year
ended December 31, 1995, an increase of $11,527,000 or 91%. Of this increase
$6,569,000 or 42% is attributable to the opening of new per Diem offices and
the staffing acquisitions and $2,622,000 increase is due to the maturation of
per diem offices opened in 1995.
 
  Net earnings related to StarMed were $271,000 for 1996, as compared to a net
loss of $103,000 for 1995.
 
  Net loss related to the Company's discontinued maternity apparel subsidiary
was $2,453,000 in 1995.
 
LIQUIDITY AND CAPITAL RESOURCES

  During 1997, the Company's primary source of cash flow was from financing
activities, largely as a result of net proceeds from the Senior Notes of
$76,523,000, net proceeds from the issuance of convertible preferred stock of
$16,965,000, and other financing activities. The primary use of cash was to
fund acquisitions which totaled $73,121,000 and to fund the repayment of
certain notes and capital lease obligations of $13,764,000. Operating
activities resulted in a net use of cash of $5,322,000 during 1997 due
primarily to increases in accounts receivable.
 
  Net cash provided by operating activities for 1996 and 1995 was $1,450,000
and $2,335,000, respectively, representing a decrease of $885,000 in 1996. The
decrease was due primarily to a large increase in accounts receivable and
certain other assets which relate primarily to the Company's expansion
activities offset by
 
                                      26

<PAGE>
 
increases in net income, non-cash charges and other liabilities. In 1996, net
cash used in investing activities totaled $16,703,000 which includes (i)
$8,569,000 expended for the purchase of diagnostic imaging centers, offset by
$2,157,000 of cash acquired in the acquisition of NMR, (ii) $2,314,000 for the
purchase of Per Diem staffing businesses and (iii) $184,000 for the purchase
of limited partnership interests. During 1996, the Company purchased
$6,137,000 of investments, $4,500,000 of these investments were subsequently
set aside (restricted) pursuant to the terms of a letter of credit issued in
connection with an acquisition. An additional $600,000 in cash was set aside
(restricted) pursuant to a letter of credit issued in conjunction with a
consulting agreement to which the Company is a party. The Company expended
$1,070,000 in 1996 for medical diagnostic and office equipment. Financing
activities provided $27,110,000 in cash during the year ended December 31,
1996, which consisted of net proceeds of $25,164,000 received through a public
offering of the Company's Common Stock, $6,533,000 of net proceeds from the
issuance of subordinated debentures, $1,229,000 proceeds from borrowings
during the year (used to purchase equipment for the imaging centers),
$2,022,000 realized from the exercise of stock options and warrants, offset by
$7,773,000 utilized for the repayment of debt and capital lease obligations
and $64,000 used to purchase shares of the Company's Common Stock.
 
  The Company has never declared a dividend on its Common Stock and under the
Company's Senior Note agreement, the payments of such dividends is not
permitted.
   
  As a result of its net loss for 1997 and the late filing of its 1997 Annual
Report on Form 10-K, the Company is currently in default of certain financial
covenants under the agreements for its $78,000,000 of Senior Notes. The
financial covenant defaults under the Senior Note agreements entitle the lenders
to exercise certain remedies including acceleration of repayment. In addition,
certain medical equipment notes, and operating and capital leases of the
Company, aggregating $16,685,000 at December 31, 1997 (the "Cross-Default
Debt"), contain provisions which allow the creditors or lessors to accelerate
their debt or terminate their leases and seek certain other remedies if the
Company is in default under the terms of agreements such as the Senior Notes. In
the event that the Senior Note lenders or the holders of the Cross Default Debt
elect to exercise their right to accelerate the obligations under the Senior
Notes or the other loans and leases, such acceleration would have a material
adverse effect on the Company, its operations and its financial condition.
Furthermore, if such obligations were to be accelerated, in whole or in part,
there can be no assurance that the Company would be successful in identifying or
consummating financing necessary to satisfy the obligations which would become
immediately due and payable. As a result of the uncertainty related to the
defaults and corresponding remedies described above, the Senior Notes and the
Cross Default Debt were shown as current liabilities on the Company's
Consolidated Balance Sheet at December 31, 1997. Accordingly, the Company had a
deficit in working capital of $58,174,000 at December 31, 1997. These matters
raise substantial doubt about the Company's ability to continue as a going
concern. The report of the Company's independent auditors, Ernst & Young LLP, on
the consolidated financial statements of the Company for the year ended December
31, 1997 contains an explanatory paragraph with respect to the issues that raise
substantial doubt about the Company's ability to continue as a going concern
mentioned in Note 2 to the Company's consolidated financial statements. The
financial statements do not include any further adjustments reflecting the
possible future effects on the recoverability and classification of assets or
the amount and classification of liabilities that may have resulted from the
outcome of this uncertainty.    

  In August 1998, management reached an agreement in principle with the Senior
Note lenders with respect to existing covenant defaults and certain covenant
modifications. Under the terms of the agreement in principle, the Senior Note
lenders have agreed to waive all existing covenant defaults and to modify the
financial covenants applicable over the remaining term of the Senior Notes. In
consideration for these waivers and covenant modifications, the Company has
agreed to increase the effective blended interest rate on the Senior Notes from
7.87% to 9.00%, and issue to the Senior Note lenders warrants to acquire 375,000
shares of the Company's Common Stock at an exercise price of $7.67 per common
share. In addition, the Company has agreed to prepay $2,000,000 of principal
outstanding on the Senior Notes (without premium) and to pay a fee to the Senior
Note lenders of $500,000. The agreement in principle is subject to the execution
of definitive documents, which are expected to be completed during September
1998.
                                      27
<PAGE>
 
  In addition to reaching an agreement in principle with the Senior Note
lenders with respect to existing covenant defaults and certain covenant
modifications, the Company has taken various actions in response to this
situation, including the following: (i) it effected a workforce reduction in
March 1998 aimed at reducing the Company's overall expense levels by
approximately $5,000,000 per annum and (ii) sold the Company's temporary
healthcare staffing business, StarMed, for $33,000,000 in August 1998. Upon
execution of the definitive documents with respect to the Senior Notes, the
Senior Notes and the Cross Default Debt will no longer be in default and will
be shown as long-term debt beginning with the September 30, 1998 Consolidated
Balance Sheet.
   
        The Company has a working capital deficit of $58,174,000 at December 31,
1997 compared to a working capital surplus of $42,775,000 at December 31, 1996. 
The deficit is primarily due to $78,000,000 of Senior Notes due 2001 through 
2005 and other debt and capital leases shown as current liabilities as a result 
of financial covenant defaults under such agreements.    
    
  In connection with certain of the Company's 1997 acquisitions in which the
Company issued shares of its Common Stock as partial consideration, the Company
granted rights to have such shares registered for resale pursuant to the federal
securities laws. In certain of such acquisitions, the Company has granted
specific remedies to the sellers in the event that the registration statement
covering the relevant shares is not declared effective by the Securities and
Exchange Commission within an agreed-upon period of time, including the right to
require the Company to repurchase the shares issued to such seller. In the event
the Company is unable to register such shares by the required dates, the Company
would become obligated to repurchase the shares issued in connection with such
acquisition. As of December 31, 1997, the Company had reflected $9,734,000 of
Common Stock subject to redemption on its Consolidated Balance Sheet related to
shares that the Company may be required to repurchase. During the six months
ended June 30, 1998, the Company paid $3,311,000 to sellers who exercised their
rights to have shares of Common Stock repurchased. The Company expects to pay an
additional $5,509,000 during the remainder of 1998 ($3,696,000 of which was due
and payable on June 3, 1998 (the "June 1998 Repurchase Obligation") but has not
been paid by the Company) in connection with the settlement of certain
repurchase obligations of the Company subject, under certain circumstances, to
the consent of the Senior Note holders. With respect to the June 1998 Repurchase
Obligation which remains due and payable, the Company is in discussions with the
sellers to whom such obligations are owed and the Senior Note lenders regarding
the timing and satisfaction of the June 1998 Repurchase Obligation.    

  In addition, in connection with certain of such acquisitions, the Company
has agreed with the sellers in such acquisitions to pay to the sellers (in
additional shares and/or cash) an amount equal to the shortfall in the value
of the issued shares in the event the market value of such shares at the
relevant effective date of the registration statement or other negotiated date
is less than the market value of such shares as of the closing of the
acquisition or, in other cases, as of the execution of the relevant
acquisition agreement (referred to as "Price Protection"). Any such Price
Protection payments will be charged to stockholders' equity. Based upon the
closing sales price of the Company's Common Stock on September 1, 1998 ($4.00
per share), such shortfall would be approximately $3,351,000, excluding Price
Protection obligations related to the shares which have repurchase
obligations, referred to above. 

  In addition, in connection with certain of the Company's acquisitions, the
Company has agreed with the relevant sellers that all or a portion of the
consideration for such acquisitions will be paid on a contingent basis based
upon the profitability, revenues or other financial criteria of the acquired
business during an agreed-upon measurement period following the closing of the
acquisition (usually, one to three years). The specific terms of such
contingent consideration differ for each acquisition. In connection with
certain acquisitions, the Company and the relevant sellers have agreed to a
maximum amount of contingent consideration and in other cases the parties have
agreed that any payment of such contingent consideration may be paid in cash
or shares of Common Stock, or a combination of both. Contingent consideration
associated with acquisitions is recorded as additional purchase price when
resolved.

  Although the Company has the option, in certain cases, to pay certain of
such amounts in shares of Common Stock, payment of significant cash funds to
sellers in the event such remedies or earnout provisions are triggered 
 
                                      28

<PAGE>
 
could have a material adverse effect on the Company's cash flow and financial
condition. In addition, the Company may be required to finance all or a
portion of any such cash payments from third-party sources. No assurance can
be given that such capital will be available on terms acceptable to the
Company. In addition, the issuance by the Company of shares of Common Stock in
payment of any such owed amounts could be dilutive to the Company's
stockholders. 

  Pursuant to the terms of the Series C Convertible Preferred Stock Purchase
Agreement, dated July 21, 1997, and the Registration Rights Agreement dated
July 21, 1997, as amended, between the Company and RGC International, LDC
("RGC") (hereinafter referred to as the "RGC Agreements"), the Company issued
18,000 shares of Series C Convertible Preferred Stock, $1,000 stated value per
share (the "Series C Preferred Stock") to RGC. Under the RGC Agreements, the
Company was required to use its best efforts to include the shares of Common
Stock issuable upon conversion of the Series C Preferred Stock (the "RGC
Conversion Shares") in an effective Registration Statement on Form S-3 not
later than October 1997. As amended, the RGC Agreements provide for monthly
penalties ("RGC Registration Penalties") in the event that the Company failed
to register the Conversion Shares prior to October 1997 with such penalties
continuing until July 23, 1998. 

  On June 18, 1998 2,500 shares of Series C Preferred Stock were converted
into 373,220 shares of Common Stock. Accordingly, as of June 30, 1998, 15,500
shares of the Company's Series C Preferred Stock were issued and outstanding.
Each share of the Series C Preferred Stock is convertible into such number of
shares of Common Stock as is determined by dividing the stated value ($1,000)
of each share of Series C Preferred Stock plus 3% per annum from the closing
date to the conversion date by the lesser of (i) $62.10 or (ii) the average of
the daily closing bid prices for the Common Stock for the (5) five consecutive
trading days ending five (5) trading days prior to the date of conversion.

  As a result of the Company's continued failure to register the RGC
Conversion Shares, the Company: (i) issued warrants to RGC to acquire 389,000
shares of Common Stock at an exercise prices ranging from $34.86 to $38.85 per
share, subject to reset in November 1998 (such warrants having an estimated
value, for accounting purposes, of $3,245,000); and (ii) issued interest
bearing promissory notes (the "RGC Penalty Notes") in the aggregate principal
amount of $2,450,000 due October 15, 1998. The principal amount of and
interest accrued on the RGC Penalty Notes may be converted, at the option of
the Company or RGC in certain circumstances, into additional shares of Series
C Preferred Stock or Common Stock. Pursuant to an amendment to the RGC
Agreements entered into June 1998, the Company will no longer incur any
monthly penalties for failure to register the RGC Conversion Shares following
July 23, 1998. However, if the RGC Conversion Shares are not registered as of
September 15, 1998 (the Company is currently in discussions with RGC to extend
such date), RGC may demand a one-time penalty of $1,550,000 (the "September
1998 Penalty"), payable, at the option of RGC, in cash or additional shares of
Common Stock. There can be no assurance that the Company will be able to
register the RGC Conversion Shares by such date, or any extended date, or that
the Company will be able to pay the RGC Penalty Notes when due or the
September 1998 Penalty, if such payment becomes due. Purchasers of Common
Stock could therefore experience substantial dilution upon conversion of the
Series C Preferred Stock and the RGC Penalty Notes and the exercise of such
warrants. The shares of Series C Preferred Stock are not registered and may be
sold only if registered under the Act or sold in accordance with an applicable
exemption from registration, such as Rule 144. 

  In addition to matters discussed above, the Company is subject to litigation
that may require additional future cash outlays. 

  During 1997, the Company incurred substantial debt in connection with
acquisitions of imaging centers. As of June 30, 1998, the Company's debt,
including capitalized lease obligations, totaled $155,369,000. The aggregate
estimated amounts of principal, interest and capital lease obligations due in
each of the years ended December 31, 1998 through 2002 on such debt, including
payments associated with the StarMed Sale, is $49,125,000 ($37,980,000 of
which has been paid through August 31, 1998), $25,713,000, $27,647,000,
$32,373,000 and $24,177,000, respectively. The Company does not expect to
incur significant additional debt in the near future and expects to rely on
its existing cash balances, of approximately $18,242,000 at August 31, 1998,
and its ability to enter into operating leases to fund expansions and
equipment replacement at its centers. 
 
                                      29
<PAGE>
 
  The Company's sources of liquidity consist of its cash balances and its
ability to enter into operating leases to fund expansions and equipment
replacement at its centers. At June 30, 1998 and December 31, 1997, the
Company's cash and cash equivalents were $14,085,000 and $23,198,000,
respectively. As a result of improvements in the Company's billing and
collection systems, the Company expects its cash flow from operations,
including changes in accounts receivable, to increase from the level achieved
in the six months ending June 30, 1998. Assuming that the Company executes
definitive documents with respect to the Senior Notes consistent with the
agreement in principle, management believes that the positive cash flow from
operations, the Company's existing cash balances, and net cash proceeds from
the StarMed Sale will provide it with sufficient funds available to finance
its needs through 1998. 

  In order to meet one of Nasdaq's alternative listing requirements, the Company
effected a one-for-three reverse stock split of its Common Stock on July 24,
1998. On July 28, 1998, the Nasdaq Qualifications Listing Panel notified the
Company that the Company had complied with Nasdaq's continued listing
qualifications and that the Common Stock would continue to be listed on The
Nasdaq Stock Market. The share data included in this Report of Form 10-K has
been adjusted to reflect the impact of the reverse stock split. There can be no
assurance that in the future the Common Stock will meet the continued listing
requirements for The Nasdaq Stock Market.

SEASONALITY AND INFLATION

  The Company believes that its imaging business is generally unaffected by
seasonality. The impact of inflation and changing prices on the Company has
been primarily limited to salary, medical and film supplies and rent increases
and has not been material to date to the Company's operations. Notwithstanding
the foregoing, general inflationary expectations and growing health care cost
containment pressures in the future may cause the Company not to be able to
raise the prices for its diagnostic imaging procedures by an amount sufficient
to offset such negative effects. While the Company has responded to these
concerns in the past by increasing the volume of its business there can be no
assurance that the Company will be able to increase its volume of business in
the future. In addition, current discussions within the Federal Government
regarding national health care reform are emphasizing containment of health
care costs as well as expansion of the number of eligible parties. The
implementation of this reform could have a material effect on the financial
results of the Company. 
 
IMPACT OF YEAR 2000 ON COMPANY'S COMPUTER SOFTWARE
 
  The Computer programming code utilized in the Company's financial, billing
and imaging equipment systems were generally written using two digits rather
than four to define the applicable year. As a result, those computer programs
have time-sensitive software that recognizes a date using 00's as the year
1900 rather than the year 2000. This could cause a system failure or
miscalculations resulting in disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in other normal business activities.
 
  The Company has completed an assessment of its material financial and
billing computer systems. The Company is in the process of upgrading these
systems to be Year 2000 compliant and expects to complete this process by late
1998 to early 1999. The cost to be incurred related to Year 2000 compliance
for these systems is currently not expected to be material.

  The Company has initiated a program to determine whether the computer
applications of its significant payors and suppliers will be upgraded in a
timely manner. The Company has also initiated a program to determine whether
embedded applications that control certain medical and other equipment will be
affected. The Company has not yet completed these reviews. The nature of the
Company's business is such that any failure to these types of applications may
have a material adverse effect on its business. If the Company determines that
certain of its suppliers will not be year 2000 compliant, then the Company
will endeavor to find alternative suppliers; however, there can be no
assurance that the Company will be able to find alternative suppliers.
 
  Because of the many uncertainties associated with Year 2000 compliance
issues, and because the Company's assessment is necessarily based on
information from third party-vendors, payors and suppliers, there
 
                                      30
<PAGE>
 
can be no assurance that the Company's assessment is correct or as to the
materiality or effect of any failure of such assessment to be correct.
 
  Software sold by the Company's wholly-owned subsidiary, Dalcon Technologies,
Inc., is expected to be fully year 2000 compliant in connection with the
annual upgrade planned for late 1998.
 
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
 
  SFAS No. 130, "Reporting Comprehensive Income", requires an entity to report
comprehensive income and its components for fiscal years beginning after
December 15, 1997. This new standard increases financial reporting
disclosures, but will have no impact on the Company's financial position or
results of operations.
 
  Statement Of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use", requires an entity to expense all
software development costs incurred in the preliminary project state training
costs and data conversion costs for fiscal years beginning after December 15,
1998. The Company believes that this statement will not have a material effect
on the Company's accounting for computer software acquisition cost.
 
  Statement Of Position 97-2, "Consolidation of Physicians' Practice
Entities", requires an entity to consolidate Physicians' Practice Entities in
circumstances in which substantial control is exercised by the Company. The
Company believes that this statement will not have a material effect on the
Company's financial position or results of operations.
 
DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

  Statements contained in this Report that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Investors are cautioned that forward-looking
statements are inherently uncertain. Actual performance and results may differ
materially from that projected or suggested herein due to certain risks and
uncertainties including, without limitation: the ability of the Company to
effectively integrate the operations and information systems of businesses
acquired in 1997 and earlier; the ability of the Company to generate net
positive cash flows from operations; the payment timing and ultimate
collectibility of accounts receivable (including purchased accounts
receivable) from different payor groups (including Personal Injury-type); the
economic impact of involuntary share repurchases and other payments (including
price protection payments and penalty payments) caused by the delay in the
effectiveness of the Company's Registration Statement and by the recent decline
in the Company's share price; the ability of the Company and its Senior Note
Lenders to finalize and execute definitive documents, in general, and consistent
with their agreement-in-principle, which cure all existing loan covenant
defaults and which modify the financial covenants applicable over the remaining
term of the Senior Notes; the impact of a changing and increasing mix of managed
care and personal injury claim business on contractual allowance provisions, net
revenues and bad debt provisions; the extent of Medicare reimbursement
reductions effected by the Health Care Financing Administration (HCFA) in line
with its recent proposals; the ultimate economic impact of recent litigation
including shareholder and former management lawsuits against the Company and
certain of its Directors; the availability of debt and/or equity capital, on
reasonable terms, to finance operations as needed and to finance growth; and the
effects of federal and state laws and regulations on the Company's business over
time. Additional information concerning certain risks and uncertainties that
could cause actual results to differ materially from that projected or suggested
may be identified from time to time in the Company's Securities and Exchange
Commission filings and the Company's public announcements.
 
                                      31

<PAGE>
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Registrant's response to this item is incorporated herein by reference to
the consolidated financial statements and consolidated financial statement
schedule and the reports thereon of independent auditors, listed in Item
14(a)(l) and (2) and appearing after the signature page to this Annual Report on
Form 10-K.

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

     On December 4, 1997, Coopers & Lybrand LLP ("Coopers & Lybrand") resigned
as auditor of the Company.

     In connection with the audit of the Company's financial statements for the
fiscal year ended December 31, 1996 and in the subsequent interim period (the
"Reporting Period"), there were no matters of disagreement with Coopers &
Lybrand on any matters of accounting principles or practices, financial
statement disclosure, or auditing scope or procedures which, if not resolved to
the satisfaction of Coopers & Lybrand, would have caused Coopers & Lybrand to
make reference thereto in their report.  During the Reporting Period, Coopers &
Lybrand's report on the Company's financial statements did not contain an
adverse opinion or a disclaimer of opinion nor was it qualified or modified as
to uncertainty, audit scope, or accounting principles.

     On December 8, 1997, the Company engaged Ernst & Young, LLP ("Ernst &
Young") to audit the financial statements of the Company.  Ernst & Young had
previously served as the Company's independent auditors for the fiscal years
ended December 31, 1994 and 1995.

                                      32
<PAGE>
 
                                   PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS

        The directors, executive officers and certain key employees of the
Company as of September 29, 1998 are as follows:

<TABLE>
<CAPTION>
         NAME          AGE POSITION
         ----          --- --------
 <C>                   <C> <S>
 Sally W. Crawford....  44 Director
 Peter B. Davis.......  53 Director
 Gary L. Fuhrman......  37 Director
 John H. Josephson....  36 Director
 Duane C. Montopoli...  49 Chief Executive Officer, President and Director
 Gary N. Siegler......  36 Director
                           Chairman of the Board and Director, Chairman of the
 D. Gordon Strickland.  51 Executive Committee
 Gerald H. Allen......  50 Senior Vice President--Diagnostic Imaging Business
                           Senior Vice President--Legal Affairs and
 Christopher J. Joyce.  34 Administration and Secretary
                           Chief Financial Officer and Senior Vice President--
 Geoffrey A. Whynot...  39 Finance
</TABLE>

  Sally W. Crawford was appointed a director of the Company by the Board of
Directors in June 1998 and is a member of the Board's Audit Committee. Ms.
Crawford was the Chief Operating Officer of Healthsource Inc. from 1985 to
1997. Prior thereto, Ms. Crawford was employed by Beacon Health where she was
the marketing director. Ms. Crawford is also a director of Harborside
Healthcare, Yankee Publishing and CYTYC Corporation.

  Peter B. Davis was appointed a director of the Company by the Board of
Directors in June 1998 and is a member of the Board's Compensation Committee.
Mr. Davis is the President and the CEO of St. Joseph Hospital in Nashua, New
Hampshire. From January 1997 through June 1998, Mr. Davis was the Interim
President and CEO of Optima Healthcare, a New Hampshire joint operating
company, where he has been employed since January 1997. 

  Gary L. Fuhrman has been a director of the Company since 1992 and is a
member of the Board's Compensation and Audit Committees. Mr. Fuhrman has been
a director and Senior Vice President of Arnhold and S. Bleichroeder, Inc., an
investment banking firm, since March 1995 and January 1993, respectively, and
a Vice President of such firm for more than five years prior thereto. 

  John H. Josephson has been a director of the Company since July 1994 and is
a member of the Board's Executive and Compensation Committees. Mr. Josephson
is a Vice President and Director of Allen & Company Incorporated, an
investment banking firm, and has been with such firm since 1987. Mr. Josephson
is also a director of Norwood Promotional Products, Inc. 

  Duane C. Montopoli was appointed President and Chief Executive Officer and a
director of the Company effective January 30, 1998. Mr. Montopoli is a member
of the Board's Executive Committee. Previously, Mr. Montopoli was President
and Chief Executive Officer of Chemfab Corporation (NYSE:CFA) which he joined
in 1986. Until January 1990, he was also a partner in Oak Grove Ventures which
he joined in December 1983. Prior to that time, Mr. Montopoli was employed by
Arthur Young & Company (now Ernst & Young LLP) where he was a general partner
from October 1982 through December 1983. 

  Gary N. Siegler, a director since 1990, served as Chairman of the Board of
Directors of the Company from 1990 until June 1998. Mr. Siegler is a member of
the Board's Audit Committee. Mr. Siegler is a co-founder and, since January
1989, has been President of Siegler, Collery & Co., a New York-based
investment firm ("Siegler Collery"). Mr. Siegler is a principal member of the
general partner of The SC Fundamental Value Fund, L.P. ("Fundamental Value
Fund"), a fund investing in marketable securities, and an executive officer of
SC Fundamental Value BVI, Inc. ("Fundamental Value BVI"), the managing partner
of the investment advisor to 
 
                                      33
<PAGE>
 
an offshore fund investing in marketable securities. Mr. Siegler serves as the
Chairman of the Board of Directors of National R.V. Holdings, Inc., a
manufacturer of motor homes and other recreational vehicles.

  D. Gordon Strickland has been a director of the Company since December 1997
and was appointed Chairman of the Board's Executive Committee in January 1998.
He was appointed Chairman of the Board in June 1998. Mr. Strickland is Senior
Vice President--Investments for Tauber Enterprises, a private investment
holding company. Mr. Strickland was President and Chief Executive Officer of
Kerr Group, Inc. ("Kerr Group"), a NYSE-listed manufacturer of plastic
packaging products, from 1996 to September 1997. From 1986 to 1996, he served
as Senior Vice President, Finance and Chief Financial Officer of Kerr Group.

  Gerald H. Allen was appointed in March 1998 as President of the Imaging
Division of the Company (now, Senior Vice President--Diagnostic Imaging
Business) and since April 1995 has also held the positions of Senior Vice
President--Operations and Senior Vice President--Development. Mr. Allen was
employed by the Company in several executive capacities from 1984 to 1993.
From 1993 through March 1995, Mr. Allen was the Executive Vice President and
Chief Financial Officer of Prime Capital Corporation, a merchant banking
company.
 
  Christopher J. Joyce was appointed Senior Vice President--Legal Affairs and
Administration and Secretary in April 1998. Previously, he was Executive Vice
President and General Counsel of Alliance Entertainment Corp., a publicly-
traded entertainment and music distribution company which filed for protection
under Chapter 11 of the United States Bankruptcy Code in July 1997. From
February 1992 to July 1995, Mr. Joyce served as Executive Vice President of
Business Affairs and General Counsel of Independent National Distributors,
Inc., a privately-held independent music distribution company. From September
1988 to February 1992, Mr. Joyce was an associate at the law firm of Willkie
Farr & Gallagher.

  Geoffrey A. Whynot was appointed Senior Vice President and Chief Financial
Officer of the Company in March 1998. Previously, he was Chief Financial
Officer of Kerr Group. During his tenure with Kerr Group, Mr. Whynot served as
Assistant Controller, Corporate Vice President and Treasurer, prior to
becoming CFO. A Certified Public Accountant, Mr. Whynot was employed by Arthur
Andersen & Company from 1980 to 1987.
 
                                      34

<PAGE>
 
ITEM 11. EXECUTIVE COMPENSATION
 
  The following table sets forth all compensation awarded to, earned by or
paid for the fiscal years specified below to certain individuals serving as
executive officers of the Company (the "Named Officers") during the fiscal
year ended December 31, 1997:
 
<TABLE>
<CAPTION>
                                                                              LONG TERM COMPENSATION
                                                                     -----------------------------------------
                                     ANNUAL COMPENSATION                              AWARDS
                             --------------------------------------- -----------------------------------------
                                                        OTHER ANNUAL RESTRICTED SECURITIES
                                                        COMPENSATION   STOCK    UNDERLYING      ALL OTHER
NAME AND PRINCIPAL POSITION  YEAR SALARY($)    BONUS($)  AWARDS(1)   SARS(#)(2)  OPTIONS    COMPENSATION($)(3)
---------------------------  ---- ---------    -------- ------------ ---------- ----------  ------------------
<S>                          <C>  <C>          <C>      <C>          <C>        <C>         <C>
Lawrence J. Ramaekers        1997 $119,510(5)       --      --          --        25,000(6)          --
 Former Acting President
 and Chief Executive Of-
 ficer(4)
William D. Farrell           1997 $247,342     $150,000     --          --           --           $6,016
 Former President and
 Chief Operating Offi-       1996 $152,415     $150,000     --          --        46,666          $4,093
 cer(7)                      1995 $131,643     $ 60,000     --          --        45,000          $3,245
John P. O'Malley, III        1997 $626,550          --      --          --           --
 Former Executive Vice       1996 $183,333          --      --          --        67,812
 President Finance and
 Chief                                                                                               --
 Financial Officer(8)                                                                                --
Gary I. Fields               1997 $106,542          --      --          --        20,000             --
 Former Senior Vice Pres-
 ident and General Coun-
 sel(7)
Gregory Mikkelsen            1997 $179,867     $ 10,000     --          --           --              --
 President and Chief Ex-     1996 $ 68,955          --      --          --        16,666             --
 ecutive
 Officer of StarMed(9)
</TABLE>
--------
(1) The aggregate amount of all perquisites and other personal benefits paid
    to each Named Individual is not greater than either $50,000 or 10% of the
    total of the annual salary and bonus reported for either such executive.
 
(2) Due to the fact that the 1997 Plan was not presented to the Company's
    shareholders for approval within one year of the plan's adoption by the
    Company, all options granted pursuant to the 1997 Plan have lapsed and
    such grants are not deemed to be outstanding.
 
(3) Represents matching contributions under the Company's 401(k) plan.
 
(4) J. Alix & Associates ("J. Alix") was retained by the Company on November
    2, 1997 to provide interim management services to the Company. Mr.
    Ramaekers, a principal of J. Alix, was appointed Acting President and
    Chief Executive Officer of the Company on November 2, 1997 and served in
    such capacity until February 2, 1998.
 
(5) Represents the portion of the fees paid to J. Alix for Mr. Ramaekers'
    services during the year ended December 31, 1997.

(6) Represents warrants to purchase 25,000 shares of Common Stock issued to J.
    Alix in connection with its engagement by the Company to provide interim
    management services to the Company. 
 
(7) On November 7, 1997, Mr. Farrell and Mr. Fields resigned from their
    respective positions.
 
(8) Mr. O'Malley was appointed Executive Vice President--Finance and Chief
    Financial Officer in September 1996 and removed from such position on
    November 8, 1997.

(9) Mr. Mikkelsen served as President and Chief Operating Officer of StarMed,
    which was sold by the Company in August 1998.
 
EMPLOYMENT AGREEMENTS
 
  The Company is a party to an employment agreement with Mr. Duane C.
Montopoli (the "Montopoli Employment Agreement"). The term of the Montopoli
Employment Agreement shall continue until terminated by either the Company or
Mr. Montopoli. Pursuant to the Montopoli Employment Agreement, Mr. Montopoli
acts as President and Chief Executive Officer of the Company, and is entitled
to receive an annual base salary of $275,000. Such annual salary may be
increased from time to time in the discretion of the Board of Directors. Mr.
Montopoli is eligible to receive a bonus for each calendar year during his
term of employment provided he is employed on the last day of the calendar
year. The bonus' target amount for any year shall be equal to 50% of Mr.
Montopoli's base salary for such year and the actual amount of the bonus shall
be determined by the Board of Directors within 60 days following the end of
such year. In connection with the execution of the Montopoli
 
                                      35

<PAGE>
 
Employment Agreement, the Company granted to Mr. Montopoli ten-year options to
purchase 200,000 shares of Common Stock, 133,333 of which have an exercise
price of $31.875 and 66,666 of which have an exercise price of $43.50. Such
options were to vest in five equal annual installments beginning January 30,
1998, unless sooner accelerated by certain "change of control" events. Under
the terms of the Montopoli Employment Agreement, the Company is obligated to
pay the premiums with respect to a term life insurance policy with a death
benefit payable to Mr. Montopoli's named beneficiaries in the amount of $1
million. In the event Mr. Montopoli's employment is terminated by the Company
other than for "Cause" or "Disability" (as such terms are defined in the
Montopoli Employment Agreement), or if Mr. Montopoli terminates his employment
for "Good Reason" (as defined in the Montopoli Employment Agreement), the
Company shall (i) pay Mr. Montopoli a lump sum payment equal to his accrued
but unpaid salary and a portion of the bonus he would have received for such
year; (ii) continue his base salary for a period of 18 months; and (iii)
continue benefits under the Company's employee welfare plans during the salary
continuation period unless such benefits are provided by another employer. Mr.
Montopoli is prohibited from competing with the Company for a period of 18
months following the termination of the Montopoli Employment Agreement. 
    
  The Company is a party to an employment agreement with Mr. William D.
Farrell dated January 1, 1997, which was scheduled to expire on December 31,
1999. Pursuant to such employment agreement, Mr. Farrell acted as President
and Chief Operating Officer of the Company, for which he received an annual
salary of $225,000. In addition, pursuant to such agreement, Mr. Farrell is
prohibited from competing with the Company for a period of one year following
the termination of the agreement. On November 7, 1997, Mr. Farrell resigned
from his position as President and Chief Operating Officer of the Company. The
Company is in litigation with Mr. Farrell relating, in part, to Mr. Farrell's
employment agreement. See "ITEM 3 - Litigation" and "ITEM 13 - Certain
Relationships and Related Transactions."    
    
  The Company is party to a non-competition and consulting agreement with Mr.
John P. O'Malley III which expired on August 30, 1998 entered into in
connection with the acquisition of NMR in August 1996 (the "NMR Acquisition").
Pursuant to such consulting agreement, Mr. O'Malley receives $550,000
annually, and the Company issued to Mr. O'Malley at the closing of the NMR
Acquisition (i) five-year warrants to purchase 16,666 shares of Common Stock
at an exercise price of $24.00 per share, and (ii) in exchange of his NMR
employee stock options, four separate five-year stock purchase warrants to
purchase 3,437; 9,166; 13,750; and 11,458 shares of Common Stock at exercise
prices of $12.00, $10.08, $12.54 and $14.19, respectively. Subsequent to the
closing of the NMR Acquisition, Mr. O'Malley was appointed Senior Vice
President--Finance and Chief Financial Officer of the Company in September
1996 and he was removed from such position on November 8, 1997 for failure to
perform certain of his functions as Chief Financial Officer. The Company is in
litigation with Mr. O'Malley relating, in part, to Mr. O'Malley's consulting
agreement. See "ITEM 3 - Litigation" and "ITEM 13 - Certain Relationships and
Related Transactions."    

  The Company is a party to an employment agreement with Mr. Geoffrey A.
Whynot (the "Whynot Employment Agreement"). The term of the Whynot Employment
Agreement shall continue until terminated by either the Company or Mr. Whynot.
Pursuant to the Whynot Employment Agreement, Mr. Whynot acts as Senior Vice
President--Finance and Chief Financial Officer of the Company, and is entitled
to receive an annual base salary of $185,000. Such annual salary may be
increased from time to time in the discretion of the Board of Directors. Mr.
Whynot is also eligible to receive a bonus for each calendar year during this
term of employment provided he is employed on the last day of the calendar
year. For calendar year 1998, Mr. Whynot shall receive a bonus in an amount
not less than $100,000. For all other calendar years, the target amount of the
bonus shall be equal to 50% of Mr. Whynot's base salary for such year and the
actual amount of the bonus shall be determined by the Board of Directors at
its discretion and paid no later than March 15 of the calendar year following
the calendar year for which the bonus is awarded. In connection with the
execution of the Whynot Employment Agreement, the Company granted to Mr.
Whynot ten-year options to purchase 53,333 shares of Common Stock at an
exercise price of $31.875. Such options were to vest in four equal annual
installments beginning March 23, 1999, unless sooner accelerated by certain
"change of control" events. In the event Mr. Whynot's employment is terminated
by the Company other than for "Cause" or "Disability" (as such terms 
 
                                      36

<PAGE>
 
are defined in the Whynot Employment Agreement), or if Mr. Whynot terminates
his employment for "Good Reason" (as defined in the Whynot Employment
Agreement), the Company shall (i) pay him a lump sum payment equal to his
accrued but unpaid salary and a portion of the bonus he would have received
for such year; (ii) continue his base salary for a period of 12 months;
provided that such amounts will be offset by any compensation received from
another employer; further, provided that if such termination occurs within 12
months following a "Change in Control" (as defined in the Whynot Employment
Agreement), Mr. Whynot shall receive a lump sum payment equal to 12 months of
his then base salary, which amount shall not be subject to reduction for any
compensation earned from another employer; and (iii) continue benefits under
the Company's employee welfare plans during the salary continuation period
unless such benefits are provided by another employer. Mr. Whynot is
prohibited from competing with the Company for a period of 12 months following
the termination of the Whynot Employment Agreement.
      
  The Company is a party to an employment agreement with Mr. Christopher J.
Joyce (the "Joyce Employment Agreement"). The term of the Joyce Employment
Agreement shall continue until terminated by either the Company or Mr. Joyce.
Pursuant to the Joyce Employment Agreement, Mr. Joyce acts as Senior Vice
President--Legal Affairs and Administration which position includes serving as
the Company's General Counsel and Secretary, and is entitled to receive an
annual base salary of $170,000. Such annual salary may be increased from time
to time in the discretion of the Board of Directors. Mr. Joyce is also
eligible to receive a bonus for each calendar year during this term of
employment provided he is employed on the last day of the calendar year. For
calendar year 1998, Mr. Joyce shall receive a bonus not less than 50% of Mr.
Joyce's base salary for such year. For all other calendar years, the target
amount of the bonus shall be equal to 50% of Mr. Joyce's base salary for such
year and the actual amount of the bonus shall be determined by the Board of
Directors, in its discretion, and paid no later than March 15 of the calendar
year following the calendar year for which the bonus is awarded. In connection
with the execution of the Joyce Employment Agreement, the Company granted to
Mr. Joyce ten-year options to purchase 40,000 shares of Common Stock at an
exercise price of $31.875. Such options were to vest in four equal annual
installments beginning April 6, 1999, unless sooner accelerated by certain
"change of control" events. In the event Mr. Joyce's employment is terminated
by the Company other than for "Cause" or "Disability" (as such terms are
defined in the Joyce Employment Agreement), or if Mr. Joyce terminates his
employment for "Good Reason" (as defined in the Joyce Employment Agreement),
the Company shall (i) pay him a lump sum payment equal to his accrued but
unpaid salary and a portion of the bonus he would have received for such year;
(ii) continue his base salary for a period of 9 months; and (iii) continue
benefits under the Company's employee welfare plans during the salary
continuation period unless such benefits are provided by another employer. Mr.
Joyce is prohibited from competing with the Company for a period of nine
months following the termination of the Joyce Employment Agreement.     
      
  Following the Company's 1998 Annual Meeting of Stockholders on July 23, 1998
at which the stockholders approved the Company's 1998 Stock Option Plan (the
"1998 Plan"), the Compensation Committee of the Board cancelled all of the
options granted to Messrs. Montopoli, Whynot and Joyce in connection with
their employment agreements described above. In exchange for such
cancellation, on July 23, 1998, the Compensation Committee granted Messrs.
Montopoli, Whynot and Joyce options to purchase 150,000, 41,666 and 31,333
shares of Common Stock, respectively (the "New Options"), under the 1998 Plan.
The exercise price of $8.625 for all of the New Options granted to Messrs.
Whynot and Joyce and 100,000 of the new Options granted to Mr. Montopoli
equalled the fair market value of the Common Stock on the date of grant. The
remaining 50,000 New Options granted to Mr. Montopoli were granted at an
exercise price of $20.25, which represented $11.625 over the fair market value
of the Common Stock on the date of grant. The Compensation Committee believes
that such cancellation and exchange was warranted in order to continue to
provide an appropriate incentive for Messrs. Montopoli, Whynot and Joyce to
promote the success of the Company's business, and because each of these
executives joined the Company only recently and after the end of the last
fiscal year.        
 
STOCK OPTION PLANS
           
  The information in this Report, including the information below concerning the
Company's stock option plans, gives effect to the one-for-three reverse stock
split of the Common Stock on July 24, 1998.    
 
                                      37


<PAGE>
 
 1992 Stock Option Plan

  In July 1992, the Company adopted and approved the 1992 Stock Option Plan
(the "1992 Plan"). The 1992 Plan is designed to serve as an incentive for
retaining qualified and competent directors, employees and consultants. The
1992 Plan provides for the award of options to purchase up to 80,000 shares of
Common Stock, of which 47,334 were subject to outstanding options as of April
1, 1998. The 1992 Plan is administered by the Stock Option Committee of the
Board of Directors. The Stock Option Committee has, subject to the provisions
of the 1992 Plan, full authority to select Company individuals eligible to
participate in the 1992 Plan, including officers, directors (whether or not
employees) and consultants. The 1992 Plan provides for the awarding of
incentive stock options (as defined in Section 422 of the Internal Revenue
Code of 1986) and non-incentive stock options. Options granted pursuant to the
1992 Plan have such vesting schedules and expiration dates as the Stock Option
Committee has established or shall establish in connection with each
participant in the 1992 Plan, which terms shall be reflected in an option
agreement executed in connection with the granting of the option. In fiscal
1997, no options were granted under the 1992 Plan.        
 
 1995 Stock Option Plan
     
  In March 1995, the Company adopted and approved the 1995 Stock Option Plan
(the "1995 Plan"). The 1995 Plan is designed to serve as an incentive for
retaining qualified and competent directors, employees and consultants. The
1995 Plan provides for the award of options to purchase up to 133,333 shares
of Common Stock, of which 43,410 were subject to outstanding options as of
April 1, 1998. The 1995 Plan is administered by the Stock Option Committee of
the Board of Directors. The Stock Option Committee has, subject to the
provisions of the 1995 Plan, full authority to select Company individuals
eligible to participate in the 1995 Plan, including officers, directors
(whether or not employees) and consultants. The 1995 Plan provides for the
awarding of incentive stock options (as defined in Section 422 of the Internal
Revenue Code of 1986) and non-incentive stock options. Options granted
pursuant to the 1995 Plan have such vesting schedules and expiration dates as
the Stock Option Committee has established or shall establish in connection
with each participant in the 1995 Plan, which terms shall be reflected in an
option agreement executed in connection with the granting of the option. In
fiscal 1997, no options were granted under the 1995 Plan.      
 
 1996 Stock Option Plan
       
  In February 1996, the Company adopted and approved the 1996 Stock Option
Plan (the "1996 Plan"). The 1996 Plan is designed to serve as an incentive for
retaining qualified and competent directors, employees and consultants. The
1996 Plan provides for the award of options to purchase up to 74,666 shares of
Common Stock, of which 51,721 were subject to outstanding options as of April
1, 1998. The 1996 Plan is administered by the Stock Option Committee of the
Board of Directors. The Stock Option Committee has, subject to the provisions
of the 1996 Plan, full authority to select Company individuals eligible to
participate in the 1996 Plan, including officers, directors (whether or not
employees) and consultants. The 1996 Plan provides for the awarding of
incentive stock options (as defined in Section 422 of the Internal Revenue
Code of 1986) and non-incentive stock options. Options granted pursuant to the
1996 Plan have such vesting schedules and expiration dates as the Stock Option
Committee has established or shall establish in connection with each
participant in the 1996 Plan, which terms shall be reflected in an option
agreement executed in connection with the granting of the option. In fiscal
1997, no options were granted under the 1996 Plan.        
 
 1996 Stock Option Plan B
       
  In February 1996, the Company adopted and approved the 1996 Stock Option
Plan B (the "1996 B Plan"). The 1996 B Plan is designed to serve as an
incentive for retaining qualified and competent directors, employees and
consultants. The 1996 B Plan provides for the award of options to purchase up
to 333,333 shares of Common Stock, of which 160,109 were subject to
outstanding options as of April 1, 1998. The 1996 B Plan is administered by
the Stock Option Committee of the Board of Directors. The Stock Option
Committee has, subject to the provisions of the 1996 B Plan, full authority to
select Company individuals eligible to participate in the 1996 B Plan,
including officers, directors (whether or not employees) and consultants. The
1996 B Plan provides for the         
 
                                      38

<PAGE>
 
 
awarding of incentive stock options (as defined in Section 422 of the Internal
Revenue Code of 1986) and non-incentive stock options. Options granted
pursuant to the 1996 B Plan have such vesting schedules and expiration dates
as the Stock Option Committee has established or shall establish in connection
with each participant in the 1996 B Plan, which terms shall be reflected in an
option agreement executed in connection with the granting of the option. In
fiscal 1997, 5,000 options were granted under the 1996 B Plan.          
 
 1997 Stock Option Plan
        
  On May 27, 1997, the Company adopted and approved the 1997 Stock Option Plan
(the "1997 Plan"). The 1997 Plan was designed to serve as an incentive for
retaining qualified and competent directors, employees and consultants. As of
April 1, 1998, there were 580,333 shares of Common Stock subject to
outstanding options granted under the 1997 Plan. Due to the fact that the 1997
Plan was not presented to the Company's shareholders for approval within one
year of the plan's adoption by the Company, all options granted pursuant to
the 1997 Plan have lapsed and such grants are not deemed to be outstanding.
           
 1998 Stock Option Plan         
              
  In July 1998, the Company's Board of Directors adopted and approved the 1998
Stock Option Plan (the "1998 Plan"). The 1998 Plan is designed to serve as an
incentive for retaining qualified and competent directors, employees and
consultants. The 1998 Plan provides for the award of options to purchase up to
500,000 shares of Common Stock, of which 361,166 shares were subject to
outstanding options as of September 1, 1998. The 1998 Plan is administered by
the Compensation Committee of the Board of Directors. The Compensation
Committee has, subject to the provisions of the 1998 Plan, full authority to
select eligible employees, consultants and directors of the Company and its
subsidiaries that may participate in the 1998 Plan and the type, extent and
terms of the options granted to them. The 1998 Plan provides for the awarding
of incentive stock options (as defined in Section 422 of the Internal Revenue
Code of 1986) and non-incentive stock options. Options granted pursuant to the
1998 Plan will have such vesting schedules and expiration dates as the
Compensation Committee shall establish in connection with each participant in
the 1998 Plan, which terms shall be reflected in an option agreement executed
in connection with the granting of the option.        
         
1998 Non-Employee Director Stock Option Plan        
       
  In July 1998, the Company's Board of Directors adopted and approved the 1998
Non-Employee Director Stock Option Plan (the "Directors Plan"). The Directors
Plan is designed to serve as an incentive for retaining qualified persons who
are neither employees nor officers of the Company to service as members of the
Board of Directors. The Directors Plan provides for the award of options to
purchase up to 66,666 shares of Common Stock, of which 20,000 shares were
subject to outstanding options as of September 1, 1998. The Directors Plan can
be administered by either the Board of Directors or the Compensation
Committee. Unless otherwise determined by the Compensation Committee, the
Directors Plan provides for automatic grants of options to purchase up to
3,333 shares of Common Stock at the time a person becomes a non-employee
director and on an annual basis thereafter. The options granted pursuant to
the Directors Plan are not intended to be incentive stock options (as defined
in Section 422 of the Internal Revenue Code of 1986). Options granted pursuant
to the Directors Plan will have exercise prices equal to the fair market value
of the Common Stock on the date of grant, will expire ten years from the date
of grant and generally vest in equal quarterly installments over a one-year
period.        
 
                                      39

<PAGE>
 
OPTIONS AND WARRANTS GRANTED IN LAST FISCAL YEAR
 
  The following table sets forth certain information concerning options and
warrants granted during fiscal 1997 to the Named Officers.
<TABLE>        
<CAPTION>
                                                                                  POTENTIAL
                                    INDIVIDUAL GRANTS                             REALIZABLE
                                           (1)                                     VALUE AT
                                    -----------------                           ASSUMED ANNUAL
                                    PERCENT OF TOTAL                            RATES OF STOCK
                                      OPTIONS/SARS                            PRICE APPRECIATION
                                       GRANTED TO     EXERCISE OR            FOR OPTION TERM (2)
                         OPTIONS      EMPLOYEES IN    BASE PRICE  EXPIRATION --------------------
          NAME           GRANTED       FISCAL YEAR      ($/SH)       DATE     5% ($)    10% ($)
          ----           -------    ----------------- ----------- ---------- --------- ----------
<S>                      <C>        <C>               <C>         <C>        <C>       <C>
Lawrence Ramaekers......  8,333(3)            (4)       $54.375     5/2/99   $   7,507 $   40,798
                          8,333(3)            (4)       $ 63.00     5/2/99   $       0 $        0
                          8,333(3)            (4)       $ 75.00     5/2/99   $       0 $        0
William D. Farrell......    --             --               --         --          --         --
John P. O'Malley, III...    --             --               --         --          --         --
Gary I. Fields..........  8,333               (4)       $ 36.00    5/19/02   $  82,884 $  183,153
                         11,666               (4)       $ 42.00    5/19/02   $  46,038 $  186,414
Gregory Mikkelsen           --             --               --         --          --         --
</TABLE>          
--------
(1) Due to the fact that the 1997 Plan was not presented to the Company's
    shareholders for approval within one year of the plan's adoption by the
    Company, all options granted pursuant to the 1997 Plan have lapsed and
    such grants are not deemed to be outstanding.
(2) The 5% and 10% assumed annual rates of appreciation of the grant date
    market prices are mandated by rules of the Securities and Exchange
    Commission ("SEC") and do not reflect estimates or projections of future
    Common Stock prices. There can be no assurance that the amounts reflected
    in this table will be achieved.
       
(3) Represents warrants to purchase 25,000 shares of Common Stock issued to J.
    Alix in connection with its engagement by the Company to provide interim
    management services to the Company. Mr. Ramaekers, a principal of J. Alix,
    was appointed Acting President and Chief Executive Officer of the Company
    on November 2, 1997 and served in such capacity until February 2, 1998.
            
(4) After giving effect to the termination of all conditional options granted
    during 1997 under the Company's 1997 Stock Option Plan, no options or
    warrants were granted in 1997 to any of the Company's Named Officers,
    except Mr. Fields. Warrants were granted to J. Alix as described in
    footnote 3 above.
 
OPTION/WARRANT VALUES
 
  The following table sets forth, as of December 31, 1997 the number of
options and warrants and the value of unexercised options and warrants held by
the Named Officers.
 
<TABLE>         
<CAPTION>
                          SHARES                                                       VALUE OF UNEXERCISED
                         ACQUIRED                NUMBER OF UNEXERCISED                IN-THE-MONEY OPTIONS AT
                            IN       VALUE   OPTIONS AT DECEMBER 31, 1997            DECEMBER 31, 1997 ($)(1)
                         EXERCISE   REALIZED ------------------------------------    -------------------------
          NAME             (#)        ($)     EXERCISABLE          UNEXERCISABLE     EXERCISABLE UNEXERCISABLE
          ----           --------   -------- --------------       ---------------    ----------- -------------
<S>                      <C>        <C>      <C>                  <C>                <C>         <C>
Lawrence J. Ramaekers...     --          --            25,000(2)                --    $      0          --
William D. Farrell......  17,500    $891,065            7,777                   --    $113,744          --
John P. O'Malley, III...   3,437(3) $192,197           55,486(4)              8,889   $619,796      $23,334
Gary I. Fields..........     --          --               --                    --         --           --
Gregory Mikkelsen.......   2,700    $136,513            2,855                11,111   $      0      $     0
</TABLE>       
--------
      
(1) On December 31, 1997 the last reported sales price for the Common Stock on
    the Nasdaq Market was $28.13.        
 
                                      40

<PAGE>

 
(2) Represents warrants to purchase 25,000 shares of Common Stock issued to J.
    Alix in connection with its engagement by the Company to provide interim
    management services to the Company. Mr. Ramaekers, a principal of J. Alix,
    was appointed Acting President and Chief Executive Officer of the Company
    on November 2, 1997 and served in such capacity until February 2, 1998.
   
(3) Represents shares underlying warrants issued to Mr. O'Malley, the former
    Executive Vice-President--Finance and Chief Financial Officer of NMR, in
    connection with the NMR Acquisition. See "Executive Compensation--Employment
    Agreements."     
              
(4) Of such total amount of shares, 51,040 shares represent shares underlying
    warrants issued to Mr. O'Malley, the former Executive Vice-President--
    Finance and Chief Financial Officer of NMR, in connection with the NMR
    Acquisition. See "Executive Compensation--Employment Agreements."    
 
                                      41

<PAGE>
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  The following table set forth as of September 8, 1998 the number and
percentage of shares of Common Stock held by (i) each of the Named Officers and
directors of the Company, (ii) all persons who are known by the Company to be
the beneficial owners of, or who otherwise exercise voting or dispositive
control over, five percent or more of the Company's outstanding Common Stock and
(iii) all of the Company's present executive officers and directors as a group:
   
<TABLE>         
<CAPTION>
        BENEFICIAL                                   COMMON STOCK PERCENTAGE OF
          OWNER                                        OWNED(1)    OUTSTANDING
        ----------                                   ------------ -------------
<S>                                                  <C>          <C>
Gary N. Siegler(2)(3)...............................  1,442,698       17.4%
 c/o Siegler, Collery & Co.
 10 East 50th Street
 New York, NY 10022
Duane C. Montopoli(4)...............................     49,400          *
Gary L. Fuhrman(5)..................................     37,530          *
John H. Josephson(6)................................     14,790          *
D. Gordon Strickland................................      2,000          * 
Sally W. Crawford...................................      5,000          * 
Geoffrey A. Whynot..................................      4,500          * 
Christopher J. Joyce................................        500          *
Peter M. Collery(2)(7)..............................  1,030,662       13.0%
 c/o Siegler, Collery & Co.
 10 East 50th Street
 New York, NY 10022
Fir Tree Partners(8)................................    953,666       12.0%
 1211 Avenue of the Americas
 29th Floor
 New York, New York 10036
StarMed Investors, L.P.(2)..........................    480,362        6.1%
 c/o Siegler, Collery & Co.
 10 East 50th Street
 New York, NY 10022
HHH Investments Limited Partnership(9)..............    443,333        5.6%
 920 King Street
 Wilmington, DE 19801
TJS Partners, L.P.(10)..............................    790,247        9.9%
 115 East Putnam Avenue
 Greenwich, CT 06830
William D. Farrell..................................      8,277          *
John P. O'Malley, III(11)...........................     56,991          *
Gary I. Fields......................................      2,333          *
All executive officers and Directors as a group (9    1,556,418       18.6%
 in
 number) (2)(3)(4)(5)(6)............................
</TABLE>    
--------
  * Less than one percent.
 (1) Except as otherwise indicated, the persons named in the table have sole
     voting and investment power with respect to the shares of Common Stock
     shown as beneficially owned by them.
 
                                      42
<PAGE>
 
 (2) Messrs. Siegler and Collery, due to their joint ownership of Siegler
     Collery and other affiliates which control StarMed Investors, L.P. (which
     is included in the table), and certain other entities which beneficially
     own an aggregate of 481,401 shares of Common Stock are each deemed to
     beneficially own all of the shares of Common Stock owned of record by all
     such entities.         
        
 (3) Includes 202,887 shares underlying outstanding options which are
     exercisable immediately or within 60 days, 67,632 shares owned by The
     Gary N. Siegler Foundation, a charitable foundation, and warrants to
     acquire 175,000 shares of Common Stock held by 712 Advisory Services,
     Inc. Mr. Siegler is deemed to beneficially own all of the shares of
     Common Stock owned of record by such entities.          
        
 (4) Includes 30,000 shares underlying outstanding options which are
     exercisable immediately or within 60 days.        
       
 (5) Includes 12,000 shares underlying outstanding options which are
     exercisable immediately or within 60 days.         
        
 (6) Includes 13,333 shares underlying outstanding options which are
     exercisable immediately or within 60 days.         
       
 (7) Includes 17,000 shares underlying outstanding options which are
     exercisable immediately or within 60 days.         
        
 (8) Based solely upon information contained in a Schedule 13D, as amended,
     filed with the SEC. According to the Schedule 13D, Mr. Jeffrey
     Tannenbaum, in his capacity as the sole shareholder, executive officer,
     director and principal of Fir Tree Partners, may also be deemed to be the
     beneficial owner of the shares held by Fir Tree Partners.        
        
 (9) Based solely upon information contained in a Schedule 13D, as amended by
     Amendments Nos. 1, 2 and 3 thereto, filed with the SEC. As disclosed in
     Amendment No. 3 to such Schedule 13D filed with the SEC on June 17, 1998,
     the total in the table excludes (i) an aggregate of 127,508 shares of
     Common Stock owned by three corporations, the sole shareholders of which
     are the limited partners of HHH Investments Limited Partnership ("HHH"),
     (ii) 13,333 shares of Common Stock owned by The Francis D. Hussey, Jr.
     Pension Plan (the "Pension Plan") and (iii) 3,333 shares of Common Stock
     owned by Francis D. Hussey, Jr. Mr. Hussey is the president of the
     general partner of HHH and is the trustee and a beneficiary of the
     Pension Plan.        
        
(10) Based solely upon information contained in a Schedule 13D filed with the
     SEC. According to the Schedule 13D, Mr. Thomas J. Salvatore, in his
     capacity as the general partner of TJS Management, L.P., the general
     partner of TJS Partners, L.P., may also be deemed to be the beneficial
     owner of the shares held by TJS Partners, L.P.       
        
(11) Includes 4,444 shares underlying outstanding options which are
     exercisable immediately or within 60 days and warrants to acquire 51,040
     shares of Common Stock.         
 
                                      43

<PAGE>
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  During 1997, in connection with the placement of the Series C Convertible
Preferred Stock, the Company paid $967,000 in fees and expenses to the
placement agent, Arnhold and S. Bleichroeder, Inc. ("ASB"), of which Gary
Fuhrman, a director of the Company, is an executive officer and director. In
addition, ASB acted as placement agent for the private placement of certain of
the Company's debentures in 1996 and 1995 for which it was paid placement
agent fees and expenses in 1996 and 1995 of $356,650 and $247,500,
respectively. Also during 1997, for legal services rendered to the Company,
the Company paid legal fees and expenses in the amount of $971,000 to Werbel &
Carnelutti, of which Stephen Davis, a former director of the Company, is a
partner. Mr. Davis' firm also performed legal services for the Company during
1996 and 1995. In addition, during 1997, the Company reimbursed the managing
underwriter of the Company's October 1996 public offering $84,000 in charter
fees (which rates were at or below market rates) for the use by the managing
underwriter and the Company of an airplane owned by an affiliate of Mr. Gary
N. Siegler, a director of the Company and former Chairman of the Board of the
Company, during the public offering roadshow.       
        
  In 1997 and previous years, the Company paid an annual financial advisory
fee to 712 Advisory Services, Inc., a financial advisory firm of which Mr.
Gary N. Siegler is the sole stockholder, sole director and president (the
"Affiliate"). Mr. Neil H. Koffler, a director of the Company, is also an
employee of the Affiliate. Such fees amounted to $112,500, $102,000 and
$225,000 in the years ended December 31, 1997, 1996, and 1995, respectively.
During the year ended December 31, 1997, the Company also paid transaction
related advisory fees and expenses (including fees associated with the
issuance of the Senior Notes) to the Affiliate of $1,761,000 and issued to the
Affiliate warrants to purchase 225,000 shares of the Company's Common stock
exercisable at prices ranging from $30.93 to $37.77 per share for financial
advisory services rendered to the Company in connection with such
transactions. As discussed below, pursuant to recommendations made by a
special committee of the Board of Directors, the Affiliate has reimbursed to
the Company $1,536,000 of the fees paid to the Affiliate for services rendered
in 1997 and waived $112,500 of fees payable for 1997. In addition, during
1996, the Company paid transaction related advisory fees and expenses to the
Affiliate of $363,000 and issued to the Affiliate warrants to purchase 40,000
shares of Common Stock at $27.00 per share for services rendered to the
Company in connection with the Company's acquisition of NMR, a public offering
by the Company of its Common Stock and other transactions.        
       
  In order to compensate officers, directors, employees and consultants to the
Company for services rendered or to be rendered to the Company, the Company
from time to time has granted options at fair market value to such
individuals. As of December 31, 1997, stock options to purchase 489,555 shares
of the Company's Common Stock had been issued to Mr. Siegler and Mr. Koffler.
Included in this amount were stock options to purchase 250,000 shares and
5,000 shares of the Company's Common Stock which were granted to Mr. Siegler
and Mr. Koffler, respectively, under the 1997 Plan. As discussed below, Mr.
Siegler and Mr. Koffler voluntarily agreed to relinquish the stock options
that were granted to them under the 1997 Plan and to permit the Board's
Compensation Committee, with the assistance of compensation experts, to
determine the appropriate director compensation for them for 1997.       
       
  Additionally, in September 1997, the Company acquired, for $3.25 million, a
limited partnership interest in Dune Jet Services, L.P. (the "Partnership"), a
Delaware limited partnership formed for the purposes of acquiring and
operating an airplane for the partners' business uses and for third-party
charter flights. The general partner of the Partnership is Dune Jet Services,
Inc., a Delaware corporation, the sole stockholder of which is Mr. Siegler. In
October 1997, the Company's interest in the Partnership was repurchased by the
Partnership at cost plus interest following discussions among management
(members of which expressed objections to such acquisition), a special
committee of the Company's Board of Directors (the "Committee"), and other
members of the Board of Directors (including Mr. Siegler).        
        
  In February 1995, the Company consummated the acquisition (the "Maternity
Acquisition") of Maternity Resources, Inc. ("Maternity"), a manufacturer and
retailer of maternity apparel. The Maternity Acquisition was       
 
                                      44
 
<PAGE>
 
 
consummated pursuant to a stock purchase agreement (the "Maternity Agreement")
among the Company, Maternity and the securityholders of Maternity (the
"Maternity Sellers"). Pursuant to the Maternity Agreement, the Company
acquired 100% of the issued and outstanding common stock and preferred stock
of Maternity from the Maternity Sellers in exchange for an aggregate of
160,000 shares of Common Stock and preferred stock of the Company. Messrs.
Gary N. Siegler, a director of the Company, and Peter M. Collery, a former
director of the Company, were directors and executive officers of, and
securityholders in, the Maternity Sellers.         
       
INDEPENDENT COMMITTEE INVESTIGATION INTO RELATED-PARTY TRANSACTIONS       
 
  In October 1997, members of the Company's management communicated to the
Board that certain Company stockholders had questioned them regarding the
manner in which related-party transactions were being scrutinized by the
Company and its Board. Management stated that it shared the concerns of these
stockholders and had engaged counsel to conduct a review of such transactions.
 
  In order to address and satisfy the concerns management had communicated,
the Company authorized a review of its practices regarding related-party
transactions, as well as the fairness of all such transactions and the
adequacy of the disclosure of the same, including but not limited to
transactions as to which fees already had been paid and warrants and options
to purchase shares had been issued, and public disclosure had been made in
prior periods. The review also was to seek to develop recommendations as to
what changes, if any, should be made to the Company's procedures regarding
related-party transactions.
        
  To oversee the review, the Board formed the Committee consisting of
directors who were not officers, directors, employees, stockholders or
otherwise affiliates of the Affiliate. The Committee retained, on behalf of
the Company, outside counsel with which neither the Company nor any of its
directors has or had any current or prior relationship, to assist and advise
the Committee in the conduct of the review. Mr. Siegler, on behalf of the
Affiliate, expressed its position that the related-party transactions and fees
are and were proper, but nevertheless advised the Committee that the Affiliate
would return to the Company any sums that the Committee deemed improper.       
        
  Thereafter, in response to expressions of dissatisfaction with the Committee
and its ongoing review, as well as disclosure related thereto, by certain
members of management who questioned, among other things, the Committee's
ability to conduct an independent review, the Board determined, and the
Company announced, that it was seeking to add to the Board two new independent
directors. The new directors, who would retain other independent counsel of
their choice, would assume ultimate responsibility for the review. Mr. Siegler
and the Affiliate thereafter restated that although they believe that all
related-party transactions and financial advisory fees are and were proper,
they nevertheless agreed to abide by the findings of the Company's independent
review and to return to the Company any sums that the Committee deemed
improper. On December 8, 1997, D. Gordon Strickland and Peter J. Powers were
appointed to the Board of Directors of the Company and to serve as the members
of the Committee that was formed to examine the related-party transactions.
The Committee engaged the law firm of Kaye, Scholer, Fierman, Hays & Handler
to advise and assist its examination.        
 
  The Committee issued the results of its investigation and certain
recommendations in a report to the Company's Board of Directors and on April
6, 1998, the Company's Board of Directors voted to adopt the recommendations
contained in the report.
 
  The Committee reported to the directors that it had determined that: (i)
there was no evidence of any federal or state crimes or securities law
violations in connection with the related party transactions in question; (ii)
all related-party matters were disclosed in public filings; (iii) the
Affiliate performed acquisition advisory services fully consistent with the
expectations and understanding of the committee of outside directors that had
approved the Affiliate's acquisition fees; and (iv) the acquisition advisory
fees paid to the Affiliate in connection with the Company's acquisitions in
1997 were within the range of customary acquisition advisory fees paid to
investment bankers on transactions of similar size.

 
                                      45

<PAGE>
 

  The Committee also recommended and the Board of Directors has adopted the
following measures to improve corporate governance:
 
  . To avoid any appearance of possible conflicts of interest, the Board
    adopted a policy disfavoring related-party transactions. The policy can
    be subject to exceptional circumstances, but even exceptional
    circumstances will be considered only in the informed judgment of the
    Board or an independent committee, assisted by independent counsel.
 
  . The Chief Executive Officer of the Company, with the assistance of the
    Company's general counsel and in consultation with the Board of
    Directors, will be responsible for the selection of all outside counsel,
    bearing in mind the policy disfavoring related-party transactions. To
    avoid any appearance of possible conflicts of interest, corporate counsel
    advising on issues of corporate governance and disclosure will have no
    relationship to any member of the Board of Directors. Without limiting
    the generality of the foregoing, no director of the Company will be a
    member of or counsel to such law firm. Corporate counsel advising on such
    issues will not otherwise provide legal services to any member of the
    Board of Directors, including entities affiliated with Board members.
 
  . Absent exceptional circumstances, all related-party contracts, unless
    manifestly immaterial, will be filed publicly with appropriate SEC
    filings.
 
  . The Compensation Committee has been authorized and directed to formulate
    clear written standards for reimbursement of director expenses, subject
    to review by the Board of Directors.
 
  In addition to the foregoing, the Committee recommended and the Board of
Directors has determined to endeavor to reconfigure the Board to give outside
directors a majority of its seats and select a new chairman from the outside
directors.
 
  The Committee understood that in late 1996, the Board of Directors had
turned to the Affiliate to supervise an extensive acquisition program of 59
diagnostic imaging centers and one staffing company because of the Board's
perceptions that former senior management was still relatively inexperienced
and did not yet have the formal training and necessary skills to manage an
extensive acquisition program, former senior management was not directly
supervising nor providing sufficient input with respect to the acquisition
program, and there was a limited window of time within which the acquisition
program could take place, given the increasingly competitive marketplace. The
Committee expressed their view that given the Board's perceptions, the Board
should have acted sooner to bring any additional needed skills in-house,
rather than continue to rely upon, and pay fees to, the Affiliate to provide
such services.
 
  Accordingly, the Committee recommended and the Affiliate agreed to reimburse
the Company approximately $1,424,000 in fees for acquisition transactions
completed after June 1, 1997, to reimburse $112,500 of the retainer paid to
the Affiliate for 1997, to waive payment of an additional $112,500 of fees
accrued by the Company for the third and fourth quarters of 1997, and to pay a
substantial amount of the expenses associated with the Committee's
investigation. All such amounts have been reimbursed or paid to the Company.
In addition, in light of the subsequent hiring of Duane C. Montopoli as
President and Chief Executive Officer, Geoffrey Whynot as Chief Financial
Officer and SBC Warburg Dillon Read as Financial Advisor, the Committee
recommended and the Affiliate agreed to allow the Company to terminate its
relationship with the Affiliate.

  Mr. Siegler and Mr. Koffler also agreed voluntarily to relinquish 255,000
stock options that were granted to them in May 1997 and permit the Board's
Compensation Committee, with the assistance of compensation experts, to
determine the appropriate director compensation for them for 1997. 
 
                                      46

<PAGE>
 
                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)  Exhibits and Financial Statements:

  1.   Financial Statements:

     The following consolidated financial statements and consolidated financial
statement schedule of Medical Resources, Inc. and the reports thereon of
independent auditors are filed as part of this Annual Report on Form 10-K and
are incorporated by reference in Item 8.

     (i)    Reports of Independent Auditors.
            
     (ii)   Consolidated Balance Sheets as of December 31, 1997 and 1996.
            
     (iii)  Consolidated Statements of Operations for the years ended December
            31, 1997, 1996 and 1995.
            
     (iv)   Consolidated Statements of Cash Flows for the years ended December
            31, 1997, 1996 and 1995.
            
     (v)    Consolidated Statements of Changes in Stockholders' Equity for the
            years ended December 31, 1997, 1996 and 1995.
            
     (vi)   Notes to Consolidated Financial Statements.

  2.   Financial Statement Schedule

     The following consolidated financial statement schedule of Medical
Resources, Inc. and subsidiaries is submitted herewith in response to Item
14(d)2:

                 Schedule II--Valuation and Qualifying Accounts

     All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not required
under the related instructions or are inapplicable and, therefore, have been
omitted.

  3.   Exhibits

     See the accompanying Exhibit Index which precedes the Exhibits filed with
this Annual Report on Form 10-K.

(b)  Reports on Form 8-K

  On November 10, 1997, the Company filed a Current Report on Form 8-K reporting
(i) under Item 5, that on November 5, 1997, parties that had agreed to sell five
related imaging centers located in Pennsylvania to the Company brought action
against the Company and five subsidiaries seeking specific performance of
acquisition agreements and breach of contract damages and (ii) under Item 6,
William D. Farrell's resignation as Director of the Company.

  On December 11, 1997, the Company filed a Current Report on Form 8-K reporting
(i) under Item 4, Coopers & Lybrand LLP's resignation as auditor of the Company
and the engagement of Ernst & Young, LLP to audit the financial statements of
the Company, and (ii) under Item 6, that D. Gordon Strickland and Peter J.
Powers were appointed to the Board of Directors of the Company.

  On December 24, 1997, the Company filed a Current Report on Form 8-K/A
reporting, amending Item 4 of the Current Report on Form 8-K dated December 4,
1997 and filed on December 11, 1997, Coopers & Lybrand LLP's resignation as
auditor of the Company and the engagement of Ernst & Young, LLP, filing as an
exhibit

                                      47

<PAGE>
 
Coopers & Lybrand LLP's letter addressed to the Securities and Exchange
Commission stating that it agrees with the statements made by the Company in
such Form 8-K.

  On January 7, 1998, the Company filed a Current Report on Form 8-K/A amending
Items 5 and 7 of the Current Report on Form 8-K dated May 30, 1997 and filed on
June 16, 1997, as amended on Form 8-K/A filed on August 13, 1997, relating to
the Company's acquisition of certain entities and including the related
financial statements with respect to such entities.

  On January 12, 1998, the Company filed a Current Report in Form 8-K, reporting
under Item 5 the creation of the Board of Director's Executive, Nominating and
Compensation Committees and the election of new directors to the Audit
Committee.

  On January 16, 1998, the Company filed a Current Report on Form 8-K/A amending
Items 5 and 7 of the Current Report on Form 8-K dated May 30, 1997 and filed on
June 16, 1997, as amended on Forms 8-K/A filed on August 13, 1997 and January 7,
1998.

  On February 23, 1998, the Company filed a Current Report on Form 8-K/A
amending Items 5 and 7 of the Current Report on Form 8-K dated May 30, 1997 and
filed on June 16, 1997, as amended on Forms 8-K/A filed on August 13, 1997,
January 7, 1998 and January 16, 1998.

  On April 8, 1998, the Company filed a Current Report on Form 8-K, reporting
under Item 5 that the Company's Board of Directors voted to adopt the
recommendations contained in the report of a Special Committee of two outside
directors elected to the Board in December 1997 and appointed to investigate
certain events and review the Company's policies regarding related party
transactions.

  On April 16, 1998, the Company filed a Current Report on Form 8-K, reporting
under Item 5 that the Company was unable to file its Annual Report on Form 10-K
for the fiscal year ended December 31, 1997 by the April 15, 1998 extended due
date for such filing.

  On May 20, 1998, the Company filed a Current Report on Form 8-K, reporting
under Item 5 that (i) Peter J. Powers had resigned as a director of the Company
effective May 13, 1998 and (ii) the Company would report a loss for the year
ended December 31, 1997 and that it expected to report a loss for the quarter
ended March 31, 1998.

                                      48

<PAGE>
 
                                 EXHIBIT INDEX

<TABLE>
<C>        <S>
      3.1  Company's Certificate of Incorporation, as amended to date.*
      3.2  Company's By-Laws, as amended.*
      3.3  Certificate of Designations, Preferences and Rights of the Company's Series C Convertible Preferred
           Stock.**
      4.1  Common Stock Specimen Certificate.*
      4.2  Shareholder Rights Plan of the Company, dated September 15, 1996.***
     10.1  Note Purchase Agreement ($52,000,000 7.77% Senior Notes), dated as of February 20, 1997, between the
           Company and the Purchasers listed therein.****
     10.2  Note Purchase Agreement ($20,000,000 8.10% and $6,000,000 8.01% Senior Notes), dated as of June 26,
           1997, between the Company and the Purchasers listed therein.*****
     10.3  Securities Purchase Agreement, dated as of July 21, 1997, between the Company and RGC International
           Investors, LDC.**
     10.4  Registration Rights Agreement, dated as of July 21, 1997, between the Company and RGC International
           Investors, LDC.**
     10.5  $15,000,000 Promissory Note, dated December 29, 1997, payable to DVI Financial Services Inc. together
           with Warrant, dated 1997 to purchase 100,000 shares of Common Stock#
     10.6  1992 Stock Option Plan.*
     10.7  1995 Stock Option Plan of the Company.******
     10.8  1996 Stock Option Plan of the Company.*******
     10.9  1996 Stock Option Plan B of the Company. *******
    10.10  Warrant, dated December 30, 1997, to purchase 817,000 shares of Common Stock issued to RGC
           International, LDC.*********
    10.11  Employment Agreement, dated January 30, 1998, between the Company and Duane C. Montopoli.*********
    10.12  Employment Agreement, dated March 23, 1998, between the Company and Geoffrey A. Whynot.*********
    10.13  Employment Agreement, dated April 6, 1998, between the Company and Christopher J. Joyce*********
    10.14  Stock Purchase Agreement dated as of July 8, 1998 between the Company
           and RehabCare Group Inc. and Healthcare Staffing Solutions, Inc.**********
    10.15  1998 Stock Option Plan**********
    10.16  1998 Non-Employee Director Stock Option Plan**********
       16  Letter re:  Change in Certifying Accountants.********
     21.1  List of Subsidiaries.*********
     23.1  Consent of Independent Auditors - Ernst & Young LLP.#
     23.2  Consent of Independent Accountants - Coopers & Lybrand LLP.#
     27.1  Financial Data Schedule.#
</TABLE>


____________________

<TABLE>
<S>          <C> 
*            Incorporated herein by reference from the Company's Registration Statement on Form S-1 (File No.
             33-48848).
**           Incorporated herein by reference from the Company's Current Report on Form 8-K dated July 21, 1997.
***          Incorporated herein by reference from the Company's Current Report on Form 8-K dated September 13,
             1996.
****         Incorporated herein by reference from the Company's Current Report on Form 8-K dated March 4, 1997.
*****        Incorporated herein by reference from the Company's Current Report on Form 8-K dated June 26, 1997.
******       Incorporated herein by reference from the Company's Annual Report on Form 10-K for the year ended
             December 31, 1995.
*******      Incorporated herein by reference from the Company's Annual Report on Form 10-K for the year ended
             December 31, 1996.
********     Incorporated herein by reference from the Company's Current Report on Form 8-K/A filed on December
             24, 1997, amending the Company's Current Report on Form 8-K dated December 4, 1997.
*********    Incorporated herein by reference from the Company's Annual Report on Form 10-K for the year ended
             December 31, 1997.
**********   Incorporated herein by reference from the Company's Registration Statement on Form S-1 (File Number
             333-24865)
#            Filed herewith.
</TABLE>

                                      49

<PAGE>
 
                                   SIGNATURES

     PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.

                                 Medical Resources Inc.

                                 By: /s/ DUANE C. MONTOPOLI
                                     ---------------------------

                                     CHIEF EXECUTIVE
                                     OFFICER (PRINCIPAL EXECUTIVE
                                       OFFICER)

     PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT IN THE CAPACITIES SET FORTH BELOW AND ON SEPTEMBER 28, 1998

              SIGNATURE                         CAPACITY IN WHICH SIGNED
 
                                          Chairman of the Board of Directors
    /s/ D. Gordon Strickland      
-------------------------------------
        D. GORDON STRICKLAND
 
         /s/ Gary N. Siegler              Director
-------------------------------------
           GARY N. SIEGLER
 
          /s/ Gary Fuhrman                Director
-------------------------------------
            GARY FUHRMAN
 
         /s/ John Josephson               Director
-------------------------------------
           JOHN JOSEPHSON
 
        /s/ Sally W. Crawford             Director
-------------------------------------
          SALLY W. CRAWFORD
 
         /s/ Peter B. Davis               Director      
-------------------------------------
           PETER B. DAVIS
 
       /s/ Duane C. Montopoli             President and Chief Executive
-------------------------------------      Officer (Principal Executive
         DUANE C. MONTOPOLI                Officer)
 
       /s/ Geoffrey A. Whynot             Chief Financial Officer (Principal
-------------------------------------      Financial/Accounting Officer)
         GEOFFREY A. WHYNOT


                                      50
<PAGE>
 
                        REPORT OF INDEPENDENT AUDITORS
 
To the Board of Directors and Stockholders of
 Medical Resources, Inc.
     
  We have audited the accompanying consolidated balance sheet of Medical
Resources, Inc. and Subsidiaries (the "Company") as of December 31, 1997 and
the consolidated statements of operations, stockholders' equity, and cash
flows for the years ended December 31, 1997 and 1995. Our audits also included
the financial statement schedule listed in the index at ITEM 14(a) for the 
years then ended. These financial statements and schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audits.    
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Medical Resources, Inc. and Subsidiaries at December 31, 1997 and the
consolidated results of their operations and their cash flows for the years
ended December 31, 1997 and 1995, in conformity with generally accepted
accounting principles. In addition, in our opinion, the financial statement
schedule referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein for 1997 and 1995.
 
  The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note 2,
the Company incurred a net loss in 1997 and has a working capital deficiency
at December 31, 1997. In addition, the Company has not complied with certain
covenants of loan agreements. These conditions raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 2. The financial statements
do not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classifications
of liabilities that may result from the outcome of this uncertainty.
 
                                          /s/ Ernst & Young LLP
 
Hackensack, New Jersey
   
May 26, 1998 except for Note 16, 
as to which the date is August 18, 1998     
 
                                      

                                      F-1
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Stockholders of
 Medical Resources, Inc.
   
  We have audited the accompanying consolidated balance sheet of Medical
Resources, Inc. and Subsidiaries (the "Company") as of December 31, 1996 and
the related consolidated statement of operations, stockholders' equity, and
cash flows and the financial statement schedule listed in the index at ITEM 
14(a) for the year ended December 31, 1996. These financial statements and the
Schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audit.    
 
  We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
 
  In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Medical Resources, Inc. and Subsidiaries at December 31, 1996 and the
consolidated results of their operations and their cash flows for the year
ended December 31, 1996, in conformity with generally accepted accounting
principles. In addition, in our opinion, the financial statement schedule
referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information required to be included therein.
 
                                          /s/ Coopers & Lybrand L.L.P.
 
Parsippany, New Jersey
March 28, 1997
 
                                      

                                      F-2
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                        AS OF DECEMBER 31, 1997 AND 1996
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                       DECEMBER 31, DECEMBER 31,
                                                           1997         1996
                                                       ------------ ------------
<S>                                                    <C>          <C>
                       ASSETS
Current Assets:
 Cash and cash equivalents...........................    $ 23,198     $ 15,346
 Short-term investments..............................         --         1,663
 Cash and short-term investments, restricted.........         600        4,500
 Accounts receivable, net............................      65,887       39,878
 Other receivables...................................       5,430        2,291
 Prepaid expenses....................................       7,027        3,715
 Income taxes recoverable............................       6,504          --
 Deferred tax assets, net............................       2,492        3,354
                                                         --------     --------
 Total current assets................................     111,138       70,747
                                                         --------     --------
Property and equipment, net..........................      64,343       24,397
Goodwill, net........................................     149,624       62,639
Other intangible assets, net.........................       6,836        2,119
Other assets.........................................       4,189        1,216
Deferred tax assets, net.............................       2,353        2,351
Restricted cash......................................         473        1,045
                                                         --------     --------
 Total assets........................................    $338,956     $164,514
                                                         ========     ========
        LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
 Senior Notes due 2001 through 2005, classified as
  current............................................    $ 78,000     $    --
 Notes and mortgages payable, classified as current..       3,206          --
 Capital lease obligations, classified as current....       9,555          --
 Current portion of notes and mortgages payable......      13,313        6,729
 Current portion of capital lease obligations........      10,311        5,992
 Borrowings under line of credit.....................       3,744          --
 Accounts payable....................................      13,141       10,903
 Accrued expenses....................................      28,018        2,167
 Income taxes payable................................         --         2,064
 Common stock subject to redemption..................       9,734          --
 Other current liabilities...........................         290          117
                                                         --------     --------
 Total current liabilities...........................     169,312       27,972
Notes and mortgages payable, less current portion....      21,539       12,638
Obligations under capital leases, less current
 portion.............................................      16,361        8,373
Convertible debentures...............................         --         6,988
Other long term liabilities..........................         178          108
                                                         --------     --------
 Total liabilities...................................     207,390       56,079
Minority interest....................................       4,662        2,051
Stockholders' equity:
 Common stock, $.01 par value; authorized 50,000
  shares, 7,296 issued and outstanding at December
  31, 1997 and 6,198 issued and 6,109 outstanding at
  December 31, 1996..................................          73           62
 Common stock to be issued; 200 shares...............         --         1,721
 Series C Convertible Preferred Stock, $1,000 per
  share stated value; 18 shares issued and
  outstanding (liquidation preference of 3% per
  annum).............................................      18,242          --
 Additional paid-in capital..........................     138,810      103,052
 Unrealized appreciation of investments..............         --            26
 Retained earnings (deficit).........................     (30,221)       2,956
 Less 89 common shares in Treasury, at cost..........         --        (1,433)
                                                         --------     --------
 Total stockholders' equity..........................     126,904      106,384
                                                         --------     --------
 Total liabilities and stockholders' equity..........    $338,956     $164,514
                                                         ========     ========
</TABLE>
 
   The accompanying notes are an integral part of the consolidated financial
                                  statements.
 
                                      

                                      F-3
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                    (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                       1997      1996    1995
                                                     ---------  ------- -------
<S>                                                  <C>        <C>     <C>
Net service revenues...............................   $144,412  $64,762 $35,860
Imaging center operating costs:
  Technical services payroll and related expenses..     33,552   10,836   6,815
  Medical supplies.................................      9,286    4,223   2,439
  Diagnostic equipment maintenance.................      7,761    3,274   1,647
  Independent contractor fees......................      6,810    1,202     437
  Administrative expenses..........................     22,878   11,937   5,252
  Other center level costs.........................      8,947    3,354   1,430
Provision for uncollectible accounts receivable....     20,364    4,705   3,378
Corporate general and administrative...............     12,157    4,567   2,994
Depreciation and amortization......................     18,733    6,964   4,274
Stock-option based compensation....................      2,536      --      --
Loss on impairment of goodwill and other long lived
 assets............................................     12,962      --      --
Other unusual charges..............................      9,723      --      --
                                                     ---------  ------- -------
    Operating income (loss)........................    (21,297)  13,700   7,194
Interest expense, net..............................      8,814    2,834   1,829
                                                     ---------  ------- -------
Income (loss) from continuing operations before
 minority interest and income taxes................    (30,111)  10,866   5,365
Minority interest (loss)...........................        636      308    (124)
                                                     ---------  ------- -------
Income (loss) from continuing operations before
 income taxes......................................    (30,747)  10,558   5,489
Provision for income taxes.........................      1,221    3,575   1,243
                                                     ---------  ------- -------
Income (loss) from continuing operations...........    (31,968)   6,983   4,246
Discontinued operations, net of tax:
  Income (loss) from discontinued operations (net
   of income tax provision of $1,079, $587 and
   $103, respectively).............................        729      271  (1,180)
  Loss on sale of discontinued business (net of tax
   benefit of $656)................................        --       --   (1,376)
                                                     ---------  ------- -------
  Income (loss) from discontinued operations.......        729      271  (2,556)
                                                     ---------  ------- -------
Net income (loss)..................................    (31,239)   7,254   1,690
Charges related to restricted common stock and
 convertible preferred stock.......................     (1,938)     --      --
                                                     ---------  ------- -------
Net income (loss) applicable to common
 stockholders......................................  $ (33,177) $ 7,254 $ 1,690
                                                     ---------  ------- -------
Income (loss) per common share applicable to common
 stockholders:
 Basic--
  Net income (loss) per share before discontinued
   operations......................................  $   (4.96) $  1.86 $  1.65
  Discontinued operations..........................        .11      .07    (.99)
                                                     ---------  ------- -------
  Net income (loss) per share......................  $   (4.85) $  1.93 $  0.66
                                                     ---------  ------- -------
 Diluted--
  Net income (loss) per share before discontinued
   operations......................................  $   (4.96) $  1.72 $  1.64
  Discontinued operations..........................        .11      .06    (.99)
                                                     ---------  ------- -------
  Net income (loss) per share......................  $   (4.85) $  1.78 $  0.65
                                                     =========  ======= =======
</TABLE>
 
   The accompanying notes are an integral part of the consolidated financial
                                  statements.
 
                                      

                                      F-4
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                      1997      1996     1995
                                                    --------  --------  -------
<S>                                                 <C>       <C>       <C>
Cash flows from operating activities:
Net income (loss).................................  $(31,239) $  7,254  $ 1,690
                                                    --------  --------  -------
Adjustments to reconcile net income to net cash
 provided by (used in) operating activities:
 Depreciation and amortization....................    19,334     7,466    4,567
 Provision for uncollectible accounts receivable..    20,656     4,784    3,378
 Deferred income tax provision....................      (836)     (841)  (2,161)
 Stock-option based compensation expense..........     2,536       --       --
 Expense incurred in connection with warrants
  issued to preferred stockholders................     2,051       --       --
 Loss on impairment of goodwill and other long
  lived assets....................................    12,962       --       --
 Loss on sale of discontinued business............       --        --     1,376
 Other, net.......................................       112        94      149
Changes in operating assets and liabilities:
 Accounts receivable..............................   (30,270)  (14,386)  (6,309)
 Other receivables................................    (2,219)   (1,814)    (171)
 Prepaid expenses.................................    (2,403)   (1,502)    (614)
 Income taxes recoverable or payable..............    (7,568)    2,186     (323)
 Other assets.....................................    (3,253)   (1,495)     (27)
 Accounts payable and accrued expenses............    16,560     2,081        4
 Other current liabilities........................      (315)   (1,510)     568
 Other long-term liabilities......................    (1,430)     (867)     208
                                                    --------  --------  -------
 Total adjustments................................    25,917    (5,804)     645
                                                    --------  --------  -------
 Net cash provided by (used in) operating
  activities......................................    (5,322)    1,450    2,335
                                                    --------  --------  -------
Cash flows from investing activities:
Purchase of property and equipment................    (5,429)   (1,070)    (877)
Acquisition of diagnostic imaging centers, net of
 cash acquired....................................   (57,883)   (6,411)  (1,764)
Acquisition of temporary staffing offices, net of
 cash acquired....................................       176    (2,314)     --
Acquisition of Dalcon Technologies, Inc., net of
 cash acquired....................................      (615)      --       --
Investment in diagnostic imaging center joint
 venture..........................................    (1,000)
Costs associated with refinancing of assets under
 capital leases...................................    (1,461)      --       --
Sale (purchase) of short-term investments, net....     6,109    (1,637)     600
Purchase of restricted short-term investments.....       --     (4,500)     --
Increase in restricted cash.......................       --       (600)     --
Change in net assets of discontinued business.....       --        --     1,396
Other, net........................................       --       (171)     --
                                                    --------  --------  -------
 Net cash used in investing activities............   (60,103)  (16,703)    (645)
                                                    --------  --------  -------
Cash flows from financing activities:
Proceeds from Senior Notes, net of issuance costs.    76,523       --       --
Proceeds from issuance of preferred stock, net....    16,965       --       --
Proceeds from sale/leaseback transactions.........     9,866       --       --
Proceeds from borrowings under notes payable......     7,850     1,229      --
Borrowings under line of credit...................     3,744       --       --
Proceeds from common stock offering...............       --     25,944      --
Common stock issuance cost........................       --       (780)     --
Proceeds from exercise of options and warrants....     2,696     2,020      --
Note and capital lease repayments in connection
 with acquisitions................................   (13,799)      --       --
Note and capital lease repayments in connection
 with Senior Notes transaction....................   (13,764)      --       --
Note and capital lease repayments in connection
 with sale/leaseback transactions.................    (4,822)      --       --
Principal payments under capital lease
 obligations......................................    (6,651)   (4,805)  (3,043)
Principal payments on notes and mortgages payable.    (5,312)   (2,968)  (1,119)
Proceeds from (redemption of) convertible
 debentures.......................................       (19)    6,533    4,103
Purchase of treasury stock........................       --        (64)  (1,368)
Purchase of Maternity preferred stock.............       --        --      (269)
                                                    --------  --------  -------
 Net cash provided by (used in) financing
  activities......................................    73,277    27,109   (1,696)
                                                    --------  --------  -------
Net increase (decrease) in cash and cash
 equivalents......................................     7,852    11,856       (6)
Cash and cash equivalents at beginning of year....    15,346     3,935    3,941
Reclassification of prior year restricted cash....       --       (445)     --
                                                    --------  --------  -------
Cash and cash equivalents at end of year..........  $ 23,198  $ 15,346  $ 3,935
                                                    ========  ========  =======
</TABLE>
 
   The accompanying notes are an integral part of the consolidated financial
                                  statements.
 
                                      

                                      F-5
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
               CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                         1997    1996    1995
                                                       -------- ------- -------
<S>                                                    <C>      <C>     <C>
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for--
 Income taxes........................................  $ 11,091 $ 3,440 $ 1,982
 Interest............................................     7,201   2,639   1,894
Supplemental Schedule of Non-Cash Investing and
 Financing Activities:
Capital lease obligations and notes payable incurred
 for diagnostic imaging and computer equipment.......    13,654   2,469   1,159
Capital lease obligations assumed in connection with
 acquisitions........................................    26,612   6,749     --
Notes payable obligations assumed in connection with
 acquisitions........................................    36,505  13,850     --
Conversion of subordinated debentures to Common
 Stock, net of issuance costs........................     6,636   5,735     --
Issuance of Common Stock in connection with
 acquisitions........................................    17,281  47,938   3,448
Common stock subject to redemption...................     9,734
Issuance of warrants in connection with acquisitions.     3,853     975     --
Issuance of warrants to convertible preferred
 stockholders........................................     2,051     --      --
Issuance of notes payable in connection with
 acquisitions........................................     4,250   1,848     --
Tax benefit from exercise of stock options...........     1,000     --      --
Maternity debt forgiveness treated as capital
 contribution........................................       --      --    1,022
</TABLE>
 
 
 
   The accompanying notes are an integral part of the consolidated financial
                                  statements.
 
                                      

                                      F-6
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                            COMMON             ADDITIONAL RETAINED   TREASURY  UNREALIZED
                                    COMMON STOCK TO  PREFERRED  PAID-IN   EARNINGS    SHARES   APPREC. ON
                           TOTAL    STOCK  BE ISSUED   STOCK    CAPITAL   (DEFICIT)  AT COST   INVESTMENTS
                          --------  ------ --------- --------- ---------- ---------  --------  -----------
<S>                       <C>       <C>    <C>       <C>       <C>        <C>        <C>       <C>
Balance at January 1,
 1995...................  $ 11,873   $ 24                       $ 18,407  $ (6,558)
Issuance of Common Stock
 related to acquisition
 of diagnostic imaging
 centers................     3,448      2   $ 1,721                1,725
Maternity debt
 forgiveness treated as
 a capital contribution.     1,022                                 1,022
Maternity short period
 (1/1-1/31/95)..........       570                                             570
Redemption by Maternity
 of its preferred stock.      (269)                                 (269)
Preferred stock buyout..         1                                     1
Purchase of treasury
 shares.................    (1,368)                                                  $(1,368)
Net income..............     1,690                                           1,690
                          --------   ----   -------   -------   --------  --------   -------      -----
Balance at December 31,
 1995...................    16,967     26     1,721               20,886    (4,298)   (1,368)
Issuance of Common Stock
 related to acquisition
 of diagnostic imaging
 centers................    47,938     19                         47,919
Warrants issued related
 to acquisition of
 diagnostic imaging
 centers................       975                                   975
Net proceeds from public
 offering of 1,226,667
 shares of Common Stock.    25,944     12                         25,932
Public offering issuance
 costs..................      (780)                                 (780)
Conversion of
 subordinated debentures
 into Common Stock......     5,735      4                          5,731
Exercise of stock
 options................     2,022      1                          2,021
Tax benefit from
 exercise of stock
 options................       368                                   368
Unrealized appreciation
 on investment..........        26                                                                $  26
Purchase of treasury
 shares.................       (65)                                                      (65)
Net income..............     7,254                                           7,254
                          --------   ----   -------   -------   --------  --------   -------      -----
Balance at December 31,
 1996...................   106,384     62     1,721              103,052     2,956    (1,433)        26
Issuance of Common Stock
 related to acquisition
 of diagnostic imaging
 centers................    10,673      4    (1,721)              10,957               1,433
Issuance of Common Stock
 related to acquisition
 of staffing offices....     2,000     --                          2,000
Issuance of Common Stock
 related to acquisition
 of Dalcon Technologies.     1,934     --                          1,934
Warrants issued related
 to acquisition of
 diagnostic imaging
 centers................     3,853                                 3,853
Warrants issued in
 connection with
 preferred stock........     2,051                                 2,051
Warrants issued in
 connection with long-
 term borrowings........       337                                   337
Conversion of
 debentures.............     6,635      5                          6,630
Exercise of stock
 options and warrants...     2,696      1                          2,695
Stock-option based
 compensation expense...     2,536                                 2,536
Tax benefit from
 exercise of stock
 options................     1,000                                 1,000
Common Stock issued in
 connection with
 acquisition earnout....     2,676      1                          2,675
Issuance of Convertible
 Preferred Stock........    16,965                    $18,000     (1,035)
Accretion of Convertible
 Preferred Stock........       --                         242                 (242)
Increase in price
 protection related to
 certain restricted
 common stock...........    (1,696)                                         (1,696)
Other, net..............        99                                   125                            (26)
Net loss................   (31,239)                                        (31,239)
                          --------   ----   -------   -------   --------  --------   -------      -----
Balance at December 31,
 1997...................  $126,904   $ 73   $   --    $18,242   $138,810  $(30,221)  $   --       $ --
                          ========   ====   =======   =======   ========  ========   =======      =====
</TABLE>
 
   The accompanying notes are an integral part of the consolidated financial
                                  statements.
 
                                      

                                      F-7
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. DESCRIPTION OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
 
 General
 
  Medical Resources, Inc., (herein referred to as "MRI" and collectively with
its subsidiaries, affiliated partnerships and joint ventures, referred to
herein as the "Company") specializes in the operation and management of
diagnostic imaging centers. The Company operates and manages primarily fixed-
site, free-standing outpatient diagnostic imaging centers (herein referred to
as "centers"), and provides diagnostic imaging network management services to
managed care providers. The Company's diagnostic imaging segment also develops
and sells radiology industry information systems through its subsidiary,
Dalcon Technologies, Inc.
 
  Through the Per Diem and Travel Nursing Divisions of its wholly-owned
subsidiaries, StarMed Staffing, Inc. and Wesley Medical Resources Inc.
("StarMed"), the Company provides temporary healthcare staffing of registered
nurses and other medical personnel to acute and sub-acute care facilities
nationwide. On August 18, 1998, the Company sold the stock of StarMed to
RehabCare Group, Inc. for gross proceeds of $33,000,000 (the "StarMed Sale").
Due to the StarMed Sale, the results of operations of StarMed are herein
reflected in the Company's Consolidated Statements of Operations as
discontinued operations. See Note 16 of Notes to Consolidated Financial
Statements.
 
  During July 1998, the Company's shareholders approved a reverse stock split
of the Company's outstanding shares of Common Stock. As a result of the
reverse stock split, each three outstanding shares of Common Stock were
automatically converted into one share of new Common Stock. The Company
effected the reverse stock split in order to meet the minimum bid price
requirement for continued listing on the Nasdaq Stock Market. The share data
included herein have been adjusted to reflect the impact of the reverse stock
split.
 
 Consolidation
 
  The accompanying consolidated financial statements include the accounts of
MRI, its wholly-owned subsidiaries, majority-owned joint ventures and limited
partnerships in which the Company is a general partner. All material
intercompany balances and transactions have been eliminated. As general
partner, the Company is subject to all the liabilities of a general partner
and as of December 31, 1997, is entitled to share in partnership profits,
losses and distributable cash as provided in the partnership agreements. The
limited partnership interests are shown in the accompanying financial
statements as minority interest. Under certain of the partnerships, the
Company also is paid a monthly management fee based on patient cash
collections and/or patient volume under management agreements. Partnership
losses allocable to limited partners in excess of their respective capital
accounts are charged to the Company as general partner. Future income related
to such partnerships will be allocated to the Company as general partner until
such time as the Company has recovered the excess losses. Certain of the
limited partnership agreements require limited partners to make cash
contributions in the event their respective capital accounts are reduced below
zero due to partnership operating losses. The Company has not reflected this
potential recovery from the limited partners due to uncertainty regarding the
ultimate receipt of the cash contributions.
 
 Revenue Recognition
 
  At each of the Company's diagnostic imaging centers, all medical services
are performed exclusively by physician groups (the "Physician Group" or the
"Interpreting Physician"), generally consisting of radiologists with whom the
Company has entered into independent contractor agreements. Pursuant to these
agreements, the Company has agreed to provide equipment, premises,
comprehensive management and administration, including responsibility for
billing and collection of receivables, and technical imaging services to the
Interpreting Physician.
 
                                      

                                      F-8
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Net service revenues are reported, when earned, at their estimated net
realizable amounts from patients, third party payors and others for services
rendered at contractually established billing rates which generally are at a
discount from gross billing rates. Known and estimated differences between
contractually established billing rates and gross billing rates ("contractual
allowances") are recognized in the determination of net service revenues at
the time services are rendered. Subject to the foregoing, the Company's
imaging centers recognize revenue under one of the three following types of
agreements with Interpreting Physicians:
 
    Type I--The Company receives a technical fee for each diagnostic imaging
  procedure performed at a center, the amount of which is dependent upon the
  type of procedure performed. The fee included in revenues is net of
  contractual allowances. The Company and the Interpreting Physician
  proportionally share in any losses due to uncollectible amounts from
  patients and third party payors, and the Company has established reserves
  for its share of the estimated uncollectible amount.
 
    Type II--The Company bills patients and third party payors directly for
  services provided and pays the Interpreting Physicians either (i) a fixed
  percentage of fees collected at the center, or (ii) a contractually fixed
  amount based upon the specific diagnostic imaging procedures performed.
  Revenues are recorded net of contractual allowances and the Company accrues
  the Interpreting Physicians fee as an expense on the Consolidated
  Statements of Operations. The Company bears the risk of loss due to
  uncollectible amounts from patients and third party payors, and the Company
  has established reserves for the estimated uncollectible amount.
 
    Type III--The Company receives from an affiliated physician association a
  fee for the use of the premises, a fee per procedure for acting as billing
  and collection agent and a fee for administrative and technical services
  performed at the centers. The affiliated physician association contracts
  with and pays directly the Interpreting Physicians. The Company's fee, net
  of an allowance based upon the affiliated physician association's ability
  to pay after the association has fulfilled its obligations (i.e., estimated
  future net collections from patients and third party payors less facility
  lease expense and Interpreting Physicians fees), constitutes the Company's
  net service revenues. Since the Company's net service revenues are
  dependent upon the amount ultimately realized from patient and third party
  receivables, the Company's revenue and receivables have been reduced by an
  estimate of patient and third party payor contractual allowances, as well
  as an estimated provision for uncollectible amounts from patients and third
  party payors.
 
  Revenues derived from Medicare and Medicaid are subject to audit by such
agencies. The Company is not aware of any pending audits.
 
  The Company also recognizes revenue from the sale of radiology information
systems. Such revenues are recognized on an accrual basis as earned.
 
 Reclassification
 
  Certain prior year items have been reclassified to conform to the current
year presentation.
 
 Use of Estimates
 
  The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of revenues, expenses, assets
and liabilities, and the disclosure of contingent assets and liabilities in
the consolidated financial statements and accompanying notes. The most
significant estimates relate to contractual allowances, the allowance for
doubtful accounts receivable, income taxes, contingencies and the useful lives
of equipment. In addition, healthcare industry reforms and reimbursement
practices will continue to impact the Company's operations and the
determination of contractual and other allowance estimates. Actual results
could differ from management's estimates.
 
                                     

                                      F-9
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
 Cash and Cash Equivalents
 
  For financial statement purposes cash equivalents include short-term
investments with an original maturity of ninety days or less. Restricted cash
consists of amounts held pursuant to the terms of letters of credit and is
classified based upon the expiration of the restriction.
 
 Short-Term Investments
 
  At December 31, 1996 the Company's short-term investments, consist of
certificates of deposits and treasury bills with maturities between three and
twelve months. Such securities are classified as available-for-sale.
Securities available for sale are carried at fair value with unrealized gains
and losses, net of tax, reported as a separate component of shareholders'
equity. Any realized gains and losses are determined on the specific
identification method.
 
  Restricted short-term investments at December 31, 1996 consist of $4,500,000
of United States Government obligations held pursuant to a letter of credit
issued in connection with one of the Company's acquisitions. The letter of
credit served to reserve consideration for the acquisition in the event that
the shares of the Company's Common Stock issued to the seller were not
registered within 60 days of the closing of the sale. During 1997, the shares
were registered within the specified timeframe of the agreement, and as such,
the restriction of the investment was removed.
 
 Investments in Joint Ventures and Limited Partnerships
 
  The minority interests in the equity of consolidated joint ventures and
limited partnerships, which are not material, are reflected in the
accompanying consolidated financial statements. Investments by the Company in
joint ventures and limited partnerships over which the Company can exercise
significant influence but does not control are accounted for using the equity
method.
 
  The Company suspends recognition of its share of joint ventures losses in
entities in which it holds a minority interest when its investment is reduced
to zero. The Company does not provide for additional losses unless, as a
partner or joint venturer, the Company has guaranteed obligations of the joint
venture or limited partnership.
 
 Property and Equipment
 
  Property and equipment procured in the normal course of business is stated
at cost. Property and equipment purchased in connection with an acquisition is
stated at its estimated fair value, generally based on an appraisal. Property
and equipment is depreciated for financial accounting purposes using the
straight-line method over the shorter of their estimated useful lives,
generally five to seven years, or the term of a capital lease, if applicable.
Leasehold improvements are being amortized over the shorter of the useful life
or the remaining lease term. Expenditures for maintenance and repairs are
charged to operations as incurred. Renewals and betterments are capitalized.
 
                                     

                                      F-10
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
 Goodwill and other intangible assets
 
  The excess of purchase price of businesses over the fair value of assets
acquired is recorded as goodwill and is amortized on a straight line basis
generally over twenty years. Other intangible assets consist of covenants not
to compete, value of managed care contracts, organizational costs and
capitalized lease costs related to acquired businesses and are amortized on a
straight line basis over their respective initial estimated lives of three to
ten years. Gross intangible assets and related accumulated amortization are as
follows (in thousands):
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                                1997     1996
                                                              --------  -------
   <S>                                                        <C>       <C>
   Goodwill
     Gross intangible........................................ $157,362  $65,666
     Less accumulated amortization...........................   (7,738)  (3,027)
                                                              --------  -------
       Net................................................... $149,624  $62,639
                                                              ========  =======
   Other intangibles
     Gross intangibles....................................... $  9,484  $ 3,996
     Less accumulated amortization...........................   (2,648)  (1,877)
                                                              --------  -------
       Net................................................... $  6,836  $ 2,119
                                                              ========  =======
</TABLE>
 
  Amortization expense from continuing operations for goodwill was $5,626,000,
$1,039,000 and $161,000 in 1997, 1996 and 1995, respectively. Amortization
expense for other intangibles was $1,151,000, $506,000 and $337,000 in 1997,
1996 and 1995, respectively.
 
  The Company periodically reviews goodwill to assess recoverability based
upon expectations of undiscounted cash flows and operating income of each
entity having a material goodwill balance. An impairment would be recognized
in operating results, if the sum of the expected future cash flows
(undiscounted and without interest charges) is less than the carrying value of
the related costs in excess of net assets acquired. The amount of the
impairment would be measured by comparing the carrying value of intangible and
other long-lived assets to their fair values. See discussion of 1997
impairment loss in Note 3 of the Notes to Consolidated Financial Statements.
 
                                     

                                      F-11
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
 Earnings Per Share
 
  Effective for the year ended December 31, 1997, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share." The adoption of SFAS No. 128 requires the presentation of Basic
Earnings per Share and Diluted Earnings per Share. Basic earnings per share is
based on the weighted average number of common shares outstanding during the
year. Diluted earnings per share is based on the weighted average number of
common shares outstanding during the year plus the potentially issuable common
shares related to outstanding stock options, warrants and convertible debt.
Earnings per share amounts for prior periods, including related quarters, have
been restated to conform to the requirements of SFAS No. 128. The computations
of basic earnings per share and diluted earnings per share were as follows (in
thousands, except per share amounts):
 
<TABLE>
<CAPTION>
                                                        1997     1996   1995
                                                      --------  ------ -------
<S>                                                   <C>       <C>    <C>
BASIC EARNINGS PER SHARE INFORMATION
Income (loss) from continuing operations............. $(31,968) $6,983 $ 4,246
Income (loss) from discontinued operations...........      729     271  (2,556)
                                                      --------  ------ -------
Net income (loss)....................................  (31,239)  7,254   1,690
Charges related to restricted common stock and
 convertible preferred stock.........................   (1,938)    --      --
                                                      --------  ------ -------
Net income (loss) applicable to common Stockholders.. $(33,177) $7,254 $ 1,690
                                                      ========  ====== =======
Weighted average number of common shares.............    6,832   3,760   2,577
                                                      ========  ====== =======
Net income (loss) per share before discontinued
 operations.......................................... $  (4.96) $ 1.86 $  1.65
Discontinued operations..............................     0.11    0.07   (0.99)
                                                      --------  ------ -------
Basic earnings per share............................. $  (4.85) $ 1.93 $  0.66
                                                      ========  ====== =======
DILUTED EARNINGS PER SHARE INFORMATION
Income (loss) from continuing operations............. $(31,968) $6,983 $ 4,246
Loss from discontinued operations....................      729     271  (2,556)
                                                      --------  ------ -------
Net income (loss)....................................  (31,239)  7,254   1,690
Interest savings from conversion of convertible
 subordinated debentures.............................      --      405     --
Charges related to restricted common stock and
 convertible preferred stock.........................   (1,938)    --      --
                                                      --------  ------ -------
Net income (loss) applicable to common Stockholders
 after assumed conversions........................... $(33,177) $7,659 $ 1,690
                                                      ========  ====== =======
Weighted average number of common shares.............    6,832   3,760   2,577
Incremental shares issuable on exercise of warrants
 and options.........................................      --      139      17
Incremental shares issuable on conversion of
 convertible subordinated debentures.................      --      404     --
                                                      --------  ------ -------
Weighted average number of diluted common shares.....    6,832   4,303   2,594
                                                      ========  ====== =======
Net income (loss) per share before discontinued
 operations.......................................... $  (4.96) $ 1.72 $  1.64
Discontinued operations..............................     0.11    0.06   (0.99)
                                                      --------  ------ -------
Diluted earnings (loss) per share.................... $  (4.85) $ 1.78 $  0.65
                                                      ========  ====== =======
</TABLE>
 
  Warrants, options and the Series C Convertible Preferred Stock are not
dilutive in 1997.
 
                                     

                                      F-12
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
 Stock Options
 
  SFAS No. 123, Accounting for Stock-Based Compensation requires the Company
to choose between two different methods of accounting for stock options. The
Statement defines a fair-value-based method of accounting for stock options
but allows an entity to continue to measure compensation cost for stock
options using the accounting prescribed by APB Opinion No. 25, Accounting for
Stock Issued to Employees (APB No. 25). The Company has elected to continue
using the accounting methods prescribed by APB No. 25 and will disclose the
amount of the proforma compensation expense, required to be disclosed under
the SFAS No. 123. See disclosure in Note 9 of the Notes to the Consolidated
Financial Statements.
 
 Income Taxes
 
  The Company accounts for income taxes under SFAS No. 109, Accounting for
Income Taxes. Under the asset and liability method of SFAS No. 109, deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax bases. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. Under SFAS No. 109, the effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. As of December 31,
1997, the Company has provided a valuation reserve against a portion of its
net deferred income tax assets due to uncertainty regarding the ultimate
recovery of such deferred income tax assets. See further discussion in Note 10
of the Notes to the Consolidated Financial Statements.
 
 Recent Accounting Pronouncements
 
  SFAS No. 130, "Reporting Comprehensive Income", requires an entity to report
comprehensive income and its components for fiscal years beginning after
December 15, 1997. This new standard increases financial reporting
disclosures, but will have no impact on the Company's financial position, cash
flows or results of operations.
 
  Statement Of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use", requires an entity to expense all
software development costs incurred in the preliminary project state, training
costs and data conversion costs for fiscal years beginning after December 15,
1998. The Company believes that this statement will not have a material effect
on the Company's accounting for computer software acquisition cost.
 
  Statement Of Position 97-2, "Consolidation of Physicians' Practice
Entities", requires an entity to consolidate Physicians' Practice Entities in
circumstances in which substantial control is exercised by the Company. The
Company believes that this statement will not have a material effect on the
Company's financial position, cash flows or results of operations.
 
2. BASIS OF FINANCIAL STATEMENT PRESENTATION AND ISSUES AFFECTING LIQUIDITY
 
  As a result of its net loss for 1997 and the late filing of its 1997 Annual
Report on Form 10-K, the Company is currently in default of certain financial
covenants under the agreements for its $78,000,000 of Senior Notes. Management
and the Senior Note lenders are engaged in discussions to resolve this matter.
In the event the parties are unable to reach agreement, the lenders are
entitled, at their discretion, to exercise certain remedies including
acceleration of repayment. There can be no assurance that the Senior Note
lenders will provide the Company with an amendment or waiver of the defaults.
In addition, certain medical equipment notes, and operating and capital leases
of the Company, aggregating $16,685,000 at December 31, 1997 (the "Cross-
 
                                     

                                      F-13
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
Default Debt"), contain provisions which allow the creditors or lessors to
accelerate their debt or terminate their leases and seek certain other
remedies if the Company is in default under the terms of agreements such as
the Senior Notes.
 
  In the event that the Senior Note lenders or the holders of the Cross
Default Debt elect to exercise their right to accelerate the obligations under
the Senior Notes or the other loans and leases, such acceleration would have a
material adverse effect on the Company, its operations and its financial
condition. Furthermore, if such obligations were to be accelerated, in whole
or in part, there can be no assurance that the Company would be successful in
identifying or consummating financing necessary to satisfy the obligations
which would become immediately due and payable. As a result of the uncertainty
related to the defaults and corresponding remedies described above, the Senior
Notes and the Cross Default Debt were shown as current liabilities on the
Company's Consolidated Balance Sheets at December 31, 1997. Accordingly, the
Company had a deficit in working capital of $58,174,000 at December 31, 1997.
These matters raise substantial doubt about the Company's ability to continue
as a going concern. In addition to continuing to negotiate with the Senior
Note lenders in an attempt to obtain waivers or amendments of the
aforementioned defaults, the Company has taken various actions in response to
this situation, including the following: (i) it effected a workforce reduction
in March 1998 aimed at reducing the Company's overall expense levels and (ii)
it has retained the investment banking firm of SBC Warburg Dillon Read to
assist the Company in exploring a possible sale of the Company's StarMed
temporary staffing subsidiary (see Note 16 of Notes to Consolidated Financial
Statements for further discussion). The financial statements do not include
any further adjustments reflecting the possible future effects on the
recoverability and classification of assets or the amount and classification
of liabilities that may have resulted from the outcome of this uncertainty.
 
  See Note 16 of Notes to Consolidated Financial Statements for further
discussion.
 
3. LOSS ON IMPAIRMENT OF GOODWILL AND OTHER LONG-LIVED ASSETS AND OTHER
UNUSUAL CHARGES
 
  During the fourth quarter of 1997, the Company recorded a $12,962,000 loss
on the impairment of goodwill and other long-lived assets. This loss consists
of the write-off of goodwill of $10,425,000, covenants not to compete of
$118,000 and fixed assets of $2,419,000. The write-down of fixed assets
primarily relates to imaging equipment. Primarily the entire impairment
relates to eight of the Company's diagnostic imaging centers that are under-
performing. The Company has recorded impairment losses for these centers
because the sum of the expected future cash flows, determined based on an
assumed continuation of current operating methods and structures, does not
cover the carrying value of the related long-lived assets.
 
  During the fourth quarter of 1997, the Company also recorded $9,723,000 of
other unusual charges consisting of (i) $3,256,000 for the estimated net costs
associated with the resolution of the shareholder and employee lawsuits (see
discussion of litigation in Note 11 of the Notes to the Consolidated Financial
Statements), (ii) $2,243,000 for higher than normal professional fees, (iii)
$2,169,000 ($2,051,000 of which was a non-cash charge related to the issuance
of 272,000 warrants) for penalties associated with delays in the registration
of the Company's common stock issued in connection with acquisitions or
issuable upon conversion of convertible preferred stock, (iv) $1,150,000 for
the loss on investment related to a potential acquisition not consummated, (v)
$469,000 for costs associated with the investigation of related party
transactions which was concluded in April 1998 and (vi) $436,000 for
management termination benefits and related costs. The Company accrues for
legal fees as incurred.
 
  The Company expects to incur additional unusual charges of at least
$4,500,000 during 1998 primarily related to the estimated net costs associated
with the resolution of the shareholder and employee lawsuits, penalties
associated with delays in the registration of the Company's Common Stock and
costs associated with
 
                                     

                                      F-14
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
the investigation of related party transactions. Such additional unusual
charges could be substantially higher depending upon the ultimate outcome of
current negotiations regarding penalties associated with failure to register
the Company's Common Stock and the outcome of certain litigation. See further
discussion in Note 11 of the Notes to the Consolidated Financial Statements.
 
4. ACCOUNTS RECEIVABLE, NET
 
  Accounts receivable, net is comprised of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                               -----------------
                                                                 1997     1996
                                                               --------  -------
   <S>                                                         <C>       <C>
   Management fee receivables (net of contractual allowances)
     Due from unaffiliated physicians (Type I revenues)......  $ 35,540  $23,188
     Due from affiliated physicians (Type III revenues)......     8,585    9,195
   Patient and third party payor accounts receivable (Type II
    revenues)................................................    27,284   10,757
   Temporary staffing service accounts receivable............    13,400    6,335
   Less: Allowance for doubtful accounts.....................   (18,922)  (9,597)
                                                               --------  -------
                                                               $ 65,887  $39,878
                                                               ========  =======
</TABLE>
 
  Accounts receivable is net of contractual allowances which represent
standard fee reductions negotiated with certain third party payors.
Contractual allowances amounted to approximately $93,490,000, $25,270,000 and
$13,375,000 for the years ended December 31, 1997, 1996 and 1995,
respectively.
 
  The Company's receivables relate to a variety of different structures (see
discussion of revenue recognition in Note 1 of the Notes to Consolidated
Financial Statements) as well as a variety of payor classes, including third
party medical reimbursement organizations, principally insurance companies.
Approximately 24.2% and 19.5% of the Company's 1997 and 1996 imaging revenues
was derived from the delivery of services with respect to the timing of
payment is substantially contingent upon the timing of settlement of pending
litigation involving the recipient of services and third parties (Personal
Injury Type accounts receivable). The Company undertakes certain measures to
identify and document the individual's obligation to pay for services rendered
regardless of the outcome of the pending litigation. By its nature, the
realization of a substantial portion of these receivables is expected to
extend beyond one year from the date the service was rendered. The Company
anticipates that a material amount of its Personal Injury Type accounts
receivable will be outstanding for periods in excess of twelve months in the
future. The Company considers the aging of its accounts receivable in
determining the amount of allowance for doubtful accounts. For Personal Injury
Type accounts receivables, the Company provides for uncollectible accounts at
substantially higher rates than any other revenue source.
 
 
                                     

                                      F-15
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
5. SHORT-TERM INVESTMENTS
 
  The following is a summary of the investments in debt securities classified
as current assets, and which are available for sale (in thousands):
 
<TABLE>
<CAPTION>
                                                       UNREALIZED FAIR
                                                          COST    GAINS  VALUE
                                                       ---------- ----- -------
   <S>                                                 <C>        <C>   <C>
   December 31, 1996
     Available-for-sale:
       US Government obligations......................  $ 5,361    $26  $ 5,387
       Certificates of deposit........................      776    --       776
                                                        -------    ---  -------
   Total..............................................    6,137     26    6,163
     Less: Restricted Investments.....................   (4,500)   --    (4,500)
                                                        -------    ---  -------
                                                        $ 1,637    $26  $ 1,663
                                                        =======    ===  =======
</TABLE>
 
  As of December 31, 1997, there were no short-term investments available-for-
sale.
 
6. PROPERTY AND EQUIPMENT
 
  Property and equipment stated at cost are set forth below (in thousands):
 
<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                             ------------------
                                                               1997      1996
                                                             --------  --------
   <S>                                                       <C>       <C>
   Diagnostic equipment..................................... $ 63,186  $ 33,938
   Leasehold improvements...................................   18,684     9,352
   Furniture and fixtures...................................   10,571     2,997
   Land and buildings.......................................    4,987       632
   Construction in progress.................................      --        270
                                                             --------  --------
                                                               97,428    47,189
   Less: accumulated depreciation and amortization..........  (33,085)  (22,792)
                                                             --------  --------
                                                             $ 64,343  $ 24,397
                                                             ========  ========
</TABLE>
 
  Depreciation and amortization expense from continuing operations related to
property and equipment amounted to $11,955,000, $5,419,000 and $3,775,000 for
the years ended December 31, 1997, 1996 and 1995, respectively.
 
7. ACCRUED EXPENSES
 
  Accrued expenses are comprised of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                                ---------------
                                                                 1997    1996
                                                                ------- -------
   <S>                                                          <C>     <C>
   Accrued professional fees................................... $ 5,875 $   354
   Accrued payroll and bonuses.................................   4,242     792
   Accrued interest............................................   2,749     323
   Accrued radiologist fees....................................   3,398     629
   Other accrued expenses......................................  11,754      69
                                                                ------- -------
                                                                $28,018 $ 2,167
                                                                ======= =======
</TABLE>
 
 
                                     

                                      F-16
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
8. DEBT
 
  Outstanding debt consists of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                                1997     1996
                                                              --------  -------
   <S>                                                        <C>       <C>
   Senior Notes due 2001 through 2005, classified as current
    due to financial covenant defaults......................  $ 78,000  $   --
                                                              ========  =======
   Revolving line of credit.................................  $  3,744  $   --
                                                              ========  =======
   Convertible debentures...................................  $    --   $ 6,988
                                                              ========  =======
   OTHER NOTES AND MORTGAGES PAYABLE:
   Debt issued or assumed in connection with 1997
    acquisitions............................................  $ 19,809  $   --
   Debt issued or assumed in connection with 1996
    acquisitions............................................     6,785   13,748
   10.25% unsecured promissory note, monthly payments of
    $171 including interest through December 2002...........     8,000      --
   Other debt...............................................     3,464    5,619
                                                              --------  -------
       Total other notes and mortgages payable..............    38,058   19,367
                                                              --------  -------
   Less current installments................................   (13,313)  (6,729)
   Less debt shown as current due to financial covenant
    default.................................................    (3,206)     --
                                                              --------  -------
   Total other notes and mortgages payable shown as long-
    term....................................................  $ 21,539  $12,638
                                                              ========  =======
</TABLE>
 
  During 1997, the Company borrowed $78,000,000 of Senior Notes (the "Senior
Notes") from a group of insurance companies led by the John Hancock Mutual
Life Insurance Company ("John Hancock"). The notes bear interest at an average
annual rate of 7.87%, are subject to annual sinking fund payments commencing
February 2001 and have a final maturity in February 2005. The Senior Notes are
guaranteed by substantially all of the Company's diagnostic imaging
subsidiaries and collateralized by certain partnership interests owned through
subsidiaries by the Company. In addition, the agreement relating to the
issuance of the Senior Notes imposes certain affirmative and negative
covenants on the Company and its restricted subsidiaries, including
restrictions on the payment of dividends. The Company used a portion of the
proceeds from the Senior Notes to retire capital lease obligations totaling
$8,274,000 and notes payable totaling $5,490,000. The difference between the
amount used to retire capital lease obligations and the carrying value of such
obligations was approximately $1,461,000. In accordance with Financial
Accounting Standards Board Interpretation 26 ("FIN 26") "Accounting for the
Purchase of a Leased Asset by the Lessee During the Term of the Lease," the
book value of the related assets have been increased by this amount, not to
exceed the fair value of the assets, which will be amortized over the
remaining useful lives of the assets. In connection with the Senior Note
transaction, the Company paid $337,000 to 712 Advisory Services, Inc., an
affiliate (the "Affiliate") of the Company's Chairman of the Board, for
financial advisory services.
 
  The Company is currently in default of certain financial covenants under the
Senior Notes. See Notes 2 and 16 of the Notes to the Consolidated Financial
Statements.
 
  Debt issued or assumed in connection with 1997 acquisitions bear interest at
rates ranging from 8.6% to 13.75% and mature from 1998 through 2010. Such debt
includes the following convertible notes:
 
    In August 1997, as part of the purchase price for the acquisition of the
  business assets of the Presgar centers, the Company issued up to $3,700,000
  in notes convertible into the Company's Common Stock, of which, $1,200,000
  in principal amount is contingent upon the occurrence of certain events.
  The notes
 
                                     

                                      F-17
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
  ($2,500,000 outstanding at December 31, 1997) bear interest at prime plus
  1% (9.5% at December 31, 1997) and mature on August 21, 1998.
 
    In October 1997, as part of the purchase price of the acquisition of the
  Ohio centers, the Company issued $1,750,000 in notes convertible into the
  Company's Common Stock. The notes bear interest at 12% and mature on
  October 3, 1998.
 
  Debt issued or assumed in connection with 1996 acquisitions includes the
following:
 
    In January 1996, as part of the purchase price for the acquisition of the
  business assets of MRI-CT, Inc., the Company issued an $88,000 note payable
  bearing interest at prime (8.5% at December 31, 1997) due January 9, 2001.
  Also in January 1996, as part of the purchase price for the acquisition of
  the common stock of NurseCare Plus, Inc. the Company issued a note payable
  for $1,250,000 bearing interest at prime plus one percent (9.5% at December
  31, 1997) due January 12, 1999. In June 1996, the Company issued a $510,000
  note payable as part of the purchase price of WeCare Allied Health Care,
  Inc. The note bears interest at prime plus one percent (9.5% at December
  31, 1997) and is due August 1998.
 
    In August 1996, in connection with the NMR Acquisition the Company
  assumed NMR's existing equipment debt obligations, aggregating $13,235,700.
  These notes bear interest at rates ranging from 7.0% to 11.5% and require
  monthly payments ranging from $623 to $38,095 including interest (an
  aggregate of $172,539 per month). The notes are payable over varying terms
  with the last note due in December 2000. The foregoing notes are
  collateralized by the respective centers' imaging equipment. As of December
  31, 1997, the outstanding balance declined to $4,108,000 primarily as a
  result of the application of proceeds from the issuance of the Senior
  Notes.
 
  Other debt includes the following:
 
    In 1994, StarMed and a creditor renegotiated a note payable. At the time
  of the restructuring, the note balance was adjusted to the amount of the
  projected undiscounted future cash payments based upon the prevailing
  interest rate and, accordingly, no interest expense has been recorded
  subsequent to the effective date of the renegotiation other than the
  amounts attributed to a change in the variable rate and is due in 2000. The
  balance of such note at December 31, 1997 was $3,042,000.
 
  On February 7, 1996, the Company issued at par $6,533,000 aggregate
principal amount of 10.5% Convertible Subordinated Debentures due 2001 (the
"1996 Debentures"). The Company called for the redemption of the 1996
Debentures at the conversion price of $18.00 per share on or before March 27,
1997. As of December 31, 1997, all of the 1996 Debentures have been converted.
On May 30, 1995, the Company issued at par $4,350,000 aggregate principal
amount of 11% Convertible Subordinated Debentures due 2000 (the "1995
Debentures"). The 1995 Debentures automatically converted to Common Stock
when, on June 20, 1997 the market price of the Stock exceeded $18.00 per share
for a 15 consecutive day period. Under the terms of the merger agreement with
NMR, the Company assumed the obligations under NMR's 8% Convertible
Subordinated Debentures due 2001 including payment of principal and interest
(the "NMR Debentures"). The Company called for redemption of the NMR
Debentures at the conversion price of $19.62 per share on or before March 27,
1997. As of December 31, 1997, all of the NMR Debentures had either been
redeemed or converted into Common Stock of the Company. During 1997 and 1996,
debentures of $6,988,000 and $5,735,000, respectively, were converted into
Common Stock.
 
  In connection with the private placements of the 1995 Debentures and the
1996 Debentures, the Company paid $248,000 and $357,000, respectively, in
placement agent fees and expenses to an investment banking firm. Mr. Gary L.
Fuhrman, a director of the Company, is an executive officer and director of
such investment banking firm.
 
 
                                     

                                      F-18
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
  Aggregate maturities (after classification of certain amounts as current due
to the financial covenant defaults) of the Company's Senior Notes and other
notes and mortgages payable for years 1998 through 2002 and thereafter are as
follows (in thousands):
 
<TABLE>
   <S>                                                                   <C>
   1998................................................................. $94,519
   1999.................................................................   6,209
   2000.................................................................   8,385
   2001.................................................................   4,245
   2002.................................................................   2,105
   thereafter...........................................................     595
</TABLE>
 
  The Company has three revolving lines of credit from a third party financing
corporation totaling $12,000,000. The lines bear interest at prime plus 1.5%
(10% at December 31, 1997) and have a two-year term. As of December 31, 1997
and 1996, no amounts were outstanding under these lines of credit.
 
  On December 29, 1997, the Company entered into a $15 million credit facility
with DVI Financial Services Inc. (the "Facility"). The Facility provides for
two advances to the Company, one for $8 million and the other for $7 million.
In consideration for making the Facility available to the Company, the lender
received warrants to purchase an aggregate of 33,333 shares of Common Stock at
an exercise price based upon 110% of the average market prices over a period
prior to the issuance of the warrants. In the event that the lender refuses to
make the second advance, warrants to purchase 15,556 shares of Common Stock
will be canceled. As of December 31, 1997, $8,000,000 had been borrowed under
the Facility.
 
  During 1997, StarMed obtained a revolving line of credit from a third party
financing corporation. The $6,000,000 line bears interest at a rate of prime
plus 1.5% (10% at December 31, 1997), has a two year term and is
collateralized by substantially all of StarMed's accounts receivable. At
December 31, 1997, $3,744,000 was outstanding under the line. In early 1998,
StarMed increased the availability under the revolving line of credit by
$1,000,000.
 
9. STOCKHOLDERS' EQUITY
 
 Authorized Stock
 
  The authorized capital stock of the Company consists of 50,000,000 shares of
Common Stock, par value $.01 per share, and 100,000 shares of Preferred Stock,
par value $.01 per share ("Preferred Stock"). The Company has a Shareholders'
Rights Plan (described below) which requires the issuance of Series C Junior
Participating Preferred Stock, in connection with the exercise of certain
stock purchase rights. At December 31, 1997, there was (i) 7,296,333 shares of
Common Stock issued and outstanding and, (ii) 18,000 shares of Series C
Convertible Preferred Stock outstanding (the "Convertible Preferred Shares").
 
 Shareholders' Rights Plan
 
  Pursuant to the Shareholders' Rights Plan, holders of the Common Stock
possess three rights (the "Rights") to purchase one ten thousandth of a share
of Series C Junior Participating Preferred Stock for each share of Common
Stock owned. The Rights will generally become exercisable ten days after a
person or group acquires 15% of the Company's outstanding voting securities or
ten business days after a person or group commences or announces an intention
to commence a tender or exchange offer that could result in the acquisition of
15% of any such securities. Ten days after a person acquires 15% or more of
the Company's outstanding voting securities (unless this time period is
extended by the Board of Directors) each Right would, subject to certain
adjustments and alternatives, entitle the rightholder to purchase Common Stock
of the Company or stock of the
 
                                     

                                      F-19
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
acquiring company having a market value of twice the $24.00 exercise price of
the Right (except that the acquiring person or group and other related holders
would not be able to purchase common stock of the Company on these terms). The
Rights are nonvoting, expire in 2006 and may be redeemed by the Company at a
price of $.001 per Right at any time prior to the tenth day after an
individual or group acquired 15% of the Company's voting stock, unless
extended.
 
  The purpose of the Rights is to encourage potential acquirers to negotiate
with the Company's Board of Directors prior to attempting a takeover and to
give the Board leverage in negotiating on behalf of the shareholder the terms
of any proposed takeover.
 
 Convertible Preferred Stock
 
  In July 1997, the Company issued 18,000 shares of $1,000 Series C
Convertible Preferred Stock, $.01 par value, to RGC International, LDC
("RGC"). The Convertible Preferred Shares are convertible into Common Stock of
the Company at the option of RGC beginning on the date on which a registration
statement relating to the Common Stock underlying the Convertible Preferred
Shares (the "Conversion Shares") is declared effective by the Securities and
Exchange Commission, provided that, beginning 180 days from the effectiveness
of such registration statement, the Company may require the conversion of all
or a portion of the Convertible Preferred Shares.
 
  The Convertible Preferred Shares convert into the Company's Common Stock by
dividing the Stated Value of the Convertible Preferred Shares, plus 3% per
annum to the date of conversion, by the lesser of (i) $62.10 and (ii) the
average of the daily closing bid prices for the Company's Common Stock for the
five (5) consecutive trading day period ending five (5) trading days prior to
the date of conversion. If the average closing price of the Company's Common
Stock (the "Closing Price") for any ten (10) consecutive trading days does not
exceed $36.75 (the "Floor Price"), the Company has the right to block
conversion of the Convertible Preferred Shares by RGC for up to thirty (30)
days in the aggregate. Effective May 1998, in exchange for certain concessions
with respect to penalties, the Company waived the above-described right to
block conversion. If the Closing Price does not exceed the Floor Price for 30
consecutive calendar days, the Convertible Preferred Shares are redeemable, in
whole or in part, at the option of the Company for 110% of the stated value
plus 3% per annum. RGC is subject to volume restrictions which prohibit the
sale of more than 25% of the daily or weekly trading volume in any such
period, unless certain circumstances exist. The liquidation preference of each
Convertible Preferred Share is $1,000 plus 3% per annum. The holder of the
Convertible Preferred Shares is entitled to limited voting rights.
 
  As of December 31, 1997, based upon the current market price of the
Company's Common Stock, the Convertible Preferred Shares would be convertible
into 648,000 shares of Company Common Stock, representing 8% of the
outstanding shares of Common Stock as of such date after giving effect to the
conversion of the Convertible Preferred Shares. Under the terms of the
Convertible Preferred Shares, RGC is not permitted to convert Shares of the
Convertible Preferred Shares which would result in RGC owning in excess of 5%
of the outstanding shares of Common Stock. As discussed above, the Company has
the option to repurchase the shares at 110% of stated value plus 3% per annum.
 
  Pursuant to the terms of the Series C Convertible Preferred Stock Purchase
Agreement (the "Series C Preferred Stock Purchase Agreement"), dated July 21,
1997, between the Company and RGC, and the Registration Rights Agreement,
dated July 21, 1997, (the "Series C Registration Rights Agreement"), between
the Company and RGC (the Series C Stock Purchase Agreement and the RGC
Registration Rights Agreement are hereinafter referred to as the "RGC
Agreements"), the Company was required to use its best efforts to include the
shares of Common Stock issuable upon conversion of the Convertible Preferred
Stock (the "RGC
 
                                     

                                      F-20
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
Conversion Shares") in an effective Registration Statement on Form S-3 not
later than October 1997. The RGC Agreements provide for monthly penalties
("RGC Registration Penalties") in the event that the Company fails to register
the Conversion Shares prior to October 1997 with such penalties continuing
until such time as the Conversion Shares are registered as required by the RGC
Agreements.
    
  As a result of the Company's failure to register the RGC Conversion Shares
at various dates on or after December 31, 1997, the Company: (i) in lieu of
RGC Registration Penalties accruing on or before December 31, 1997, issued in
December 1997 warrants to RGC to acquire 272,333 shares of Common Stock at an
exercise price of $34.86 per share (such warrants were recorded as a 1997
expense and had an estimated value for accounting purposes of $2,051,000);
(ii) in lieu of RGC Registration Penalties accruing during the month of
January 1998, issued warrants to RGC to acquire 116,667 shares of Common Stock
at an exercise price of $38.85 per share (such warrants having an estimated
value for accounting purposes only of $1,194,000); and (iii) in lieu of RGC
Registration Penalties accruing from February 1, 1998 to April 30, 1998,
issued to RGC interest bearing promissory notes, due May 1, 1998 (the "RGC
Penalty Notes"), in the aggregate principal amount of $1,440,000. The value of
the warrants issued to RGC was determined for accounting purposes using the
Black-Scholes option pricing model using the following assumptions: dividend
yield 0%; expected volatility 62%; expected life of one and one-half years and
a risk free interest rate of 5.6%. On May 1, 1998, as a result of the Company's
failure to register the Conversion Shares on or before such date, RGC was
entitled under the RGC Agreements to demand a one-time penalty of $1,800,000
(the "May 1998 Penalty") payable, at the option of RGC, in cash or additional
shares of Common Stock. As of May 26, 1998, RGC had not demanded payment or
other satisfaction of the May 1998 Penalty.    
 
  On May 1, 1998, the Company did not pay RGC the $1,440,000 that was then due
and payable under the RGC Penalty Notes. Additionally, as a result of the
Company's continuing failure to register the Conversion Shares, RGC is
entitled to additional penalties of $540,000 per month (payable at the option
of RGC in cash or additional shares of Common Stock). The Company and RGC are
currently in discussions regarding the restructuring of the Penalty Notes, the
May 1998 Penalty and the on-going monthly penalties, but there can be no
assurance that the Company will be successful in restructuring such
obligations on terms favorable to the Company or its shareholders.
 
 Stock Options and Employee Stock Grants
 
  Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation" ("SFAS No. 123"), was issued in October 1995, establishing
a fair value-based method of accounting for stock-based compensation plans,
including stock options and stock purchase plans. SFAS No. 123 allows
companies to adopt a fair-value-based method of accounting for stock-based
compensation plans or, at their option, to retain the intrinsic-value based
method of Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB No. 25"), and supplement it with pro forma
disclosures of net earnings and earnings per share data as if the fair value
method had been applied. The Company has elected to continue to account for
stock-based compensation plans under APB No. 25 and, as such, the adoption of
this standard has not impacted the consolidated results of earnings or
financial condition.
 
  The Company's five stock option plans provide for the awarding of incentive
and non qualified stock options to employees, directors and consultants who
may contribute to the success of the Company. The options granted vest either
immediately or ratably over a period of time from the date of grant, typically
three or four years, at a price determined by the Board of Directors or a
committee of the Board of Directors, generally the fair value of the Company's
Common Stock at the date of grant. Options granted to consultants are
accounted for based on the fair value of the options issued.
 
  During 1996 and the first quarter of 1997, options were granted to employees
under stock option plans which were approved by the Company's Shareholders in
May 1997. The difference between the exercise price of the options and the
market price of the Company's Common Stock on the date of plan approval
resulted in
 
                                     

                                      F-21
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
compensation aggregating $3,381,000. The 1997 expense of $2,536,000
representing the portion of such options vested in 1997 is included as stock
based compensation expense in the accompanying Consolidated Statements of
Operations. The remaining balance of $845,000 will be recognized ratably over
the remaining vesting period of the options. In the following tables, these
options are treated as if they were granted on the date of the plan approvals
in May 1997.
 
  Options to purchase 580,313 shares of the Company's Common Stock granted to
employees of the Company in 1997 under an option plan (the "1997 Plan") have
lapsed and are not deemed to have been granted due to the fact that the 1997
Plan was not presented for approval to the Company's Stockholders within one
year of such plan's approval by the Board of Directors of the Company.
 
  Had the fair-value based method of accounting been adopted to recognize
compensation expense for the above plans (excluding the 1997 Plan), the
Company's net earnings and earnings per share would have been reduced to the
pro forma amounts for the years ended December 31, 1997, 1996 and 1995 as
indicated below (in thousands except per share amounts):
 
<TABLE>
<CAPTION>
                                                        1997     1996   1995
                                                      --------  ------ ------
   <S>                                                <C>       <C>    <C>
   Net income (loss) applicable to common
    stockholders:
     As reported..................................... $(33,177) $7,254 $1,690
     Pro forma.......................................  (34,049)  6,732  1,652
   Basic income (loss) per share:
     As reported.....................................    (4.85)   1.93   0.66
     Pro forma.......................................    (4.98)   1.79   0.64
   Diluted income (loss) per share:
     As reported.....................................    (4.85)   1.78   0.65
     Pro forma.......................................    (4.98)   1.66   0.64
</TABLE>
 
  The fair value of each option granted under all plans is estimated on the
date of grant using the Black-Scholes option-pricing model based on the
following assumptions:
 
<TABLE>
<CAPTION>
                                                                  1997  1996  1995
                                                                  ----  ----  ----
   <S>                                                            <C>   <C>   <C>
   All Plans:
     Dividend yield..............................................   0%    0%    0%
     Expected volatility.........................................  70%   52%   52%
     Expected life (years).......................................   2     2     2
</TABLE>
 
  The risk-free interest rates for 1997, 1996 and 1995 were based upon rates
with maturities equal to the expected term of the option. The weighted average
interest rate in 1997, 1996 and 1995 amounted to 5.52%, 5.93% and 6.41%,
respectively. The weighted average fair value of options granted during the
years ended December 31, 1997, 1996 and 1995 amounted to $12.60, $7.02 and
$3.45, respectively.
 
                                     

                                      F-22
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Stock option share activity and weighted average exercise price under these
plans and grants for the years ended December 31, 1997, 1996 and 1995, were as
follows:
 
<TABLE>
<CAPTION>
                                                     NUMBER OF  WEIGHTED AVERAGE
                                                      SHARES     EXERCISE PRICE
                                                     ---------  ----------------
   <S>                                               <C>        <C>
   Outstanding, January 1, 1995.....................  131,225        $14.76
     Granted........................................  157,500         15.96
     Exercised......................................   (4,305)        12.00
     Forfeited......................................  (21,195)        13.50
                                                     --------
   Outstanding, December 31, 1995...................  263,225         15.63
     Granted........................................  357,713         23.82
     Granted as transfer of NMR Options.............   44,229         15.15
     Exercised......................................  (81,066)        16.26
     Forfeited......................................  (40,195)        19.74
                                                     --------
   Outstanding, December 31, 1996...................  543,906         20.28
     Granted........................................  133,000         25.38
     Exercised......................................  (78,285)        15.51
     Forfeited...................................... (105,167)        21.99
                                                     --------
   Outstanding, December 31, 1997...................  493,454         22.53
                                                     ========
   Exercisable at:
     December 31, 1995..............................  100,403         15.93
     December 31, 1996..............................  303,237         19.20
     December 31, 1997..............................  376,547         20.94
</TABLE>
 
  The exercise price for options outstanding as of December 31, 1997 ranged
from $12.00 to $36.00. The following table summarizes information about stock
options outstanding and exercisable at December 31, 1997:
 
<TABLE>
<CAPTION>
                                                 OUTSTANDING      EXERCISABLE
                                               --------------- -----------------
                                     NUMBER OF AVERAGE AVERAGE NUMBER OF AVERAGE
   EXERCISE PRICE RANGE               SHARES    LIFE    PRICE   SHARES    PRICE
   --------------------              --------- ------- ------- --------- -------
   <S>                               <C>       <C>     <C>     <C>       <C>
   $12.00 to 15.00..................   67,993  6 years $ 13.92   65,381  $ 14.10
   $16.50...........................  101,667  5 years $ 16.50  101,667  $ 16.50
   $19.50 to 19.65..................   71,757  6 years $ 19.50   43,756  $ 19.53
   $22.53 to 25.50..................  137,738  9 years $ 25.26  120,555  $ 25.50
   $27.00 to 30.00..................   30,633  8 years $ 28.38   19,522  $ 27.45
   $31.14 to 33.39..................   58,667  4 years $ 31.32   22,888  $ 31.62
   $34.89 to 36.00..................   25,000  4 years $ 35.64    2,778  $ 36.00
                                      -------                   -------
   $12.00 to 36.00..................  493,455                   376,547
                                      =======                   =======
</TABLE>
 
  All the options described above were issued with exercise prices at or above
fair market value on the date of grant.
 
                                     

                                      F-23
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
 Stock Purchase Warrants
 
  The Company does not have a formal stock warrant plan. The Company's Board
of Directors authorizes the issuance of stock purchase warrants at its
discretion. The Company's Board of Directors have generally granted warrants
in connection with purchase and financing transactions. The number of warrants
issued and related terms are determined by a committee of independent
directors. All the warrants described below were issued with exercise prices
at or above fair market value on the date of grant.
 
  As of December 31, 1997, the Company had granted warrants, which are
currently outstanding, to purchase its Common Stock with the following terms:
 
<TABLE>
<CAPTION>
   WARRANTS                                           NUMBER OF     RANGE OF
   EXPIRING IN                                         SHARES    EXERCISE PRICE
   -----------                                        --------- ----------------
   <S>                                                <C>       <C>
   1998..............................................      --                --
   1999..............................................   31,062  $13.50 to $75.00
   2000..............................................      --                --
   2001..............................................  217,125    10.08 to 36.00
   2002..............................................  553,333    28.50 to 37.77
   2003..............................................   17,188             13.89
   2004..............................................   24,653    17.10 to 28.62
                                                       -------
                                                       843,361
                                                       =======
</TABLE>
 
  For services rendered by a financial advisory company owned by the Chairman
of the Board (the "Affiliate") in connection with several acquisitions, the
Company issued warrants (the "Acquisition Warrants") to purchase shares of the
Company's Common Stock at exercise prices equal to the market price of the
Company's Common Stock on the date of issuance. The fair value of such
warrants was considered part of the purchase price of the related acquisition,
and was determined (for accounting purposes only) using the Black-Scholes
option pricing model using the following assumptions: Dividend yield 0%;
expected volatility 62%; Expected life three to five years and a risk free
interest rate of 5.6% as set forth below. The Acquisition Warrants are
exercisable at prices ranging from $30.93 to $37.77 per share. As of May 26,
1998, none of the Acquisition Warrants had been exercised, and the closing
sale price of the Common Stock was $9 3/16.
 
    Warrants issued in connection with the acquisition of a diagnostic
  imaging center located in Jacksonville, Florida to purchase 10,667 shares
  of the Company's Common Stock at an exercise price of $30.93 per share. The
  warrants have a term of three years, are exercisable from the date of grant
  and have an estimated fair value (for accounting purposes only) of
  $150,000.
 
    Warrants issued in connection with the acquisition of Advanced Diagnostic
  Imaging, Inc. to purchase 45,667 shares of the Company's Common Stock at an
  exercise price of $31.80 per share. The warrants have a term of three
  years, are exercisable from the date of grant and have an estimated fair
  value (for accounting purposes only) of $662,000.
 
    Warrants issued in connection with the acquisition of a diagnostic center
  located in West Palm Beach, Florida to purchase 19,000 shares of the
  Company's Common Stock at an exercise price of $31.92 per share. The
  warrants have a term of three years, are exercisable from the date of
  grant, and have an estimated fair value (for accounting purposes only) of
  $276,000.
 
    Warrants issued in connection with the acquisition of ATI Centers, Inc.
  to purchase 56,000 shares of the Company's Common Stock at an exercise
  price of $33.18 per share. The warrants have a term of three years, are
  exercisable from the date of grant and have an estimated fair value (for
  accounting purposes only) of $847,000.
 
                                     

                                      F-24
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
    Warrants issued in connection with the acquisition of a diagnostic
  imaging center located in Rancho Cucamonga, California to purchase 18,333
  shares of the Company's Common Stock at an exercise price of $33.75 per
  share. The warrants have a term of three years, are exercisable from the
  date of grant, and have an estimated fair value (for accounting purposes
  only) of $282,000.
 
    Warrants to purchase 22,000 and 53,333 of the Company's Common Stock at
  an exercise price of $37.77 per share were granted in connection with the
  acquisition of diagnostic imaging centers in Maryland, and from Capstone
  Management, Inc., respectively. The warrants have a term of five years and
  are exercisable from the date of grant. The estimated fair value (for
  accounting purposes only) of $478,000 and $1,158,000, respectively.
 
  Effective December 30, 1997, the Company issued warrants to RGC to purchase
272,333 shares of the Company's Common Stock with an exercise price of $34.86
per share. These warrants have a term of five years and are exercisable from
the date of grant. The warrants had an estimated fair value of $2,051,000. The
fair value of such warrants was estimated using the Black-Scholes option
pricing model using the following assumptions: Dividend yield 0%, Expected
volatility 62%, Expected life one year and a risk free interest rate of 5.50%
based upon the expected life of the warrants.
 
  In December 1997, the Company granted warrants to a financing company in
connection with a line of credit entered into by the Company. The warrants to
purchase 17,778 shares of the Company's Common Stock at an exercise price of
$28.62 per share have a term of seven years and are exercisable from the date
of grant. The warrants had an estimated fair value of $337,000 which was
recorded as a deferred financing expense and is being amortized as additional
interest over the term of the facility. The fair value of each warrant was
estimated using the Black-Scholes option pricing model using the following
assumptions: Dividend yield 0%, Expected volatility 62%, Expected life seven
years and a risk free interest rate of 5.63% based on the expected life of the
warrants.
 
  For warrants granted during 1996, the fair value of each stock purchase
warrant issued has been accounted for as a component of each transaction's
purchase price and the value has been estimated on the date of grant using the
Black-Scholes option pricing model based on the following assumptions:
dividend yield--0%, expected volatility--52% and an expected life of 2 years,
unless otherwise noted.
 
  In March 1996 a financial consulting firm doing business with the Company
was granted warrants to purchase 25,000 shares of the Company's Common Stock
consisting of 12,500 warrants with an exercise price of $24.00 per share and
12,500 warrants with an exercise price of $36.00 per share. These warrants
have a term of five years and are exercisable from date of grant. The number
of such warrants was subsequently increased by 1,562 with an exercise price of
$24.00 per share and 1,562 warrants with an exercise price of $36.00 per
share. As of December 31, 1997, warrants to purchase 14,062 shares of the
Company's Common Stock at $24.00 a share and 14,062 at $36.00 per share were
outstanding. The warrants had an estimated fair value of $60,000. The fair
value of each warrant was estimated using the Black-Scholes option pricing
model using the following assumptions: Dividend yield 0%, Expected volatility
52%, Expected life 5 years and a risk free interest rate of 5.93% based upon
the expected term of the warrants.
 
  Under the terms of the merger agreement with NMR, all outstanding NMR
warrants were deemed to be exercisable for that number of shares of the
Company's Common Stock the warrant holder would have received in the NMR
Acquisition, had the holder exercised the NMR warrant prior to the NMR
Acquisition. As such, in connection with the NMR Acquisition the Company
assumed the following warrants:
 
    Warrants issued to purchase 5,729 shares of the Company's Common Stock at
  an exercise price of $21.81 per share to a radiology group providing
  services to one of its centers. As of December 31, 1997, none of the
  warrants to purchase 5,729 shares of the Company's Common Stock had been
  exercised.
 
                                     

                                      F-25
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
    Warrants issued to purchase 1,604 shares of the Company's Common Stock at
  an exercise price of $21.81 per share, in connection with the execution of
  a ground lease for one of its facilities. As of December 31, 1997, the
  warrants to purchase 1,604 shares of the Company's Common Stock have been
  cancelled and are no longer outstanding.
 
    Warrants issued to acquire 22,917 shares of the Company's Common Stock at
  $34.92 per share to a financial consulting firm. As of December 31, 1997,
  the warrants to purchase 22,917 shares of the Company's Common Stock have
  been cancelled and are no longer outstanding.
 
    Warrants granted to non-employee directors of NMR to purchase 43,542
  shares of the Company's Common Stock at $27.81 per share. As of December
  31, 1997, warrants to purchase 18,333 shares of the Company's Common Stock
  remain outstanding.
 
    Warrants granted to a non-employee director of NMR to purchase 917 shares
  of the Company's Common Stock at an exercise price of $17.10 per share. As
  of December 31, 1997, warrants to purchase 333 shares of the Company's
  Common Stock remain outstanding.
 
    Warrants issued to purchase 5,729 shares of the Company's Common Stock at
  an exercise price of $13.50 per share to a professional corporation
  providing legal services to NMR. As of December 31, 1997, all of the
  warrants to purchase 5,729 shares of the Company's Common Stock have been
  exercised and are no longer outstanding.
 
    Warrants granted to an officer and director of NMR to acquire 17,188
  shares of the Company's Common Stock at an exercise price of $13.08, and
  6,875 shares of common stock at an exercise price of $17.10. As of December
  31, 1997, none of the warrants to purchase 17,188 and 6,875 shares of the
  Company's Common Stock have been exercised.
 
  For services rendered by a financial advisory company owned by the Chairman
of the Board of Directors of the Company in connection with the NMR
Acquisition, the Company issued warrants to purchase 40,000 shares of the
Company's Common Stock at an exercise price of $27.00 per share. These
warrants have a term of five years and are exercisable from date of grant. As
of December 31, 1997, none of the warrants to purchase 40,000 shares of the
Company's Common Stock have been exercised.
 
  As required by the merger agreement with NMR, the President of NMR was
granted (i) five year warrants to purchase 13,333 shares of the Company's
Common Stock at an exercise price of $24.00 per share (the "$24.00 Warrants")
and (ii) six year warrants to purchase 66,667 shares of the Company's Common
Stock at an exercise price of $28.50 per share (the "$28.50 Warrants"), and
(iii) in exchange for his NMR employee stock options, three separate five year
warrants to purchase (A) 11,458 shares at $27.81, (B) 22,917 shares at $12.54
and (C) 11,458 shares of the Company's Common Stock at $14.19. As of December
31, 1997, 13,333 of the $24.00 Warrants, 56,000 of the $28.50 Warrants,
warrants to purchase 22,917 shares at $12.54 and 11,458 shares of the
Company's Common Stock at $14.19 remain outstanding.
 
  As required by the merger agreement with NMR, the Executive Vice President--
Finance of NMR was granted (i) five year warrants to purchase 16,667 shares of
the Company's Common Stock at an exercise price of $24.00 per share and (ii)
in exchange for his NMR employee stock options, four separate five year
warrants to purchase 3,438 shares at $12.00, 9,167 shares at $10.08, 13,750
shares at $12.54 and 11,458 shares of the Company's Common Stock at $14.19. As
of December 31, 1997, the warrants to purchase 16,667 shares at $24.00 per
share, 9,167 shares at $10.08 per share, 13,750 at $12.54 per share and 11,578
shares of the Company's Common Stock at $14.19 per share remain outstanding.
 
  The warrants the Company issued to the officers of NMR in connection with
the NMR Acquisition had an estimated fair value of approximately $650,000 and
were considered part of the consideration paid in connection
 
                                     

                                      F-26
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
with the NMR Acquisition and such value is being amortized over the term of
the officers' covenant not to compete agreements. The 188,147 warrants the
Company issued in exchange for previously outstanding NMR options or warrants
and the 40,000 warrants issued to the financial advisory company had an
estimated fair value of approximately $210,000 and $325,000 respectively, and
were considered part of the NMR Acquisition purchase price.
 
  1,984,667 shares of Common Stock were reserved for the issuance related to
the above described stock options, warrants and preferred stock.
 
10. INCOME TAXES
 
  The total income tax provisions (benefits) from continuing operations for
the years ended December 31, 1997, 1996 and 1995 are allocated as follows (in
thousands):
 
<TABLE>
<CAPTION>
                                                        1997     1996    1995
                                                       -------  ------  -------
   <S>                                                 <C>      <C>     <C>
   Tax provision (benefit) from continuing operations
    before valuation allowances....................... $(9,479) $3,575  $ 2,751
   Income tax valuation allowance related to
    continuing operations.............................  10,700     -0-   (1,508)
                                                       -------  ------  -------
       Income tax provision from continuing
        operations.................................... $ 1,221  $3,575  $ 1,243
                                                       =======  ======  =======
   Tax provision from discontinued operations......... $ 1,079  $  587  $   103
                                                       =======  ======  =======
   Tax (benefit) related to sale of discontinued
    business.......................................... $   -0-  $  -0-  $  (656)
                                                       =======  ======  =======
   Tax benefit associated with the exercise of
    employee stock options which has been credited to
    stockholders' equity.............................. $(1,000) $ (368) $   -0-
                                                       =======  ======  =======
</TABLE>
 
  The components of the Company's income tax provision (benefit) from
continuing operations are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                         DECEMBER 31, 1997
                                                       ------------------------
                                                       FEDERAL  STATE    TOTAL
                                                       -------  ------  -------
   <S>                                                 <C>      <C>     <C>
   Current provision.................................. $   993  $  990  $ 1,983
   Deferred benefit...................................    (879)    117     (762)
                                                       -------  ------  -------
   Income tax provision............................... $   114  $1,107  $ 1,221
                                                       =======  ======  =======
<CAPTION>
                                                         DECEMBER 31, 1996
                                                       ------------------------
   <S>                                                 <C>      <C>     <C>
   Current provision.................................. $ 3,263  $1,185  $ 4,448
   Deferred benefit...................................    (733)   (140)    (873)
                                                       -------  ------  -------
   Income tax provision............................... $ 2,530  $1,045  $ 3,575
                                                       =======  ======  =======
<CAPTION>
                                                         DECEMBER 31, 1995
                                                       ------------------------
   <S>                                                 <C>      <C>     <C>
   Current provision.................................. $ 2,778  $  722  $ 3,500
   Deferred benefit...................................  (1,871)   (386)  (2,257)
                                                       -------  ------  -------
   Income tax provision............................... $   907  $  336  $ 1,243
                                                       =======  ======  =======
</TABLE>
 
                                     

                                      F-27
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  A reconciliation of the enacted federal statutory income tax to the
Company's recorded effective income tax rate for continuing operations is as
follows:
 
<TABLE>
<CAPTION>
                                                           DECEMBER 31
                                                         --------------------
                                                         1997    1996   1995
                                                         -----   ----   -----
   <S>                                                   <C>     <C>    <C>
   Statutory federal income tax at 34%.................. (34.0)% 34.0 %  34.0 %
   Effect of partnership status and amounts taxed to
    parties other than the company......................   --    (1.2)    2.1
   State income tax expense (benefit) net of federal
    benefit.............................................  (1.2)   6.3     4.0
   Meals and entertainment..............................    .4     .3      .3
   Change in valuation allowance........................  34.8    --    (27.7)
   Goodwill amortization................................   2.8    1.8     --
   Other................................................   1.2   (7.3)    9.9
                                                         -----   ----   -----
   Effective tax rate...................................   4.0 % 33.9 %  22.4 %
                                                         =====   ====   =====
</TABLE>
 
  The significant components of the Company's deferred tax liabilities and
assets are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                               1997     1996
                                                             --------  -------
   <S>                                                       <C>       <C>
   Deferred tax liabilities:
     Property and equipment................................. $   (841) $  (857)
     Deferred rent..........................................      (37)     (59)
     Cash to accrual adjustment.............................      (41)    (362)
                                                             --------  -------
     Deferred tax liabilities...............................     (919)  (1,278)
   Deferred tax assets:
     Net operating losses...................................    2,956    2,956
     Tax credit carryforwards...............................      385      385
     Accounts receivable reserves...........................    5,225    3,354
     Capital leases.........................................      110      135
     Goodwill and other intangible assets written off for
      book purposes, but amortized for tax purposes.........    4,940      220
     Accrued expenses.......................................    2,721      --
     Capital loss carryforward..............................      127      133
                                                             --------  -------
   Deferred tax assets......................................   16,464    7,183
                                                             --------  -------
       Subtotal.............................................   15,545    5,905
                                                             --------  -------
   Less: Valuation allowance................................  (10,700)    (200)
                                                             --------  -------
   Net deferred tax asset................................... $  4,845  $ 5,705
                                                             ========  =======
</TABLE>
 
  The Company's existing deferred tax assets at December 31, 1997 have been
reduced by a valuation allowance of $10,700,000, due to the uncertainty
regarding the realization of the full amount of such deferred tax assets. The
valuation allowance represents the amount required to reduce all deferred
income tax assets to an amount representing the expected federal income tax
loss carryback available to the Company.
 
  At December 31, 1997, the Company has available federal net operating loss
carryforwards of approximately $8,028,000 expiring in years 1999 through 2009.
 
 
                                     

                                      F-28
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
  Utilization of the Company's tax net operating losses is limited to the
separately determined taxable incomes of certain of its subsidiaries. In
addition, the Tax Reform Act of 1986 enacted a complex set of rules ("Section
382") limiting the utilization of net operating loss carryforwards in periods
following a corporate ownership change. In general, a corporate ownership
change is deemed to occur if the percentage of stock of a loss corporation
owned (actually, constructively and in certain cases deemed owned) by one or
more "5% shareholders" has increased by 50 percentage points over the lowest
percentage of such stock owned during a specified testing period (generally a
three year period). The utilization of the Company's available net operating
loss carryforwards is subject to such limitations. Should the Company
experience further ownership changes, its ability to utilize the available
federal net operating loss carryforwards could be subject to further
limitation.
 
  The Company also has available tax credit carryforwards of approximately
$385,000 expiring between 1998 and 2011. The utilization of such credits is
also subject to a limitation similar to the net operating loss limitation
described above.
 
  At December 31, 1997, the Company had income taxes recoverable of $6,504,000
which represents estimated 1997 income tax payments made during 1997 that the
Company will be refunded upon filing of its 1997 tax return.
 
11. COMMITMENTS AND CONTINGENCIES
 
 Leases
 
  The Company has entered into noncancelable leases for certain medical
diagnostic equipment and furniture and fixtures, and has capitalized the
assets relating to these leases. In most cases, the leases are collateralized
by the related equipment. Certain leases included renewal options for
additional periods.
 
  The following is a summary of assets under capital leases which amounts are
included in Property and Equipment (in thousands):
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                               1997      1996
                                                              -------  --------
   <S>                                                        <C>      <C>
   Diagnostic equipment and associated leaseholds............ $31,211  $ 23,036
   Less: Accumulated amortization............................  (5,221)  (12,096)
                                                              -------  --------
                                                              $25,990  $ 10,940
                                                              =======  ========
</TABLE>
 
  Amortization expense relating to property and equipment under capital leases
at December 31, 1997, 1996 and 1995 was $3,496,000, $3,377,000 and $2,045,000,
respectively.
 
                                     

                                      F-29
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following analysis schedules the minimum future lease payments under
capital leases as of December 31, 1997 (in thousands):
 
<TABLE>
<CAPTION>
   YEAR ENDING DECEMBER 31,
   ------------------------
   <S>                                                                <C>
   1998.............................................................. $ 13,044
   1999..............................................................   11,263
   2000..............................................................    9,876
   2001..............................................................    5,611
   2002..............................................................    2,063
   Thereafter........................................................      571
                                                                      --------
   Total minimum lease payments......................................   42,428
   Less: amount representing interest (imputed at an average rate of
    7%)..............................................................   (6,201)
                                                                      --------
   Present value of minimum lease payments...........................   36,227
   Less current installments.........................................  (10,311)
   Less debt shown as current due to financial covenant default
    installments.....................................................   (9,555)
                                                                      --------
   Obligations under capital leases, shown as long-term.............. $ 16,361
                                                                      ========
</TABLE>
 
  In connection with certain of the Company's acquisitions, the Company
entered into agreements for the sale and leaseback of medical diagnostic
equipment. Included in future minimum lease payments listed above are
$1,782,000 for each of the years 1998, 1999, 2000, 2001 and $803,000 for 2002,
relating to these transactions.
 
  The Company leases its corporate offices and certain centers for periods
generally ranging from three to ten years. These leases include rent
escalation clauses generally tied to the consumer price index and contain
provisions for additional terms at the option of the tenant. The leases
generally require the Company to pay utilities, taxes, insurance and other
costs. Rental expense under such leases was approximately $6,585,000,
$2,597,000 and $2,238,000 for the years ended December 31, 1997, 1996 and
1995, respectively. Ten of the offices are subleased to affiliated Physicians.
By reason of the sublease arrangements, if the respective Physicians should be
unable to pay the rental on the site, the Company would be contingently
liable. As of December 31, 1997, the Company has subleased the operating sites
to the Physicians for the base rental as stipulated in the original lease. The
related sublease income has been offset by the lease rent expense. The Company
also has operating leases for diagnostic imaging equipment installed in
certain of its imaging centers.
 
  The following summary of non-cancelable obligations includes the sublease
arrangements described above, certain equipment leases and the Company's
corporate rentals. As of December 31, 1997, the aggregate future minimum lease
payments and sublease rentals are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                              ORIGINAL
   YEAR ENDED DECEMBER 31,                            LEASES  SUBLEASES   NET
   -----------------------                            ------- --------- -------
   <S>                                                <C>     <C>       <C>
   1998.............................................. $11,900  $  707   $11,193
   1999..............................................  10,106     626     9,480
   2000..............................................   9,069     643     8,426
   2001..............................................   8,280     267     8,013
   2002..............................................   5,874      96     5,778
   thereafter........................................   6,538     228     6,310
                                                      -------  ------   -------
                                                      $51,767  $2,567   $49,200
                                                      =======  ======   =======
</TABLE>
 
                                     

                                      F-30
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
 Contingencies
 
  Between November 1997 and January 1998, several lawsuits were commenced
against the Company, certain of the Company's Directors and certain officers
concerning the related party transactions investigated by the Special
Committee of the Board of Directors ("Special Committee"). The complaints in
each action assert that the Company and the named defendants violated Section
10(b) and 20(a) of the Securities Exchange Act of 1934, alleging that the
Company omitted and/or misrepresented material information in its public
filings, including that the Company failed to disclose that it had entered
into acquisitions that were not in the best interest of the Company, that it
had paid unreasonable and unearned acquisition and financial advisory fees to
related parties, and that it concealed or failed to disclose adverse material
information about the Company. Each action seeks unspecified compensatory
damages, with interest, and the costs and expenses incurred in bringing the
action. On February 9, 1998, the above-mentioned class actions were
consolidated for all purposes in federal district court in New Jersey. On
March 31, 1998, the lead plaintiffs in the consolidated class actions served
their Consolidated Class Action Complaint, asserting that the Company and the
named defendants violated Section 10(b) of the Exchange Act, and that certain
named defendants violated Sections 20(a) and 20A of the Exchange Act. The
Company intends to defend vigorously against the allegations.
 
  As previously announced by the Company the U.S. Attorney for the District of
New Jersey commenced an investigation in connection with the disclosures
regarding the related party transactions referred to above. In addition, as
previously disclosed, the Company has also received an inquiry from the SEC,
but no formal proceedings have been commenced by the SEC. The Company has
cooperated fully with these authorities and provided all information requested
by them.
 
  On November 7, 1997, the Company accepted the resignations of William D.
Farrell, as President and Chief Operating Officer of the Company and as
Director, and Gary I. Fields, as Senior Vice President and General Counsel. On
the same date, Messrs. Farrell and Fields filed a complaint in the Superior
Court of New Jersey, Law Division, Essex County, against the Company and the
members of the Company's Board of Directors, claiming retaliatory discharge
under the New Jersey Conscientious Employee Protection Act and breach of
contract. On December 17, 1997, the plaintiffs amended their complaint to add
a claim for violation of public policy. The plaintiffs allege that they were
constructively terminated as a result of their objection to certain related-
party transactions, the purported failure of the defendants to adequately
disclose the circumstances surrounding such transactions, and the Company's
public issuance of alleged false and misleading accounts concerning or
relating to such related-party transactions. The plaintiffs seek unspecified
compensatory and punitive damages, interest and costs and reinstatement of the
plaintiffs to their positions with the Company. On April 8, 1998, the Company
filed its Answer to the Amended Complaint, and asserted a counterclaim against
Messrs. Farrell and Fields for breach of fiduciary duties. The Company intends
to defend vigorously against the allegations.
 
  On November 8, 1997, the Company removed John P. O'Malley III, the Company's
Chief Financial Officer, for failure to fulfill certain of his functions as
Chief Financial Officer. Mr. O'Malley has filed a complaint in the Superior
Court of New Jersey, Law Division, Essex County, against the Company and
members of the Board of Directors, as defendants, claiming retaliatory
discharge under the New Jersey Conscientious Employee Protection Act and
defamation. Mr. O'Malley alleges that the Company terminated his employment in
retaliation for voicing the concerns of shareholders and senior management
regarding related-party transactions and because the Company did not want to
make full and adequate disclosure of the facts and circumstances surrounding
such transactions. In addition, Mr. O'Malley alleges that the Company
published false and defamatory statements about him. Mr. O'Malley seeks
unspecified compensatory and punitive damages, interest and costs of bringing
the action. On April 8, 1998, the Company filed its Answer to the Complaint,
and asserted a counterclaim against Mr. O'Malley for breach of fiduciary
duties. The Company intends to defend vigorously against the allegations.
 
                                     

                                      F-31
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The legal proceedings described above are in their preliminary stages.
Although the Company believes it has meritorious defenses to all claims
against it, the Company is unable to predict with any certainty the ultimate
outcome of these proceedings. See discussion of reserves for net costs
associated with such litigation in Note 3.
     
  In 1996, Lavina Orsi and Pompeo Orsi brought an action in the Supreme Court
of the State of New York, King's County against Advanced MRA Imaging
Associates in Brooklyn, New York, a wholly owned subsidiary of the Company
("MRA Imaging"), for damages aggregating $12,500,000. The plaintiff alleges
negligent operations, improper supervision and hiring practices and the
failure to operate the premises in a safe manner, as a result of which the
individual suffered physical injury. The Company's general liability and
professional negligence insurance carriers have been notified, and it has been
agreed that the general liability insurance will pursue the defense of this
matter, however, such insurers have reserved the right to claim that the scope
of the matter falls outside the Company's coverage. The parties to this matter
are engaged in discovery. The Company believes it has meritorious defenses to
all claims against it and therefore is of the opinion that the Company will
not incur any material settlement cost, net of insurance proceeds (if any).  
Accordingly, the Company has made no accrual for any costs associated with such 
litigation under SFAS No. 5.    
     
  In the normal course of business, the Company is subject to claims and
litigation other than those set forth above. Management believes that such
other litigation will not have a material adverse effect on the Company's
financial position, cash flows or results of operations.  Accordingly, the 
Company has made no accrual for any costs associated with such litigation under
SFAS No. 5.      

  In connection with certain of the Company's 1997 acquisitions in which the
Company issued shares of its Common Stock as partial consideration, the
Company granted rights to have such shares registered for resale pursuant to
the federal securities laws. In certain of such acquisitions, the Company has
granted specific remedies to the sellers in the event that the registration
statement covering the relevant shares is not declared effective by the
Securities and Exchange Commission within an agreed-upon period of time,
including the right to require the Company to repurchase the shares issued to
such seller. During 1997, the Company entered into an agreement to reset the
repurchase price per common share related to certain shares covered by a
repurchase agreement to the then current market price in exchange for
additional time to obtain registration of such shares. The increased amount of
such repurchase obligation of $1,696,000 was charged to retained earnings and
shown as an increase in Common Stock subject to redemption on the Consolidated
Balance Sheet. As of December 31, 1997, the Company had reflected $9,734,000
of Common Stock subject to redemption on its Consolidated Balance Sheet
related to shares that the Company may be required to repurchase. During
January 1, 1998 through May 26, 1998, the Company paid $3,275,000 to sellers
who exercised their rights to have 59,667 shares of Common Stock repurchased.
In addition, the Company expects to pay an additional $5,763,000 during the
remainder of 1998 in connection with the settlement of certain repurchase
obligations of the Company, (representing 138,000 shares of Common Stock)
subject under certain circumstances, to the consent of the Senior Notes
holders.
 
  In addition, in connection with certain of such acquisitions, the Company
has agreed with the sellers in such acquisitions to pay (in additional shares
and/or cash) to the sellers an amount equal to the shortfall in the value of
the issued shares in the event the market value of such shares at the relevant
effective date of the registration statement or other negotiated date is less
than the market value of such shares as of the closing of the acquisition or,
in other cases, as of the execution of the relevant acquisition agreement
(referred to as "Price Protection"). Any such Price Protection payments will
be charged to stockholders' equity. Based upon the closing sales price of the
Company's Common Stock on May 26, 1998 ($9 3/16 per share), such shortfall
would be approximately $9,634,000, which amount may be reduced by up to
$5,977,000 to the extent certain sellers exercise their repurchase rights
referred to above.
 
  In addition, in connection with certain of the Company's acquisitions, the
Company has agreed with the relevant sellers that all or a portion of the
consideration for such acquisitions will be paid on a contingent basis based
upon the profitability, revenues or other financial criteria of the acquired
business during an agreed-upon
 
                                     

                                      F-32
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
measurement period following the closing of the acquisition (usually, one to
three years). The specific terms of such contingent consideration differs for
each acquisition. In connection with certain acquisitions, the Company and the
relevant sellers have agreed to a maximum amount of contingent consideration,
and in other cases, the parties have agreed that any payment of such
contingent consideration may be paid in cash or shares of Common Stock, or a
combination of both. Contingent consideration associated with acquisitions is
recorded as additional purchase price when resolved.
 
12. RELATED PARTY TRANSACTIONS
 
  During 1997, in connection with the placement of the Preferred Stock, the
Company paid $967,000 in fees and expenses to Arnhold & S. Bleichroeder, Inc.,
of which Gary Fuhrman, a director of the Company, is an executive officer and
director. Also during 1997, for legal services rendered to the Company, the
Company paid legal fees in the amount of $971,000 to Werbel & Carnelutti, of
which Stephen Davis, a director of the Company, is a partner. In addition,
during 1997, the Company reimbursed the managing underwriter of the Company's
October public offering $84,000 in charter fees for the use by the managing
underwriter and the Company of an airplane owned by an affiliate of the
Chairman of the Board during the public offering roadshow.
 
  In 1997 and previous years, the Company paid an annual financial advisory
fee to 712 Advisory Services, Inc., a financial advisory firm and affiliate of
the Company's Chairman of the Board (the "Affiliate"). Mr. Neil H. Koffler, a
director of the Company, is also an employee of the Affiliate. Such fees
amounted to $112,500, $102,000 and $225,000 in the years ended December 31,
1997, 1996 and 1995, respectively. During the year ended December 31, 1997,
the Company also paid transaction related advisory fees and expenses
(including fees associated with the issuance of the Senior Notes) to the
Affiliate of $1,761,000 and issued to the Affiliate warrants to purchase
225,000 shares of the Company's Common Stock exercisable at between $30.93 and
$37.77 per share for financial advisory services rendered to the Company in
connection with such transactions. As discussed below, pursuant to
recommendations made by the Special Committee, the Affiliate has reimbursed
the Company $1,536,000 of the fees paid to the Affiliate for services rendered
in 1997 and waived $112,500 of fees payable in 1997.
 
  In order to compensate officers, directors, employees and consultants to the
Company for services rendered or to be rendered to the Company, the Company
from time to time has granted options at fair market value to such
individuals. As of December 31, 1997, stock options to purchase 489,555 shares
of the Company's Common Stock have been issued to the Chairman and Mr.
Koffler. Included in this amount are stock options to purchase 250,000 shares
and 5,000 shares of the Company's Common Stock which were granted in May 1997
to the Chairman and Mr. Koffler, respectively, under the Company's 1997 Stock
Option Plan (the "1997 Plan"). The exercise price for the options granted to
the Chairman and Mr. Koffler is $39.38, the fair market value of the Common
Stock on the date of grant. As discussed below, the Chairman and Mr. Koffler
agreed in April 1998 to relinquish the stock options that were granted to them
under the 1997 Plan.
 
  In September 1997, the Company acquired, for $3,250,000, a limited
partnership interest in Dune Jet Services, L.P. (the "Partnership"), a
Delaware limited partnership formed for the purposes of acquiring and
operating an airplane for the partner's business uses and for third party
charter flights. The general partner of the Partnership is Dune Jet Services,
Inc., a Delaware corporation, the sole stockholder of which is the Company's
Chairman. In October 1997, following discussions among management (members of
which expressed objections to such acquisition), the Special Committee, and
other members of the Board of Directors (including the Chairman), the
Company's interest in the partnership was repurchased by the partnership at
cost plus interest.
 
  In October 1997, members of the Company's management communicated to the
Board that certain Company stockholders had questioned them regarding the
manner in which related-party transactions are scrutinized by the Company and
its Board. Management stated that it shared the concerns of these stockholders
and had engaged counsel to conduct a review of such transactions.
 
                                     

                                      F-33
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  In order to address and satisfy the concerns management had communicated,
the Company instituted a special investigation to review all related-party
transactions (including those referred to above in this note 12) and the
adequacy of the disclosure of the same. The review also was to seek to develop
recommendations as to what changes, if any, should be made to the Company's
procedures regarding related-party transactions.
 
  The Committee issued the results of its investigation and certain
recommendations in a report to the Company's Board of Directors and on April
6, 1998, the Company's Board of Directors voted to adopt the recommendations
contained in the report. Accordingly, the Committee recommended and the
Affiliate agreed to reimburse the Company approximately $1,424,000 in fees for
transactions completed after June 1, 1997, to reimburse $112,500 of the
retainer paid to the Affiliate for 1997, to waive payment of an additional
$112,500 of fees accrued by the Company for the third and fourth quarters of
1997, and to pay a substantial amount of the expenses associated with the
Committee's investigations. In addition, the Committee recommended and the
Affiliate agreed to allow the Company to terminate its relationship with the
Affiliate.
 
  The Committee responded to the directors that it had determined that: (i)
there was no evidence of any federal or state crimes or securities law
violations in connection with the related party transactions in question; (ii)
all related-party matters were disclosed in public filings; (iii) the
Affiliate performed acquisition advisory services fully consistent with the
expectations and understanding of the committee of outside directors that had
approved the Affiliate's acquisition fees; and (iv) the acquisition advisory
fees paid to the Affiliate in connection with the Company's acquisitions in
1997 were within the range of customary acquisition advisory fees paid to
investment bankers on transactions of similar size.
 
  The Chairman and Mr. Koffler also agreed voluntarily to relinquish 255,000
stock options that were granted to them in May 1997 and permit the Board's
Compensation Committee, with the assistance of compensation experts, to
determine the appropriate director compensation for 1997. The 255,000 stock
options were granted at prices equal to the then current market price, and
accordingly, no expense was recorded upon issue nor income reflected upon
relinquishment for accounting purposes.
 
  In addition, for the year ended December 31, 1996, the Company paid
transaction related advisory fees and expenses to the Affiliate of $363,000
and issued to the Affiliate warrants to purchase 40,000 shares of the
Company's common stock exercisable at $27.00 per share for services rendered
to the Company, including services in connection with the NMR acquisition, the
public offering of the Company's common stock in October 1996 and other
transactions. See Note 11 of notes to Consolidated Financial Statements for
discussion of litigation matters regarding related party transactions.
 
                                     

                                      F-34
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
 
  The following estimated fair value amounts have been determined using
available market information and appropriate valuation methodologies. However,
considerable judgement is necessarily required in interpreting market data to
develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts that the Company could
realize in a current market exchange. The use of different market assumptions
and/or estimation methodologies may have a material effect on the estimated
fair value amounts.
<TABLE>
<CAPTION>
                                                               DECEMBER 31, 1997
                                                               -----------------
                                                               CARRYING   FAIR
                                                                AMOUNT   VALUE
                                                               -------- --------
                                                                (IN THOUSANDS)
   <S>                                                         <C>      <C>
   Assets:
     Cash and cash equivalents...............................  $ 23,198 $ 23,198
     Restricted cash.........................................     1,073    1,073
     Patient receivables and due from physician associations,
      net....................................................    65,887   65,887
   Liabilities:
     Notes payable, line of credit and mortgages.............   119,802  111,085
     Capital lease obligations...............................    36,227   35,281
     Convertible debentures..................................       --       --
<CAPTION>
                                                               DECEMBER 31, 1996
                                                               -----------------
                                                               CARRYING   FAIR
                                                                AMOUNT   VALUE
                                                               -------- --------
   <S>                                                         <C>      <C>
   Assets:
     Cash and cash equivalents...............................   $15,346  $15,346
     Short-term investments..................................     6,163    6,163
     Restricted cash.........................................     1,045    1,045
     Patient receivables and due from physician associations,
      net....................................................    39,878   39,878
   Liabilities:
     Notes payable, line of credit and mortgages.............    19,367   19,093
     Capital lease obligations...............................    14,365   14,681
     Convertible debentures..................................     6,988    6,972
</TABLE>
 
  The carrying amounts of cash and cash equivalents, short-term investments,
long-term investments and due from affiliated physician associations and
patient receivables, net are a reasonable estimate of their fair value. The
fair value of the Company's notes and mortgage payable, capital lease
obligations and convertible debentures are based upon a discounted cash flow
calculation utilizing rates under which similar borrowing arrangements can be
entered into by the Company.
 
14. ACQUISITIONS
 
 1997 Acquisitions
 
  On January 10, 1997, the Company, through its wholly owned subsidiary,
StarMed, acquired the assets of National Health Care Solutions, Inc. a medical
staffing company in Detroit, Michigan for approximately $50,000 in cash. The
excess of the purchase price and direct acquisition costs over the fair value
of net assets acquired amounted to approximately $311,000 and is being
amortized on a straight-line basis over 20 years.
 
  On January 16, 1997, the Company acquired a diagnostic imaging center
located in Melbourne, Florida (the "Melbourne" center) for approximately
$1,125,000 in cash. The excess of the purchase price and direct
 
                                     

                                      F-35
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
acquisition costs over the fair value of net liabilities assumed amounted to
approximately $1,311,000 and is being amortized on a straight-line basis over
20 years.
 
  On January 28, 1997, the Company acquired two diagnostic imaging centers in
southern California (the "California" centers); a multi-modality imaging
center in San Clemente, California and an imaging facility in Oceanside,
California for approximately $1,030,000 payable in cash and contingent
consideration based on the centers achieving certain financial objectives
during the one-year period subsequent to the closing of the transaction. Of
the contingent consideration payable, up to $2,600,000 of such consideration
may be payable in shares of the Company's Common Stock within 90 days of the
end of the measurement period. The measurement period ended February 28, 1998,
and the Company and the seller are currently in negotiations regarding the
contingent consideration due and payable. The excess of the purchase price and
direct acquisition costs over the fair value of net liabilities assumed
amounted to approximately $4,604,000 and is being amortized on a straight-line
basis over 20 years.
 
  On February 28, 1997, the Company acquired a diagnostic imaging center
located in Jacksonville, Florida (the "Jacksonville" center) for 71,667 shares
of the Company's Common Stock valued at $2,333,000 and contingent
consideration based on the center achieving certain financial objectives
during the one year period subsequent to the closing of the transaction. The
shares of the Company's Common Stock issued in connection with the acquisition
are subject to registration rights. Contingent consideration of up to
$1,850,000 is payable in shares of the Company's Common Stock within 90 days
of the end of the measurement period. The excess of the purchase price and
direct acquisition costs, including 10,667 warrants, with an exercise price of
$30.93, valued (for accounting purposes only) at $150,000 issued to the
Affiliate for financial advisory services, over the fair value of net assets
acquired amounted to approximately $2,245,000 and is being amortized on a
straight-line basis over 20 years.
 
  On March 10, 1997, the Company acquired Advanced Diagnostic Imaging, Inc.
("ADI") for approximately $6,986,000 in cash, plus $825,000 of deferred
consideration which was paid in March 1998. ADI owned interests in and
operated nine diagnostic imaging centers in the Northeast. As part of the
transaction, the Company has acquired an option to purchase an additional
center located in the Northeast. This option has not been exercised. The
excess of the purchase price and direct acquisition costs, including 45,667
warrants, with an exercise price of $31.80, valued (for accounting purposes
only) at $662,000 issued to the Affiliate for financial advisory services,
over the fair value of net liabilities assumed amounted to approximately
$14,299,000 and is being amortized on a straight-line basis over 20 years.
 
  On March 10, 1997, the Company acquired a diagnostic imaging center located
in West Palm Beach, Florida (the "Palm Beach" center) for approximately
$3,459,000 in cash and 18,890 shares of the Company's Common Stock valued at
approximately $600,000. The shares of the Company's Common Stock issued in
connection with the acquisition are subject to registration rights and price
protection equal to the difference between the issuance price ($31.77 per
share) and the market price at effectiveness of the registration statement.
The Company may satisfy any deficiency in such price by the issuance of
additional shares of Common Stock. As of May 26, 1998, the shares of Common
Stock issued in connection with the acquisition had not been registered by the
Company. The excess of the purchase price and direct acquisition costs,
including 19,000 warrants, with an exercise price of $31.92, valued (for
accounting purposes only) at $276,000 issued to the Affiliate for financial
advisory services, over the fair value of net assets acquired amounted to
approximately $2,178,000 and is being amortized on a straight-line basis over
20 years.
 
  On March 14, 1997, the Company acquired a diagnostic imaging center in
Rancho Cucamonga, California (the "Rancho Cucamonga" center) for approximately
$3,948,000 in cash and 14,672 shares of the Company's Common Stock valued at
$500,000. The shares of the Company's Common Stock are subject to registration
 
                                     

                                      F-36
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
rights. The excess of the purchase price and direct acquisition costs,
including 18,333 warrants with an exercise price of $33.75 valued (for
accounting purposes only) at $282,000 issued to the Affiliate for financial
advisory services, over the fair value of net assets acquired amounted to
approximately $4,073,000 and is being amortized on a straight-line basis over
20 years.
 
  Effective May 1, 1997, the Company acquired Capstone Management Group, Inc.
("Capstone") for approximately $6,934,000 in cash and 132,401 shares of the
Company's Common Stock valued at $6,696,000 and contingent consideration based
on the centers achieving certain financial objectives during the one year
period beginning June 1997. The shares of the Company's Common Stock issued in
connection with the acquisition are subject to registration rights and price
protection equal to the issuance price, as adjusted ($53.775 per share). The
Company must satisfy any deficiency in cash. In November 1997, the Company and
the sellers agreed that the sellers would have the right to require the
Company to repurchase up to 105,921 shares of Common Stock (obligations
related to repurchase of 26,480 shares have expired) at various intervals in
the event the Company failed to register the shares of Common Stock prior to
such intervals. As of May 26, 1998, the Company had purchased 37,192 shares of
Common Stock from the sellers for aggregate consideration of $2,000,000 and
will be required on June 3, 1998 to repurchase the remaining 68,729 shares of
Common Stock for aggregate consideration of approximately $3,696,000.
Contingent consideration based upon future cash flow is payable within 90 days
of the end of the measurement period. Capstone owned and operated ten
diagnostic imaging centers, nine of which are located in the northeast and one
located in Ohio. The excess of the purchase price and direct acquisition
costs, including 53,333 warrants, with an exercise price of $37.77, valued
(for accounting purposes only) at $1,158,000 issued to the Affiliate for
financial advisory services, over the fair value of net liabilities assumed
amounted to approximately $15,292,000 and is being amortized on a straight-
line basis over 20 years.
 
  On May 7, 1997, the Company acquired ATI Centers, Inc. ("ATI") for
approximately $13,558,000 in cash consideration and contingent consideration
based on the centers achieving certain financial objectives during the one
year period subsequent to the closing of the transaction. Contingent
consideration of up to $1,500,000 is payable within 90 days of the end of the
measurement period. ATI owned and operated eleven diagnostic imaging centers
in New Jersey and Pennsylvania. The excess of the purchase price and direct
acquisition costs, including 56,000 warrants, with an exercise price of
$33.18, valued (for accounting purposes only) at $847,000 issued to the
Affiliate for financial advisory services, over the fair value of net assets
acquired amounted to approximately $13,445,000 and is being amortized on a
straight-line basis over 20 years.
 
  On May 7, 1997, the Company acquired two diagnostic imaging centers located
in Maryland (the "Maryland" centers) for approximately $2,830,000 in cash and
39,722 shares of the Company's Common Stock valued at $1,500,000. The shares
of the Company's Common Stock issued in connection with the acquisition are
subject to registration rights and price protection equal to the difference
between the issuance price ($37.77 per share) and the market price at
effectiveness of the registration statement. The Company may satisfy any price
deficiency by the issuance of additional unregistered shares of Common Stock
or by the payment of cash. As of May 26, 1998, the shares of Common Stock
issued in connection with the acquisition had not been registered by the
Company. The excess of the purchase price and direct acquisition costs,
including 22,000 warrants, with an exercise price of $37.77, valued (for
accounting purposes only) at $478,000 issued to the Affiliate for financial
advisory services, over the fair value of net assets acquired amounted to
approximately $4,404,000 and is being amortized on a straight-line basis over
20 years.
 
  On June 24, 1997, the Company acquired the assets of Wesley Medical
Resources, Inc. ("Wesley") a medical staffing company in San Francisco,
California for 45,741 shares of the Company's Common Stock valued at
$2,000,000 and contingent consideration based on the company achieving certain
financial objectives during the three year period subsequent to the
transaction. In the event that substantially all of the capital stock
 
                                     

                                      F-37
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
or assets of Wesley are sold by the Company prior to the completion of the
measurement period, the measurement period shall be deemed to be completed as
of the date of such sale. The shares issued in connection with the acquisition
are subject to registration rights. Contingent consideration based upon future
cash flow is payable within 90 days of the end of the measurement period. The
excess of the purchase price and direct acquisition costs over the fair value
of net assets acquired amounted to approximately $2,448,000 and is being
amortized on a straight-line basis over 20 years. See Note 16.
 
  On June 24, 1997 the Company announced it had invested $1,000,000 in a joint
venture for a multi-modality imaging center located in Manhattan, New York.
The Company will own approximately 51% of the center which is expected to open
in June 1998.
 
  On June 30, 1997, the Company acquired three diagnostic imaging centers in
New York (the "New York" centers) for approximately $4,338,000 in cash and
50,785 shares of the Company's Common Stock valued at $2,546,000. The shares
of the Company's Common Stock issued in connection with the acquisition are
subject to registration rights. In the event that the registration statement
was not declared effective by December 30, 1997, the sellers may sell the
shares back to the Company for $2,546,000. In March 1998, the Company issued
an interest bearing convertible promissory note in the amount of $2,546,000
payable in ten monthly installments in exchange for the shares of Common Stock
issued in connection with the acquisition. The excess of the purchase price
and direct acquisition costs over the fair value of net assets acquired
amounted to approximately $6,709,000 and is being amortized on a straight-line
basis over 20 years.
 
  On July 31, 1997, the Company acquired a diagnostic imaging center in
Hollywood, Florida (the "Hollywood" center) for approximately $1,532,000 in
cash and 12,513 shares of the Company's stock valued at $674,000 and
additional consideration based on the center's performance over a three year
period subsequent to the closing of the transaction. The shares of the
Company's Common Stock issued in connection with the acquisition are subject
to registration rights and price protection equal to the difference between
the issuance price ($54.00 per share) and the market price at effectiveness of
the registration statement. The Company may satisfy any price deficiency by
the issuance of additional shares of Common Stock or by the payment of cash.
In the event that the registration statement is not declared effective by
February 1, 1998, the seller may sell the shares back to the Company for
$674,000. As of May 26, 1998, the shares of Common Stock issued in connection
with the acquisition had not been registered by the Company. The excess of the
purchase price and direct acquisition costs over the fair value of net assets
acquired amounted to approximately $1,071,000 and is being amortized on a
straight-line basis over 20 years.
 
  On August 1, 1997, the Company acquired Coral Way MRI, Inc. ("Coral Way
MRI") a diagnostic imaging center in Miami, Florida for $684,000 in cash and
30,748 shares of the Company's stock valued at $1,650,000 and additional
consideration based on the center's performance over a two year period
subsequent to the closing of the transaction. The shares of the Company's
Common Stock issued in connection with any additional consideration are
subject to registration rights. The excess of the purchase price and direct
acquisition costs over the fair value of net assets acquired amounted to
approximately $2,062,000 and is being amortized on a straight-line basis over
20 years.
 
  On August 13, 1997, the Company acquired MRI of Jupiter, Inc. a diagnostic
imaging center in Jupiter, Florida for approximately $2,000,000 in cash and
2,446 shares of the Company's stock valued at $125,000 plus additional
consideration based on the center's performance over the one year period
subsequent to the closing of the transaction. The shares of the Company's
Common Stock issued in connection with the acquisition are subject to
registration rights and price protection equal to the difference between the
issuance price ($51.00 per share) and the market price at effectiveness of the
registration statement. The Company may satisfy any price deficiency by the
issuance of additional registered shares of Common Stock or by the payment of
cash. As of
 
                                     

                                      F-38
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
May 26, 1998, the shares of Common Stock issued in connection with the
acquisition had not been registered by the Company. The excess of the purchase
price and direct acquisition costs over the fair value of net assets acquired
amounted to approximately $1,541,000 and is being amortized on a straight-line
basis over 20 years.
 
  On August 21, 1997, the Company acquired four diagnostic imaging centers
(the "Presgar" centers) on the west coast of Florida for approximately
$5,575,000 in cash and up to $3,700,000 in promissory notes, due August 21,
1998 and convertible into the Company's Common Stock, of which $1,200,000 in
principal amount is contingent upon the occurrence of certain events, plus the
assumption of indebtedness of $5,446,000. The excess of the purchase price and
direct acquisition costs over the fair value of net liabilities assumed
amounted to approximately $8,514,000 and is being amortized on a straight-line
basis over 20 years.
 
  On August 29, 1997, the Company acquired a controlling interest in a limited
partnership and a limited liability company which each operate an imaging
center located in San Jose, California (the "San Jose" centers) for
approximately $3,037,000 in cash and 14,472 shares of the Company's stock
valued at $693,000 plus the assumption of indebtedness of $3,854,000 and
additional consideration based on each center's performance over the one year
period subsequent to the closing of the transaction. The shares of the
Company's Common Stock issued in connection with the acquisition are subject
to registration rights and price protection equal to the difference between
the issuance price ($47.88 per share) and the market price at effectiveness of
the registration statement. The Company may satisfy any price deficiency by
the issuance of additional shares of Common Stock or by the payment of cash.
As of May 26, 1998, the shares of Common Stock issued in connection with the
acquisition had not been registered by the Company. As a result of the failure
to have the registration statement declared effective by February 28, 1998,
the seller is entitled to sell the shares back to the Company at their
issuance price. The excess of the purchase price and direct acquisition costs
over the fair value of net liabilities assumed amounted to approximately
$4,198,000 and is being amortized on a straight-line basis over 20 years.
 
  On September 4, 1997, the Company acquired Germantown MRI Center
("Germantown MRI") a diagnostic imaging center located in Germantown,
Pennsylvania for approximately $805,000 in cash. The excess of the purchase
price and direct acquisition costs over the fair value of net assets acquired
amounted to approximately $279,000 and is being amortized on a straight-line
basis over 20 years.
 
  On September 5, 1997, the Company acquired MRI Imaging Center of Charlotte
County a diagnostic imaging center in Port Charlotte, Florida (the "Port
Charlotte" center) for $1,293,000 in cash and 25,094 shares of the Company's
stock valued at $1,340,000 plus the assumption of indebtedness of $29,000 and
contingent consideration based on the center's performance over the two year
period subsequent to the closing of the transaction. The shares of the
Company's Common Stock issued in connection with any contingent consideration
are subject to registration rights. The excess of the purchase price and
direct acquisition costs over the fair value of net assets acquired amounted
to approximately $1,608,000 and is being amortized on a straight-line basis
over 20 years.
 
  On September 16, 1997, the Company acquired one diagnostic imaging center
located in Bronx, New York and one diagnostic imaging center located in
Queens, New York (the "Bronx and Queens" centers) for approximately $1,750,000
in cash and 34,238 shares of the Company's stock valued at $1,750,000 plus the
assumption of indebtedness of $197,000. The shares of the Company's Common
Stock issued in connection with the acquisition are subject to registration
rights and price protection equal to the difference between the issuance price
($51.00 per share) and the market price at effectiveness of the registration
statement. The sellers have the right to require the Company to satisfy any
price deficiency by the issuance of additional unregistered shares of Common
Stock or by the payment of cash. As of May 26, 1998, the shares of Common
Stock issued in connection with the acquisition had not been registered by the
Company. The excess of the purchase price and
 
                                     

                                      F-39
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
direct acquisition costs over the fair value of net assets acquired amounted
to approximately $2,444,000 and is being amortized on a straight-line basis
over 20 years.
 
  On September 24, 1997, the Company acquired Dalcon Technologies, Inc.
("Dalcon") located in Nashville, Tennessee a software developer and provider
of radiology information systems for $645,000 in cash and 35,722 shares of the
Company's stock valued at $1,934,000. The shares of the Company's Common Stock
issued at the closing are subject to registration rights. The excess of the
purchase price and direct acquisition costs over the fair value of net
liabilities assumed amounted to approximately $2,615,000 and is being
amortized on a straight-line basis over 5 years.
 
  On October 4, 1997, the Company acquired six diagnostic imaging centers
located in Ohio (the "Ohio" centers) for approximately $8,018,000 in cash and
a $1,750,000 promissory note, due October 3, 1998 and convertible at the
Company's option into shares of Common Stock. The excess of the purchase price
and direct acquisition costs over the fair value of net assets acquired
amounted to $7,791,000 and is being amortized on a straight-line basis over 20
years.
 
  Each of the above acquisitions consummated in 1997 (the "1997 Acquisitions")
was accounted for under the purchase method of accounting. The operations of
the imaging center acquisitions are included as part of continuing operations
in the Consolidated Statements of Operations from the date of purchase. With
respect to the 1997 Acquisitions, the fair value of the assets acquired and
liabilities assumed, in the aggregate, was approximately $64,759,000 and
$64,908,000, respectively. Contingent consideration associated with
acquisitions is recorded as additional purchase price when resolved.
 
  As recommended by the Special Committee, the Affiliate has repaid to the
Company $1,424,000 representing all of the financial advisory fees paid by the
Company to the Affiliate with respect to the acquisition of Wesley, Manhattan,
New York, MRI of Jupiter, Presgar, San Jose, Germantown, Port Charlotte and
Bronx and Queens centers. See Note 12 of Notes to Consolidated Financial
Statements.
 
 1996 Acquisitions
 
  On January 9, 1996, the Company consummated the acquisition of the business
assets of MRI-CT, Inc., ("MRI-CT") comprised primarily of four diagnostic
imaging centers in New York City. The acquisition was consummated pursuant to
an Asset Purchase Agreement dated December 21, 1995 by and among the Company
and MRI-CT. Pursuant to the Agreement, a wholly owned subsidiary of the
Company acquired all of the business assets of MRI-CT for a combination of
$553,000 cash, 64,704 shares of the Company's Common Stock valued at $914,000
and a $88,000 note payable bearing interest at prime due January 9, 2001. The
excess of the purchase price over the fair value of net assets acquired
amounted to $1,540,000 and is being amortized on a straight line basis over 20
years.
 
  On January 12, 1996, the Company consummated the acquisition of the common
stock of NurseCare Plus, Inc. ("NurseCare"), a California corporation based in
Oceanside, California, which provides supplemental healthcare staffing
services for clients including hospitals, clinics and home health agencies in
Southern California. The NurseCare acquisition was consummated pursuant to a
Stock Purchase Agreement dated as of January 11, 1996 by and among StarMed
Staffing, Inc. ("StarMed") and NurseCare. Pursuant to the NurseCare agreement,
StarMed acquired from NurseCare all of the common stock of NurseCare for
$2,514,000 payable $1,264,000 in cash and a note payable for $1,250,000
bearing interest at prime plus one percent due January 12, 1999. The excess of
the purchase price over the fair value of net assets acquired amounted to
$2,087,000 and is being amortized on a straight line basis over 20 years. See
Note 16.
 
                                     

                                      F-40
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  On May 1, 1996, the Company entered into an Asset Purchase Agreement with
Americare Imaging Centers, Inc. and MRI Associates of Tarpon Springs, Inc.
("Americare"), which owns and operates imaging centers in the Tampa, Florida
area. Pursuant to the acquisition agreement, the Company acquired certain of
the assets and liabilities of Americare for $1,500,000 cash and 76,250 shares
of the Company's Common Stock valued at $1,275,000. The excess of the purchase
price over the fair value of net assets acquired amounted to $2,862,000 and is
being amortized on a straight line basis over 20 years.
 
  On May 22, 1996, the Company entered into an Asset Purchase Agreement with
Clearwater, Florida based Access Imaging Center, Inc. ("Access"). Pursuant to
the acquisition, the Company acquired certain of the assets and liabilities of
Access for $1,300,000 cash and 64,021 shares of the Company's Common Stock
valued at $1,445,000. The excess of the purchase price over the fair value of
net assets acquired amounted to $1,972,000 and is being amortized on a
straight line basis over 20 years.
 
  On June 28, 1996, the Company entered into an Asset Purchase Agreement with
WeCare Allied Health Care, Inc. ("WeCare"), a healthcare staffing company.
Pursuant to the agreement, the Company acquired certain assets for $1,050,000
cash and a $510,000 note payable bearing interest at prime plus one percent
due July 1998. The excess of the purchase price over the fair value of net
assets acquired amounted to $1,769,000 and is being amortized on a straight
line basis over 20 years. See Note 16.
 
  On July 3, 1996, the Company acquired a diagnostic imaging center in
Centereach, New York ("Centereach"). Pursuant to the acquisition, the Company
acquired certain of the assets for approximately $3,100,000 in cash. The
excess of the purchase price over the fair value of net assets acquired
amounted to $2,989,000 and is being amortized on a straight line basis over 20
years.
 
  On August 30, 1996, the Company consummated the NMR Acquisition. NMR was
engaged directly and through limited partnerships in the operation of eighteen
diagnostic imaging centers. Pursuant to the acquisition agreement, NMR was
merged into a wholly owned subsidiary of the Company and each issued and
outstanding share of NMR Common Stock was converted into 0.2292 shares of the
Company's Common Stock resulting in the issuance of 1,485,500 shares of the
Company's Common Stock valued at $39,350,000. The excess of the purchase price
and direct acquisition costs (including $200,000 in fees and 40,000 warrants,
with an exercise price of $27.00, valued (for accounting purposes only) at
$325,000 for financial advisory services issued to the Affiliate) over the
fair value of net assets acquired amounted to approximately $35,286,000 and is
being amortized on a straight line basis over twenty years.
 
  On November 25, 1996 the Company consummated the acquisition of two
diagnostic imaging centers in Garden City and East Setauket, New York (the
"Long Island" centers). Pursuant to the acquisition agreement, the Company
acquired certain assets and liabilities for a $4,500,000 convertible
promissory note due January 9, 1997 and $1,900,000 in cash. The convertible
promissory note converted into 177,725 shares of the Company's Common Stock
upon registration of the shares in accordance with its terms at a conversion
price of $25.32. The excess of the purchase price and direct acquisition
costs, including $60,000 in financial advisory fees paid to the Affiliate,
over the fair value of net assets acquired amounted to $6,042,000 and is being
amortized on a straight line basis over 20 years.
 
  On December 16, 1996, the Company acquired the Imaging Center of the
Ironbound in Newark, New Jersey (the "Ironbound" center) from TME, Inc. for
$216,000 in cash and 6,289 shares of Company Common Stock valued at $200,000.
The excess of the purchase price and direct acquisition costs over the fair
value of net assets acquired amounted to approximately $440,000 and is being
amortized on a straight line basis over 20 years.
 
  Each of the above acquisitions consummated in 1996 (the "1996 Acquisitions")
were accounted for under the purchase method of accounting. The operations of
the imaging center acquisitions are included as part of
 
                                     

                                      F-41
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
continuing operations in the Consolidated Statements of Operations from the
date of purchase. Contingent consideration associated with acquisitions is
recorded as additional purchase price.
 
 1995 Acquisitions
 
  On February 24, 1995, the Company consummated a merger (the "Merger") with
Maternity Resources, Inc. ("Maternity Resources"), a Delaware corporation
engaged in the wholesale, manufacture and retail sale of maternity apparel.
The merger was consummated pursuant to a Stock Purchase Agreement (the
"Agreement") dated as of February 24, 1995 by and among the Company, Maternity
Resources and the other parties named therein (the "Sellers"). Maternity
Resources was formed on December 27, 1994 for the sole purpose of acquiring
Maternity Retail Partners, L.P. and Kik Kin, L.P. Pursuant to the Agreement,
the Company acquired (i) 100% of the issued and outstanding common stock of
Maternity Resources from the Sellers in exchange for an aggregate of 160,000
shares of the Company's Common Stock, par value $0.01 and (ii) 100% of the
issued and outstanding shares of Series B and Series C Preferred Stock of
Maternity Resources from the holders thereof in exchange for shares of the
Company's Series A Preferred Stock and Series B Preferred Stock. At the time
of the Merger, the Company and Maternity Resources were under common control
through stock ownership and, as a result, the Merger was accounted for as a
transfer between entities under common control. Under this method of
accounting, when entities are under common control, the assets, liabilities
and operations are combined at historical cost in a manner similar to that in
pooling of interests accounting. In November 1995, the Company sold its
Maternity Resources subsidiaries and consequently transferred all of Maternity
Resources liabilities to unaffiliated third parties. The Company has no
material contingent liabilities remaining with respect to Maternity Resources.
Since the Maternity operations have been sold, Maternity Resources has been
reported as a discontinued operation.
 
  Maternity apparel revenues were recognized on an accrual basis as earned and
realizable and consisted of net revenue derived from the wholesale and retail
sale of maternity clothing and apparel. Maternity apparel revenues amounted to
approximately $11,057,000 for the year ended December 31, 1995. The initial
purchase price of $4,076,000 (the aggregate recorded fair value of the Common
Stock and the Preferred Stock issued by the Company in connection with the
Merger) exceeded the book value of net assets acquired of $1,120,000 by
$2,955,000. This amount could be considered a distribution to shareholders. On
December 27, 1995, preferred shares, which were included as part of the
$4,076,000 having a potential redemption value of $2,392,000 were redeemed by
the Company for an agreed upon aggregate amount of $24,000. The net amount
paid in excess of the net assets acquired after the redemption amounted to
$564,000. The acquisition of Maternity was accounted for in a manner similar
to that in a pooling of interests. This accounting resulted in certain
adjustments directly to stockholders' equity. A credit of $1,022,000 was made
to paid-in-capital related to the forgiveness of certain debt owed by
Maternity to affiliated organizations that is accounted for as a capital
contribution due to the related party nature. A credit of $570,000 was made to
retained deficit that represents a portion of Maternity's January 1995 losses
attributable to a subsidiary. These losses were included in the Company's 1994
operations in recognition of the then full year's operating results for the
specific subsidiary's year ended January 31, 1995. Accordingly, the amount
duplicated in 1995 operating results is reversed. A charge of $269,000 to
paid-in-capital relates to a cash redemption by Maternity of its then
outstanding redeemable preferred stock prior to the merger. Maternity Retail
Partners L.P. has also been included in the Company's consolidated operating
results for the twelve months ended December 31, 1995.
 
  On May 26, 1995, the Company consummated the acquisition of the business
operations of New England MRI, Inc. ("New England MRI"), a Florida corporation
based in Fort Myers, Florida, which owned and managed two diagnostic imaging
centers (the "Centers"). The acquisition was consummated pursuant to an Asset
Purchase Agreement (the "Agreement") dated as of May 17, 1995 by and among two
of the Company's wholly owned subsidiaries--Fort Myers Resources, Inc. ("FMR")
and Central Fort Myers Resources, Inc.
 
                                     

                                      F-42
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
("CFMR"), and "New England MRI". Pursuant to the Agreement, FMR acquired
substantially all of the assets of one of the centers and CFMR acquired all of
the assets of the other center through the issuance of 400,000 shares of the
Company's Common Stock valued at $3,449,000. Of the 400,000 shares, 200,000
shares were issued at closing with the remaining 200,000 shares to be issued
within two years of closing (200,000 of such shares were issued in 1997). The
centers achieved certain earnings objectives and as a result, an additional
66,667 shares were issued in September 1997, to New England MRI, in accordance
with the additional consideration provisions in the purchase agreement. The
market value of the shares upon issuance was recorded as additional goodwill
subject to amortization over the stated period. The excess of the purchase
price over the fair value of net assets acquired amounted to approximately
$5,746,000 and is being amortized on a straight line basis over 20 years. The
accompanying Consolidated Financial Statements include the operations of FMR
and CFMR from the above date of acquisition. The shares issued to New England
MRI as consideration for the purchased assets are subject to certain
registration rights.
 
  On June 19, 1995, the Company consummated the acquisition of the business
operations of PCC Imaging, Inc. ("PCC"), which owns and manages a diagnostic
imaging center. The acquisition was consummated pursuant to an Asset Purchase
Agreement (the "Agreement") dated June 19, 1995 by and among the Company's
wholly owned subsidiary, Hackensack Resources, Inc. ("HRI") and PCC. Pursuant
to the agreement, HRI acquired substantially all of the assets of the center
for $1,800,000 in cash. The acquisition was accounted for as a purchase, under
which the purchase price was allocated to the acquired assets and assumed
liabilities based upon fair values at the date of acquisition. The excess of
the purchase price over the fair value of net assets acquired amounted to
$751,000 and is being amortized on a straight line basis over 20 years. The
accompanying consolidated financial statements include the operations of PCC
from the above date of acquisition.
 
  The following table summarizes the unaudited pro forma results of continuing
operations for the years ended December 31, 1997 and 1996, assuming the 1997
imaging center acquisitions had occurred on January 1, 1997 and 1996 and the
1996 imaging center acquisitions had occurred on January 1, 1996 (in
thousands, except per share data):
 
<TABLE>
<CAPTION>
                                                         1997           1996
                                                      -----------    -----------
                                                      (UNAUDITED)    (UNAUDITED)
   <S>                                                <C>            <C>
   Revenue, net......................................  $185,309       $192,131
   Operating income (loss)...........................   (17,323)(a)     26,190
   Income (loss) before income taxes.................   (30,134)        10,360
   Net income (loss) from continuing operations......   (31,355)         6,376
   Basic net income (loss) per share from continuing
    operations.......................................  $  (4.87)      $   1.70
</TABLE>
--------
(a) 1997 pro forma results include a $12,962,000 loss on the impairment of
    goodwill and other long-lived assets and other unusual charges of
    $9,723,000. See Note 3 of the Notes to the Consolidated Financial
    Statements for further details.
 
                                     

                                      F-43
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
15. QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
 
  The following is a summary of unaudited quarterly consolidated financial
results of continuing operations for the years ended December 31, 1997 and
1996 (in thousands except per share amounts) (see Note 16):
 
<TABLE>
<CAPTION>
                                                FIRST  SECOND   THIRD  FOURTH
                                               QUARTER QUARTER QUARTER QUARTER
                                               ------- ------- ------- -------
   <S>                                         <C>     <C>     <C>     <C>
   1997
     Revenue, net............................. $26,841 $37,877 $42,022 $37,672
     Operating income (loss)..................   6,713   5,896   9,159 (43,065)
     Net income (loss) from continuing
      operations..............................   3,362   2,628   3,909 (43,805)
     Basic earnings (loss) per share from
      continuing operations...................    0.53    0.39    0.56   (6.06)
     Diluted earnings (loss) per share from
      continuing operations...................    0.50    0.36    0.49   (6.06)
   1996
     Revenue, net............................. $11,367 $12,899 $17,088 $23,408
     Operating income.........................   2,064   2,771   3,704   5,161
     Net income from continuing operations....   1,235   1,538   1,775   2,435
     Basic earnings per share from continuing
      operations..............................    0.45    0.51    0.49    0.43
     Diluted earnings per share from
      continuing operations...................    0.44    0.47    0.45    0.40
</TABLE>
 
  In the table above, the second quarter of 1997 has been restated to include
a non-cash charge of $2,305,000 for compensation expense resulting from stock
options granted in 1996 and early 1997 that were approved by the Company's
stockholders in May 1997.
 
  The fourth quarter of 1997 includes a $12,962,000 loss on the impairment of
goodwill and other long-lived assets and other unusual charges of $9,723,000.
See Note 3 of the Notes to the Consolidated Financial Statements for further
details. The fourth quarter of 1997 also includes additional charges related
to increases in the estimated provision for uncollectible accounts receivable
and higher contractual allowance estimates.
 
  Quarterly results are generally affected by the timing of acquisitions.
 
16. SUBSEQUENT EVENTS
 
AGREEMENT IN PRINCIPLE REGARDING SENIOR NOTE DEFAULTS
 
  Management has reached an agreement in principle with the Senior Note
lenders with respect to existing covenant defaults and certain covenant
modifications. Under the terms of the agreement in principle, the Senior Note
lenders have agreed to waive all existing covenant defaults and to modify the
financial covenants applicable over the remaining term of the Senior Notes. In
consideration for these waivers and covenant modifications, the Company has
agreed to increase the effective blended interest rate on the Senior Notes
from 7.87% to 9.00%, and issue to the Senior Note lenders warrants to acquire
375,000 shares of the Company's Common Stock at an exercise price of $7.67 per
common share. In addition, the Company has agreed to prepay $2,000,000 of
principal outstanding on the Senior Notes (without premium) and to pay a fee
to the Senior Note lenders of $500,000. The agreement in principle is subject
to the execution of definitive documents, which are expected to be completed
during September 1998. There can be no assurance, however, that definitive
documents effecting the agreement in principle will be executed.
 
  Upon execution of the definitive documents with respect to the Senior Notes,
the Senior Notes and the Cross Default Debt will no longer be in default and
will be shown as long-term debt in future financial statements of the Company.
 
                                     

                                      F-44
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
SALE OF STARMED
 
  Through the Per Diem and Travel Nursing Divisions of its wholly-owned
subsidiaries, StarMed Staffing, Inc. and Wesley Medical Resources Inc.
("StarMed"), the Company provides temporary healthcare staffing of registered
nurses and other medical personnel to acute and sub-acute care facilities
nationwide. On August 18, 1998, the Company sold the stock of StarMed to
RehabCare Group, Inc. for gross proceeds of $33,000,000 (the "StarMed Sale").
Due to the StarMed Sale, the amounts in the accompanying Consolidated
Statements of Operations and related notes thereto have been restated to
reflect StarMed as a discontinued operation.
 
  Net cash proceeds from the StarMed Sale were used as follows: (i)
$13,786,000 to repay StarMed's outstanding third-party debt (in accordance
with the terms of sale) (ii) $2,000,000 was placed in escrow to be available,
for a specified period of time, to fund indemnification obligations that may
be incurred by the Company (part or all of this amount may be payable to the
Company over time) and (iii) an additional $2,000,000 was placed into escrow
to be applied as a partial repayment of the Company's $78,000,000 of Senior
Notes. The remaining net proceeds of approximately $13,400,000 increased the
Company's consolidated cash balances. For accounting purposes, a pretax gain
from the StarMed Sale of approximately $5,000,000 is expected to be reported
in the third quarter of 1998.
 
 
  The following table shows summary balance sheets for StarMed as of December
31 (in thousands):
 
<TABLE>
<CAPTION>
                                                                 1997    1996
                                                                ------- -------
      <S>                                                       <C>     <C>
                               ASSETS
      Current Assets
        Cash and cash equivalents.............................. $   455 $   --
        Accounts receivable, net...............................  12,657   5,287
        Other Current Assets...................................     279     185
                                                                ------- -------
          Total current assets.................................  13,391   5,472
      Property and equipment, net..............................     428     275
      Goodwill, net............................................  10,442   8,026
      Other assets.............................................     218     --
                                                                ------- -------
        Total assets........................................... $24,479 $13,773
                                                                ======= =======
                LIABILITIES AND STOCKHOLDER'S EQUITY
      Current Liabilities:
        Current notes and mortgages payable                     $   850 $ 1,275
        Borrowings under line of credit........................   3,744     --
        Debt due parent........................................   4,000   3,554
        Accounts payable and accrued expenses                     2,229     884
                                                                ------- -------
          Total current liabilities............................  10,823   5,713
      Notes and mortgages payable, less current portion........   2,827   3,635
      Debt due parent..........................................   6,279     --
      Equity...................................................   4,550   4,425
                                                                ------- -------
        Total liabilities and stockholder's equity............. $24,479 $13,773
                                                                ======= =======
</TABLE>
 
                                     

                                      F-45
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following table shows summary statements of operations for StarMed for
the years ended December 31 (in thousands):
 
<TABLE>
<CAPTION>
                                                        1997    1996    1995
                                                       ------- ------- -------
      <S>                                              <C>     <C>     <C>
      Net service revenues............................ $57,974 $29,023 $16,133
      Office level operating costs and provision for
       uncollectible accounts receivable..............  47,123  24,316  13,543
      Corporate general and administrative............   8,089   3,212   1,984
      Depreciation and amortization...................     601     502     293
                                                       ------- ------- -------
        Operating income..............................   2,161     993     313
      Interest expense, net...........................     353     135     --
                                                       ------- ------- -------
      Income before income taxes......................   1,808     858     313
      Provision for income taxes......................   1,079     587     416
                                                       ------- ------- -------
      Net income (loss)............................... $   729 $   271 $  (103)
                                                       ======= ======= =======
</TABLE>
    
See note 14 for discontinued operations relating to Maternity Resources, Inc.
for 1995.    
 
  In June 1998, an individual filed a complaint against the Company, StarMed,
Wesley Medical Resources, Inc., a subsidiary of the Company ("Wesley"), and
certain officers and directors of the Company in the United States District
Court for the Northern District of California. The complaint, among other
things, alleges that the defendants omitted and/or misrepresented material
information in the Company's public filings and that they concealed or failed
to disclose adverse material information about the Company in connection with
the sale of Wesley to the Company by the plaintiff. The plaintiff seeks
damages in the amount of $4.25 million or, alternatively, recession of the
sale of Wesley. The Company believes that it has meritorious defenses to the
claims asserted by plaintiff, and intends to defend itself vigorously. In July
1998, the Company and the named defendants filed a motion to dismiss the
plaintiff's complaint on numerous grounds. The legal proceeding described
above is in its preliminary stages. Although the Company believes it has
meritorious defenses to all claims against it, the Company is unable to
predict with any certainty the ultimate outcome of such proceeding.
 
                                     

                                      F-46
<PAGE>
 
                            MEDICAL RESOURCES, INC.
 
                 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                          BALANCE AT  ADDITIONS                          BALANCE
                         BEGINNING OF CHARGED TO                         AT END
      DESCRIPTION           PERIOD     EXPENSE   ADDITIONS/(DEDUCTIONS) OF PERIOD
      -----------        ------------ ---------- ---------------------- ---------
<S>                      <C>          <C>        <C>                    <C>
Year ended December 31,
 1995
  Total Allowances for
   Doubtful Accounts....   $ 2,881     $ 3,378          $      0 (1)
                                                            (427)(2)     $ 5,832
Year ended December 31,
 1996
  Total Allowances for       5,832       4,705                78 (1)
   Doubtful Accounts....                                    (247)(2)      10,368
Year ended December 31,
 1997
  Total Allowances for      10,368      20,364               292 (1)
   Doubtful Accounts....                                 (12,102)(2)      18,922
</TABLE>
--------
(1) Represents provision for bad debts of discontinued operations.
(2) Uncollectible accounts written off, net of recoveries.
 
                                      

                                      F-47