SECURITIES AND EXCHANGE COMMISSION
                                Washington, D.C.

                                   FORM 10-KSB

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

                  For the fiscal year ended: September 30, 1997

                                       OR

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

           For the transition period from ____________ to ___________

                         Commission file number: 0-8632

                             MEDICAL DYNAMICS, INC.
              ---------------------------------------------------
             (Exact name of Registrant as specified in its charter)

          Colorado                                               84-0631765
-------------------------------                           ----------------------
(State or other jurisdiction of                                (IRS Employer
incorporation or organization)                            Identification Number)

         99 Inverness Drive East
           Englewood, Colorado                                          80112
---------------------------------------                              ----------
(Address of principal executive offices)                             (Zip Code)

       Registrant's telephone number, including area code: (303) 790-2990

        Securities registered pursuant to Section 12(b) of the Act: None

          Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $.001 Par Value

     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,  and (2) has been  subject to such filing
requirements for the past 90 days.

                                  (1) Yes  X    No
                                         -----    -----
                                  (2) Yes  X    No
                                         -----    -----
                                              
     Check if there is no disclosure  of  delinquent  filers in response to Item
405 of  Regulation  S-B, and no  disclosure  will be  contained,  to the best of
Registrant's   knowledge,   in  definitive   proxy  or  information   statements
incorporated  by reference in Part III of this Form 10-KSB or any  amendments to
this Form 10-KSB.[XX ]


<PAGE>




     The issuer's revenues for its most recent fiscal year were $982,800.

     The  aggregate  market  value of the voting  stock held by non-  affiliates
computed by reference  to the price at which the stock was sold,  or the average
bid and asked  prices of such stock,  as of  December 8, 1997 was  approximately
$27,952,323.

Class                                       Outstanding at December 8 , 1997
-----                                       --------------------------------

Common Stock                                        9,255,736 shares

                    Documents incorporated by reference: None







                                       -2-




<PAGE>



                             MEDICAL DYNAMICS, INC.

                                   FORM 10-KSB

                                     PART I

Item 1. Business.
-----------------

     (a) Business Development
     ------------------------

     Medical Dynamics,  Inc., a Colorado corporation  incorporated in March 1971
("MEDY" or the "Company"),  is engaged in the design,  development,  manufacture
and  marketing  of medical  and dental  video  cameras  and  related  disposable
products for a variety of professional  specialties.  MEDY's principal  products
are small,  color,  medical and dental video  camera  systems for use in patient
diagnosis and various  surgical  procedures.  MEDY has been  manufacturing  such
cameras  since  August  of 1981.  In  October  1997  MEDY  acquired  100% of the
outstanding  capital stock of Computer Age Dentist,  Inc.  (CADI),  a California
corporation based in Los Angeles, California. CADI is engaged in the development
and sale of Practice  Management Software and related electronic services to the
dental   profession.   MEDY  also  has  one  inactive   subsidiary,   MedPacific
Corporation, a Washington state corporation.  MEDY's principal executive offices
and  manufacturing  facilities  are  at  99  Inverness  Drive  East,  Englewood,
Colorado, 80112. Its telephone number at that address is (303) 790-2990.

     During the fiscal year ended  September 30, 1997,  MEDY was not involved in
any  bankruptcy,  receivership  or similar  proceeding  nor did it engage in any
material  reclassification,  or consolidation.  During that period, MEDY did not
dispose of any material  amounts of its assets other than in the ordinary course
of its business.

     During the 1995 fiscal year MEDY entered into a distribution agreement with
Micro-  Medical  Devices,  Inc.  (MMD),  of  Castle  Rock,  Colorado.  MMD  is a
corporation formed by and wholly-owned by MEDY's Chairman.  MMD manufactures and
sells minimal  quantities  of various  medical  products to MEDY.  See Item 12 -
"Certain Relationships and Related Transactions, Distribution Agreement."

     As  discussed  in  Note 2 to the  financial  statements,  the  Company  has
suffered recurring losses and negative cash flows from operations. Subsequent to
fiscal year end, MEDY sold a convertible  debenture in the amount  $1,100,000 to
The Tailwind Fund, Ltd., an unaffiliated  entity,  pursuant to an exemption from
registration  under  Regulation  D.  Despite  the  recurring  operating  losses,
management  believes  the Company has  adequate  capital  resources to carry out
planned  activities  in  fiscal  1998.  See also  "Management's  Discussion  and
Analysis of Financial Condition and Results of Operations."


                                       -3-



<PAGE>



     (b) Business of the Issuer
     --------------------------

     As a  result  of the  acquisition  of CADI in  October  1997,  MEDY has two
principal business segments:

     (i) The  design,  development,  manufacture  and  marketing  of medical and
dental  video  cameras  and  related  disposable   products  for  a  variety  of
professional  specialties  ("The  Medical  and Dental  Camera  Segments".  These
products are used in surgical, diagnostic, research and teaching applications by
physicians, dentists, and other health care professionals.

     (ii) The development and sale of dental  practice  management  software and
related electronic services ("The Dental Practice Management Segment").

The Medical and Dental Camera Segment

     A variety of less invasive  diagnostic  and surgical  techniques  have been
developed  which enable  operations to be performed or observation to occur with
minimal surgical incisions.  Arthroscopy and Laparoscopy are the two most common
surgical   procedures   performed   utilizing  the  types  of  surgical  cameras
manufactured by MEDY. MEDY's current product offerings in this area are the 5980
Digital Surgical Video Camera,  and Model 5990 Optical Catheter System,  as well
as two disposable drape products, Cam-Wrap and Lap- Wrap.

     MEDY has recently applied it's surgical camera expertise to the development
of  intraoral  dental  cameras  for use as a  diagnostic  tool  for  the  dental
profession.  MEDY  believes  that the True  Vision(TM)  family of cameras it has
created represents the state-of-the- art for this camera  technology,  with high
resolution surgical camera picture quality coupled with competitive pricing.

     Existing  Products and New Products.  MEDY's  principal  products and their
markets,  and new products which are under development,  are as follows.  MEDY's
medical  video  camera  systems  and  disposable   medical   products  are  sold
principally  to  physicians  and  hospitals,  either  directly or through one of
MEDY's  independent  sales  representatives.  MEDY's  intraoral dental camera is
typically  sold  through  a  select  dealer  distribution  network  or on an OEM
distributor  basis.  MEDY has engaged in marketing  and  advertising  of all its
products at dental conventions and through a sales representative or distributor
network. During the years ended September 30, 1997 and 1996, MEDY spent $140,800
and $193,700,  respectively,  on sales  promotions,  conventions and advertising
expenses.

     True Vision(TM) and True Vision 2 Intraoral  Dental Camera.  MEDY currently
manufactures and markets dental video cameras which are designed for most common
dental applications. These camera models contain a high performance video sensor
coupled with a 1/4" lens and camera system which  management  believes  provides
superior high resolution  picture quality  compared to other cameras used in the


                                       -4-



<PAGE>


dental profession.  The cameras'  state-of-the-art  technology  consists of easy
angle,  high  resolution  viewing,  a single lens  format,  and the smallest and
lightest hand piece available in the market today. Production and sales of these
cameras  began in September of 1996.  The  principal  market for the True Vision
cameras are dentists.

     Model 5980 and 5990 Cameras.  Sales of the 5980 and 5990 model cameras were
minimal in fiscal 1997. Management  anticipates an increase in 5990 sales in the
upcoming  year through a distributor  that is  negotiating  for a  non-exclusive
license on the 5990 Optical Catheter System, although no assurances can be given
as to the  successful  completion of that license or the level of sales that may
be generated by it.

     Miniaturized   Electronic   Endoscopes.   MEDY  is  developing   Electronic
Endoscopes in the four  millimeter  diameter  range that will utilize either CCD
(Charged  Coupled  Device) or CMOS  (Complementary  Metal Oxide Sensor)  imaging
chips and  incorporating  MEDY's  "Rotatable  Chip"  technology  acquired  via a
license  agreement from High Tech Medical  Instrumentation,  Inc. on U.S. Patent
No.  4,858,001  entitled  Modular  Endoscopic  Apparatus  With  Image  Rotation.
Depending on the  availability  of imaging chips,  these devices should be ready
for market  during  calendar  1999.  Management  of MEDY  believes this to be an
important  project  because it will  provide  the market with  Electronic  Video
Arthroscopes,  Cystoscopes,  Ureteroscopes  and other devices which have all the
advantages of image clarity and light weight design similar to the  Registrant's
existing ten millimeter  Electronic  Video  Laparoscope,  but in four millimeter
diameters.  That diameter is the industry standard for these types of endoscopes
and have been previously unavailable to the market in the electronic or "chip on
a stick" format.  This project will again give the Registrant a product  entrant
into the $1 billion annual endoscopic capital equipment market.

     Intraoral Dental Cameras  Incorporating CMOS Imaging Chips. Due to the CMOS
imaging  chip's lower volume  costs,  MEDY is pursuing  this project as a way in
which to  substantially  lower the cost of the Intra Oral  Camera to the market.
The time frame for potential introduction to the market is calendar 1999.

     During  each of 1997 and 1996  fiscal  years,  sales of  various  models of
medical video camera systems (including ancillary camera equipment)  contributed
approximately 2% and 22% of MEDY's total revenue,  respectively.  Dental cameras
and related accessories contributed 70% of revenues for the year ended September
30, 1997.

     Inventory  and  Raw  Materials.  MEDY  is  required  to  carry  significant
quantities of inventory to meet rapid delivery  requirements  of customers or to
assure  itself of a  continuous  allotment  of goods from  suppliers.  MEDY also
carries  a  significant  quantity  of  repair  parts.  At  September  30,  1997,
inventories  of repair parts valued at $32,000  were  classified  as a long-term
asset in MEDY's balance sheet.  This estimate was determined by considering both
historical and projected  levels of sales for goods included in  inventories.  A
substantial  portion of raw  materials is expected to be utilized for repairs of
equipment  sold over the past  several  years  (see  note 3 to the  consolidated
financial statements). MEDY has continued to maintain an inventory of components


                                       -5-



<PAGE>


for its Models  5500,  5940,  5960,  5970,  and 5980  cameras,  the 5990 Optical
Catheter(TM)  System, and various peripherals.  Sufficient  quantities of MEDY's
disposable product line such as Lap-Wrap and Cam-Wrap must also be maintained in
anticipation of customer's future needs.

     MEDY is able to obtain the raw  materials  for its camera  products  from a
large  number of  suppliers.  MEDY does not believe  that it is dependent on any
single supplier for its raw materials. For a number of years, MEDY had purchased
cameras  from  Panasonic   Industrial   Company  -  Audio  Video  Systems  Group
("Panasonic")  exclusively.  Although Panasonic is still the primary supplier of
cameras,  MEDY now procures cameras from additional sources without  sacrificing
product or picture quality.

     Warranty.  MEDY's  medical and dental  video  cameras are  warranted  for a
one-year  period with respect to parts and labor required as a result of defects
in material and  workmanship.  Cables and optical  couplers are  warranted to be
free of defects for a period of 180 days.  Defects or malfunctions are corrected
by MEDY at  MEDY's  cost,  if the  applicable  conditions  to the  warranty  are
satisfied.  Failures  normally  occur during the early life of the cameras,  and
repair expenses  usually occur in the same year in which the camera is initially
placed in service. MEDY estimates future warranty costs and enters the estimated
cost into its  results  of  operations  based  upon  historical  experience  and
revenues currently  reported.  The estimated warranty reserve at fiscal year end
September 30, 1997 and 1996 was $11,000 and $15,000, respectively.

     Distribution  Methods.  During  fiscal 1997 MEDY  engaged  four field sales
representative  organizations to market its medical camera systems in the United
States.  The sales  representatives  enter into a one year  agreement  with MEDY
under which they receive commissions of approximately 15% to 20% on video camera
sales revenues,  10% to 15% on camera  accessories and 10% on disposable product
sales generated by them in exclusive  marketing  areas. All selling expenses are
borne by the sales representative.  The sales representative agreements prohibit
each  representative  from  purchasing or dealing in products of  competitors of
MEDY.  In addition to sales made in this manner,  MEDY also modifies some of its
products to display the labeling of its customers. Those customers then sell the
products directly to end-users.

     As of the fiscal year ended September 30, 1997, MEDY engaged  approximately
three  agents to sell medical  video  cameras and related  disposables  in areas
outside  the United  States.  The  primary  foreign  territories  where MEDY has
distributors are the United Kingdom, Western Europe, and Latin America.

     MEDY  typically  sells  products  on a net 30  day  basis  to all  domestic
customers  and on a cash or net 60 to 270 day  basis to  foreign  customers  and
distributors.  With some exceptions,  most foreign  distributors post letters of
credit to insure  payment on orders.  Inventory  levels,  net of  allowance  for
obsolescence,  for the  fiscal  years  ended  September  30,  1997 and 1996 were
$715,400 and $714,400 respectively.


                                       -6-



<PAGE>



     Competition.  With regard to MEDY's medical and dental video  cameras,  the
principal  competitive  factors to which it is subject are price,  technological
configuration, product performance, and product line diversification.  Principal
medical  competitors  in the  United  States  include  Circon/ACMI  Corporation,
Stryker Corporation,  Olympus,  Wolf, and Karl Storz, each of which manufactures
and sells some form of medical video system,  and there are certain  competitors
overseas. Principal competitors in the dental camera field are Patterson Dental,
New  Image  Industries  and   Dental/Medical   Diagnostic   Systems.   Principal
competitors in the dental software business are Dentrix,  EagleSoft and Practice
Works.  The principal  reasons why medical sales volumes have remained  volatile
over the last several years are  fluctuating  OEM revenue,  the limited  product
line  previously  offered  by MEDY,  a limited  amount of capital  available  to
promote the  products  through  successful  marketing  efforts and  distribution
channels,  and the  consolidation of hospitals  coupled with less influence over
buying decisions by physicians.  Such limitations have proven detrimental to the
ongoing operations of MEDY to date.

     Government Regulation.  The United States Food and Drug Administration (the
"FDA"),  pursuant to the Medical Device Amendments of 1976 to the Food, Drug and
Cosmetic Act (the "Act") and regulations promulgated  thereunder,  regulates the
testing, manufacturing, packaging, distribution and marketing of medical devices
in the United States, including certain of the products manufactured by MEDY.

     The Act requires manufacturers of medical devices to register annually and,
semi-annually,  to list new  devices  being  produced  by the  manufacturer  for
commercial distribution.

     The Act also  classifies  medical  devices  and  requires  compliance  with
specific  manufacturing and quality assurance  standards.  The FDA has published
regulations  defining good manufacturing  practices to provide that each step of
the  manufacturing  process  for  any  device  is  controlled  to  maximize  the
probability   that  the   finished   product   meets  all   quality  and  design
specifications.  The regulations also require that each manufacturer establish a
quality assurance  program by which the manufacturer  monitors the manufacturing
process and maintains records which show compliance with the FDA regulations and
the  manufacturer's  written  specifications  and  procedures  relating  to  the
devices.

     MEDY's   facilities  and  records  are  subject  to  periodic   unannounced
inspections by the FDA for compliance with the applicable FDA  regulations.  The
FDA may issue reports or citations where the  manufacturer  has failed to comply
with all appropriate regulations and procedures. If the FDA finds a manufacturer
not to be in such compliance,  the FDA may prohibit a manufacturer  from selling
the products for which the manufacturer is not in compliance, until such time as
the  manufacturer  complies with the applicable FDA regulations  with respect to
those  products.  Compliance  with  the  provisions  of the Act  and  the  FDA's
regulations is time consuming and expensive due to the extensive  record keeping
required.


                                       -7-



<PAGE>



     MEDY's  last  inspection  by the FDA was in  October  1996 when no  adverse
actions were taken.  MEDY has not been  inspected  since that date,  although an
inspection is scheduled for December, 1997.

     Research and Development.  During the fiscal years ended September 30, 1996
and 1997,  MEDY spent  approximately  $206,900 and  $200,300,  respectively,  on
company-sponsored  research and  development  activities.  During those periods,
there  were  minimal  customer-sponsored  research  activities  relating  to new
products,  services,  techniques  or to the  improvement  of existing  products,
services or techniques.

The Dental Practice Management Operations

     With its October 1997 purchase of Computer Age Dentist,  Inc. (CADI),  MEDY
now offers  software for the dental  office that  provides  patient  scheduling,
patient education, graphical charting, word processing, camera and digital x-ray
integration and insurance benefits database. The software:

     o    allows the scheduling of patients and dental  professionals,  and ties
          scheduled patients directly to their dental records;

     o    integrates with all intraoral dental cameras,  allowing the dentist to
          include  intra- oral pictures  directly on the patient's  computerized
          chart:

     o    provides  for  computer  based  charting  and  digitized  x-rays to be
          automatically  attached to the  patient's  chart for easy  viewing and
          printing;

     o    integrates  the  patient's   chart   directly  with  word   processor,
          spreadsheet,  and database functions,  allowing the dentist and his or
          her staff to create  correspondence,  charts, and reports based on the
          patient's information; and

     o    provides  the  ability  to  submit   claims  to  insurance   companies
          electronically,  track laboratory requests and results, and many other
          services useful to the modern dental office.

     CADI's current  product is a  Windows-based  application  and is a flexible
open  architecture  design that can be used either through a computer  keyboard,
mouse, or light pen. Charts,  reports,  statements,  x-rays, and pictures can be
printed on plain paper laser printers.

     No Principal Customers and No Significant Inventory Requirements.  CADI has
over 2,200 customer installations throughout the United States serving in excess
of 3,500 dental  professionals and,  therefore,  it is not dependent on sales to
any principal customer.

     There are no significant inventory requirements for this business.


                                       -8-


<PAGE>



     Distribution Methods. Distribution for CADI's software product is conducted
both with direct sales  people  employed by the Company and through a network of
value-added  resellers (VARs). The Windows 95-based multi-user product sells for
approximately  $7,000 each,  including  one-year of free  upgrades and telephone
technical support.  In CADI's last fiscal year ending September 30, 1997, it had
approximately  $2.9 million of revenue.  Management  of MEDY believes that those
revenues  can be increased  over time with the  addition of working  capital for
future R&D,  additional  acquisitions of companies in similar  businesses and an
expanded  distribution  system.  It is  Management's  intention to pursue all of
those  strategies  in  attempting  to  profitably  grow  that  business,  but no
assurances can be made as to the success of that effort.

     Competition.  There are no significant individual competitors in the Dental
Practice  Management  Segment;  instead,  there  are a  large  number  of  small
companies which offer dental practice management software and related electronic
services of their own design.  MEDY believes  that CADI's  software is among the
more highly  integrated  and easier to use software  products  available for the
dental  office.  CADI's  software  is more  expensive  than  that of many of its
competitors, but MEDY believes that its superior features justify its price.

     Research and Development. CADI is continually seeking to improve its dental
practice  management  software  and related  electronic  services.  The software
industry is  characterized by continual  changes and  improvements  and, in some
case, startling new designs (such as the changes from DOS-based  applications to
Windows,  and from  Windows  3.1 to  Windows  95).  CADI must keep its  software
current for new versions of computer  operating  system software being published
by third parties,  as well as to maintain existing software which may be running
on older computers. MEDY anticipates that CADI will spend approximately $200,000
on research and  development  in the fiscal year ending  September  30, 1998, as
compared to minimal amounts that were charged to operations  during its last two
fiscal years as an independent company.

     Governmental Regulation.  There is no governmental regulation which impacts
the development and sale of CADI's dental practice management software.  Because
the dental industry is so dependent on government and private  insurance company
oversight,  however,  it is important  for the CADI software to be able to allow
dentists  and  their  offices  to  show  compliance  with  governing  rules  and
regulations.  Consequently,  CADI has developed its dental  practice  management
software to allow  dentists  and dental  offices to maintain  accountability  in
accordance with the requirements.

Other Information

     Principal  Customers.  MEDY had one customer who contributed 10% or more of
total gross revenues  during the 1997 fiscal year and one who  contributed  more
than 10% in the 1996 fiscal year.  Gross  billings to  Information  Presentation
Systems,  Inc.(IPS) of Marietta, GA. during fiscal year 1997 was $599,500 or 61%
of the Registrant's revenues. IPS markets and installs dental intraoral cameras,


                                       -9-

<PAGE>


multi operatory  image systems,  digital x- ray systems and other related dental
products.  Gross billings to Rosot Enterprises of Locust Valley, New York during
fiscal  year 1996  were  $108,800  or 16% of the  Registrant's  revenues.  Rosot
Enterprises  is an  international  distributing  company which  concentrates  on
Mexico, Central and South America.

     Patents, Trademarks, etc. Patents. MEDY holds an exclusive license on three
patents related to its Optical  Catheter  System(TM).  United States Patents No.
4,782,819,  No. 4,736,733,  and No. 4,754,328 expiring November 8, April 12, and
June 28, 2005,  respectively,  relating to the Optical Catheter(TM) are owned by
Dr. and Mrs. Adair and are licensed on an exclusive  basis to MEDY. The terms of
the license agreement are described under "Licenses" below.

     In addition to the above referenced patents, the following patents are also
licensed to MEDY from the Chairman:


TITLE                                   ISSUE DATE               PATENT NUMBER
-----                                   ----------               -------------

"Laser Endoscope"                        5/20/86                   4,589,404

"Laser Endoscope" (Divisional)           6/28/88                   4,754,328

"Endoscope with Removable                4/12/88                   4,736,733
 Eyepiece"

"Gas Insufflation Needle with            9/26/89                   4,869,717
 Instrument Port" (Adair Veress
 Needle)

"Rigid Video Endoscope with              11/07/89                  4,878,485
 Heat Sterilizable Sheath"
 (EVL and Lap-Wrap)
 Reissue                                 3/24/92                   RE 33854

"Deformable and Removable
 Sheath for Optical Catheter"            3/30/93                   5,197,457

"Deflectable Sheath for                  6/30/92                   5,125,395
 Optical Catheter"

"Heat Sterilizable Electronic            2/23/93                   5,188,094
 Video Endoscope"
 (Autoclavable EVL)

"Steerable Sheath for Use                7/5/94                    5,325,845
 With Selected Removable
 Optical Catheter"  


                                      -10-


<PAGE>

 

"Imaging Tissue or Stone                 5/17/94                   5,311,858
 Removal Basket"

"Stereoscopic Endoscope"                 1/17/95                   5,381,784
 (3-D EVL)

"Stereoscopic Endoscope With             2/27/96                   5,494,483
 Miniaturized Electronic
 Imaging Chip"

"Miniaturized Electronic                 2/27/96                   5,495,114
 Imaging Chip"
 (For Reduced Diameter
 Electronic Endoscopes)


     Trademarks.   MEDY  is  also  the  holder  of  United  States   Trademarks,
registration numbers 1,299,413, 1,299,414, 1,719,664, and 2,111,413 which relate
to the name "Medical  Dynamics",  the corporate logo of MEDY,  the  Adair/Veress
Needle, and True Vision, respectively.  The trademarks are granted for a term of
20 years and expire on those terms  beginning  October 8, 2004,  and if still in
use at that time may be renewed for successive 20- year periods by  application.
In addition,  MEDY claims rights in numerous  unregistered  trademarks  which it
uses  in  interstate  commerce,  and  which  are  subject  only  to  common  law
protection.  Additionally,  MEDY holds trademark  registration  number 1,282,319
which relates to the name "MedPacific  Corporation" and its corporate logo. This
Trademark  was renewed for a 20 year term in June 1990.  Computer  Age  Dentist,
Inc. holds trademark  numbers  2,034,684 and 1,930,685 on the name "Computer Age
Dentist", and the product name "O.M.S. Plus" issued February 4, 1997 and October
31, 1995, respectively.

     Licenses.  MEDY entered into an exclusive  revocable license agreement with
Dr. Edwin Adair  effective June 3, 1987, as amended,  relating to use of certain
technology invented and developed by Dr. Adair.  Before an amendment  negotiated
in September  1997, MEDY was obligated to pay Dr. Adair a minimum annual royalty
of $120,000. Additionally, Dr. Adair was obligated to give MEDY a right of first
refusal for his inventions.  Actual  royalties never exceeded the minimum annual
royalty. As a result of negotiations between the disinterested directors and Dr.
Adair,  the parties  agreed to amend the license  agreement to waive the minimum
annual  royalty due September  30, 1997 for the year then ended,  and any future
minimum annual royalty, and to waive Dr. Adair's obligation to provide MEDY with
a right of first refusal on future technology.

     Compliance  With  Environmental  Laws.  MEDY is not materially  affected by
federal,  state  and  local  provisions  which  have  been  enacted  or  adopted
regulating the discharge of materials into the environment or otherwise relating
to the protection of the environment.

                                      -11-


<PAGE>




     Employees.  At October 31,  1997,  MEDY (not  including  CADI)  employed 15
persons,  including 3 persons engaged in general administration,  and 12 persons
engaged in production, distribution, and customer service of MEDY's products. At
that date, CADI employed approximately 40 people in sales, customer service, and
administrative functions. In addition CADI had nine value-added resellers.

Item 2. Description of Property.
--------------------------------

     MEDY  leases  18,358  square  feet of space  at 99  Inverness  Drive  East,
Englewood,  Colorado,  where its principal executive offices are located and its
business activities, including research, assembly, storage and customer service,
are conducted. MEDY has used the bulk of these facilities since 1981. This lease
has been renewed through  December 31, 1998 at a rental (during 1998) of $13,845
per month. MEDY also pays certain maintenance,  insurance, common area and other
expenses with respect to the property to the extent that the lessor's  costs for
such items exceed a specified amount.  MEDY pays any increases in property taxes
due to improvements on the property and pays for utilities.

     Computer Age  Dentist,  Inc leases 5,002 square feet of office space in Los
Angeles, California at 11300 W. Olympic Boulevard, Suite 600. The lease runs for
five years from  November,  1997 to October,  2002 at a rate of $9,004 per month
which includes operating costs and property taxes.

Item 3. Legal Proceedings.
--------------------------

     There are no material  pending legal or regulatory  proceedings and MEDY is
not aware of any that are known to be contemplated.

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

     MEDY has not submitted any matter to a vote of security  holders during the
fourth quarter of the fiscal year ended September 30, 1997.


                                      -12-


<PAGE>



                                     PART II

Item 5. Market for Common Equity and Related Stockholder Matters.
-----------------------------------------------------------------

     (a) Market Information
     ----------------------

     MEDY's  common  stock is traded in the  over-the-counter  market  and price
quotations  for the two fiscal  years shown below were  reported on the National
Association of Securities  Dealers  Automated  Quotation  SmallCap Market System
under the symbol "MEDY".  The quotations  shown below were compiled by MEDY from
Monthly   Statistical  Reports  supplied  by  the  NASD.  All  quotes  represent
inter-dealer  quotations,  without retail markup, markdown or commission and may
not necessarily represent actual transactions in the common stock:


                                            High bid              Low bid
                                            --------              -------
                Fiscal Year ended
                September 30, 1996
                ------------------

                First quarter                 $1.38                $0.50
                Second quarter                 2.31                 1.03
                Third quarter                  4.06                 1.44
                Fourth quarter                 5.19                 2.13

                Fiscal Year ended
                September 30, 1997
                ------------------

                First quarter                 $4.63                $2.89
                Second quarter                 4.94                 2.19
                Third quarter                  3.19                 1.81
                Fourth quarter                 3.31                 2.28

     (b) Holders
     -----------

     The number of record  holders of the Common Stock as of September 30, 1997,
was approximately  12,844 not including an unknown number of beneficial  holders
in street name.

     (c) Dividends
     -------------

     (c)(1) Payment of Dividends.

     Because  of its need to retain  its cash for  operations  and the lack of a
positive  cash flow,  MEDY has never paid a dividend  with respect to its common
stock and does not intend to pay such a dividend in the foreseeable future.

                                      -13-


<PAGE>




     (c)(2) Restrictions on the payment of dividends.

     There are no contractual  restrictions  on the Company's  present or future
ability to pay dividends.

Item 6. Management's  Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations.
--------------



     Liquidity  and  Capital  Resources.  (September  30,  1997 as  compared  to
September 30, 1996)
During the fiscal year ended September 30, 1997, the Registrant's  current ratio
declined to 4.6 as compared to 4.7 at September  30, 1996.  Net working  capital
increased approximately $195,100.

     Principal  changes in the components of net working  capital for the fiscal
year ended September 30, 1997 consist of:

                                                                         W/C
                                            1997          1996         Effect
                                         ----------    ----------    ----------

Cash and Cash Equivalents                $  886,400    $  993,200   ($  106,800)
Trade Receivable                            127,500       181,600       (54,100)
Inventories                                 683,400       264,400       419,000
Pre-paid Expenses                            15,700        19,400        (3,700)
                                         ----------    ----------    ----------
         Current Assets:                  1,713,000     1,458,600       254,400

Accounts Payable                            297,600       217,900        79,700
Accrued Expenses                             61,100        77,500       (16,400)
Warranty Reserves                            11,000        15,000        (4,000)
                                         ----------    ----------    ----------
         Current Liabilities:               369,700       310,410        59,300

Working Capital:                         $1,343,300    $1,148,200    $  195,100
                                         ==========    ==========    ==========

During the fiscal  year ended  September  30,  1997 the  registrant  experienced
negative  cash flow from  operations  of $1,110,700 as compared to negative cash
flow from  operations  of  $779,200  during the  comparable  period of the prior
fiscal year. The aggregate increase in cash used in operating  activities during
fiscal 1997 was a result of the following factors:

Inventory  levels,  net of provisions for  obsolescence,  increased by $108,700.
Accounts  payable and accrued  expenses  increased during fiscal 1997 by $63,300
over fiscal 1996 balances.  Aggregate trade accounts  receivable cash collection
reduced  outstanding  balances  due by  $18,400  during  fiscal  1997  versus  a
reduction of $170,000 during fiscal 1996.

                                      -14-


<PAGE>

Certain  consulting  services  received by the  Registrant in prior periods were
paid for through the issuance of common stock options in lieu of cash.  Although
the services required no cash outlay, the options granted, issued at an exercise
price higher than market,  still  required the  recognition of expense under the
applicable  accounting rules. FAS 123 "Accounting for Stock-Based  Compensation"
requires that the fair value of stock  options  issued to  non-employees  of the
Company  be  computed  under an  option  pricing  model and be  recorded  in the
Registrant's  accounts.  A total of $76,100 of non-cash  consulting  expense has
been recognized to comply with this accounting  rule. The Registrant has elected
to continue to use APB 25 for the  computation of employee stock option expense.
Total non-cash  compensation  expense  recognized for employee stock options was
$33,300 during fiscal 1997. See note 5 to the Consolidated  Financial Statements
for additional information.

To curtail  operating losses and negative cash flow from operations,  management
is continually  reviewing all expense  categories to determine if any additional
reductions in expenditures are possible.

During fiscal 1997 the Registrant  maintained workforce levels approximately the
same as the levels of fiscal year 1996. In addition,  the Registrant was able to
renegotiate the license  agreement to eliminate any minimum  royalty  obligation
due to the Chairman of the Board beginning in fiscal 1997.

Without significant sales increases,  The Registrant  anticipates  negative cash
flow from  operations  for  fiscal  1998 and  beyond.  The  Registrant's  future
viability   depends  on  it's  ability  to  generate  cash  through   profitable
operations.  During  fiscal 1997,  cash flow  deficits  were funded by employee,
officer,  and consultant stock option exercises  (raising  $1,059,500 during the
fiscal year).  However, the Registrant's ability to fund it's operations will be
dependent upon achieving profitability and in generating positive cash flow from
operations. Unless the Registrant is able to increase sales revenue and maintain
profitability,   the  Registrant  may  be  facing  significant  working  capital
shortages  beginning in fiscal 1999. The Registrant  believes that it's existing
capital  resources are  sufficient for the 1998 fiscal year, due to the issuance
of a $1.1 million  convertible  debenture  which  raised a net of  approximately
$986,000 in cash on October 31, 1997. The  Registrant is not seeking  additional
debt or equity  capital at this time,  but may do so during the course of fiscal
1998. The issuance of this debenture will enable the Registrant to allocate more
capital resources to sales and marketing efforts,  research and development,  as
well as additional acquisitions in the dental products and software market.

     Results of  Operations.  (Fiscal 1997 as compared to Fiscal 1996) As an aid
to understanding  Registrants  operating results,  the following table indicates
the percentage relationships of principal revenue and expense items to total net
sales included in the consolidated  statements of operations for the years ended
September 30, 1997, and 1996 and the  percentage  changes in those items for the
same years.


                                      -15-


<PAGE>
<TABLE>
<CAPTION>

    As a percent of total
    revenue for the years                                                 Percentage
     ended September 30,                                                  change from
      1997        1996                  Revenue/Expense Items         FYE 1996 to FYE 1997
      ----        ----                  ---------------------        ---------------------


    <S>         <C>                     <C>                             <C>  
     100.0%      100.0%                 Net sales                           47.2%
      66.2%       55.6%                 Cost of goods sold                  75.4%
      33.8%       44.5%                 Gross profit                        11.9%
       8.3%       15.4%                 Other operating revenue             21.1%
     113.5%      173.6%                 Selling general and                 (3.8%)
                                          administrative
      11.1%       78.6%                 Fair value of common               (79.2%)
                                          stock options
      20.4%       31.0%                 Research and Dev.                   (3.2%)

      17.6%       31.0%                 Depreciation                       (16.5%)
      35.3%       13.1%                 Obsolete Inventory                 297.3%
       7.2%        0.0%                 Loss on Loaner                     100.0%
    (163.1%)    (267.6%)                Operating loss                     (10.3%)
       5.6%        6.7%                 Other income/(expense)              21.8%
    (157.5%)    (260.8%)                Net income (loss)                  (11.1%)

</TABLE>


     Additionally,  as an aid to  understanding  trends of the  Registrant,  the
following  ratios  describe  historical  summaries  of  liquidity,  activity and
profitability for the years ended September 30, 1997 and 1996.

                                                        1997             1996
                                                        ----             ----

         Liquidity
         ---------
         Current ratio                                   4.6              4.7
         Current ratio less inventory                    2.8              3.9

         Activity
         --------
         Trade receivables turnover                      7.7              3.7
         Inventory turnover                              1.4              .09

         Profitability
         -------------
         Return on assets                              (80.8%)         (77.9%)
         Return on equity                             (100.0%)         (86.8%)
         Return on sales                              (157.5%)        (260.8%)


                                      -16-

<PAGE>



     Revenue.  Revenues  increased $315,000 or 47.2% over fiscal 1996. The sales
results by product category can be summarized as follows:

                                   1997              1996           Var.
                                   ----              ----           ----

Catheters & Accessories           $1,300            $8,300         ($7,000)
Cam Wrap & Lap Wrap              191,400           223,400         (32,000)
General Accessories               83,600           253,700         (170,000)
Medical Cameras                   20,200           159,900        (139,700)
Electronics                        1,500            24,800         (23,300)
AV Needle                            600            33,000         (32,400)
Dental Camera & Accessories      684,900            11,500          673,400
Returns & Allowances               (700)          (46,800)           46,100
                                   -----          --------           ------
         Total Sales:           $982,800          $667,800         $315,000
                                ========          ========         ========



     The sales decrease in all categories,  except cameras, was due primarily to
a lack of market acceptance for the Registrant's medical products, a decrease in
capital  budget  expenditures  in  hospitals  coupled with less  influence  over
purchasing decisions by physicians, reduced marketing efforts by the Registrant,
and increased  competition  from other  manufacturers of surgical  cameras.  The
decrease  in  product  sales in the above  categories  was  offset by the market
introduction  of the dental camera and dental camera  accessories in late fiscal
1996.

Foreign  market sales for fiscal 1996 were $235,400 or 35% of net sales.  Export
sales for the year ended September 30, 1997 were $80,700 or 8.2%. The Registrant
has  experienced a slowdown in the foreign  marketplace  due to the same factors
listed above for domestic sales.  The Registrant  remains  optimistic  regarding
expansion  of the foreign  distribution  network in fiscal  1998,  although  the
emphasis in  expanding  that  network  will be to increase  revenue  from dental
cameras and accessory sales.

     Cost of Goods Sold.  Cost of goods sold for the fiscal years ended 1997 and
1996 were  $650,700  and $371,000  respectively,  for an increase of $279,700 or
75.4%.  Cost of goods sold as a percent of revenue increased to 66.2% for fiscal
1997 from 55.6% in fiscal  1996.  The overall  increase in cost of goods sold is
due  primarily to the  increase of sales volume by $315,000 or 47.2%,  while the
increase in cost of sales as a  percentage  of revenue is due to the increase in
sales  of lower  margin  dental  cameras  and  dental  camera  accessories  as a
percentage of product sales.

     Selling,  General & Administrative Expenses (S,G&A). S,G&A expenses for the
fiscal years 1997 and 1996 were $1,115,600 and $1,159,600,  respectively,  for a
decrease of $44,000 or 3.8%.  The  decrease is  primarily  due to the  continued
effectiveness  during  fiscal  1997  of  cost  cutting  measures  instituted  by
management,   highlighted  by  increased  sales  and  production  volumes.   The
Registrant continues to adhere to a cost containment strategy designed to reduce
or eliminate expenses in all areas when practical.

                                      -17-



<PAGE>

     Stock Based  Compensation.  Stock-based  compensation  for the fiscal years
1997 and was 1996,  $109,400  and  $525,000,  respectively,  for a  decrease  of
$415,600  or 79.2%.  The  decrease is due to a large  decrease in stock  options
granted in fiscal 1997 with most of the 1997  expense  related to the vesting of
options granted in the previous fiscal year.

     Research & Development  Research and development costs for the fiscal years
1997 and 1996 were $200,300 and $206,900, respectively, for a decrease of $6,600
or 3.2%.  The  Registrant's  R & D efforts  continue  to focus on the  intraoral
dental camera and it's improvements.  The Registrant will, however,  continue to
fund R & D as it deems  appropriate  to  maintain or gain a  competitive  market
advantage.

     Depreciation & Amortization  Depreciation  and  amortization  costs for the
fiscal  years 1997 and 1996 were  $173,300  and  $207,600,  respectively,  for a
decrease of $34,300 or 16.5%. Depreciation and amortization is a function of the
estimated useful lives ascribed to the underlying  assets and can be affected by
additions and retirements.  Please refer to the "Notes to Consolidated Financial
Statements"  for a more  detailed  description  of  the  underlying  assets  and
management's estimates of their useful lives.

     Provision  for Obsolete  and  Slow-moving  Inventories  The  provision  for
obsolete  inventory  was  increased  in fiscal  1997 by  $346,800.  Management's
decision to increase this reserve is predicated on the declining  level of sales
of  the  Company's  medical  video  cameras  and  related  products.  Management
continues to expect these inventories to liquidate. For a more detailed analysis
of inventories  please refer to Note 3 in the "Notes to  Consolidated  Financial
Statements".

     Loss on  Impairment  of  Demonstration  Equipment For the fiscal year ended
September 30, 1997,  Registrant's  management team estimated the carrying amount
on the books for field and  demonstration  equipment was overstated  compared to
fair market value by $70,600. This amount was recognized as a loss to adjust the
carrying  value to  estimated  market  value.  This  provision  was  computed in
accordance  with a new  accounting  standard  that was required to be adopted in
fiscal 1997.

     Gain on Sale of Demonstration Equipment For the fiscal year ended September
30,  1997  there  was no gain  or loss  realized  on the  sale of  demonstration
equipment as compared to a gain of $7,400 in fiscal year 1996.

     Interest Income & Expense For the fiscal years ended September 30, 1997 and
1996,  interest  income net of  interest  expense  categories  were  $54,800 and
$37,600,  respectively, for a net increase of $17,200 or 45.7%. This increase is
a function of cash flow and conservative  investment strategies.  The Registrant
invests  non-current  cash  requirements  in  either a U.S.  government  bond or
money-market fund.

                                      -18-

<PAGE>

Effect of Changing Prices and Inflation

     Generally,   inflation  has  not  been  a  significant   factor  on  MEDY's
operations.


Item 7. Financial Statements.
        ---------------------

     The following consolidated financial statements are filed as a part of this
Form 10-KSB and are included immediately following the signature page.

        Report of Independent Certified Public Accountants

        Consolidated Balance Sheet - September 30, 1997

        Consolidated Statements of Operations - Years ended September 30, 1997
        and 1996

        Consolidated Statements of Stockholders' Equity - Years ended
        September 30, 1997 and 1996

        Consolidated Statements of Cash Flows - Years ended September 30, 1997
        and 1996

        Notes to Consolidated Financial Statements

Item 8. Changes in and Disagreements With Accountants on Accounting and
        Financial Disclosure.
        ----------------------------------------------------------------

     On September 5, 1996 the board of directors of Medical Dynamics,  Inc. (the
"Registrant")  approved the  engagement  of Hein +  Associates,  LLP, of Denver,
Colorado,  to audit and report on MEDY's financial statements for the year ended
September 30, 1996.

     On such  date,  the board of  directors  also  approved  the  dismissal  of
McGladrey & Pullen, LLP, of Denver, Colorado as the Company's previous auditors.

     The  reports  of  McGladrey  &  Pullen,  LLP  on  the  Company's  financial
statements  as of September 30, 1995,  and for the year then ended  contained an
explanatory  paragraph as to the ability of MEDY to continue as a going concern.
Such  reports  for the last two years  contained  no other  adverse  opinion  or
disclaimer of an opinion.  None of such reports were qualified or modified as to
uncertainty, audit scope, or accounting principles.

     During MEDY's two most recent fiscal years and subsequent  interim  periods
through  the date of  dismissal  of  McGladrey  &  Pullen,  LLP,  there  were no
disagreements  with  McGladrey  &  Pullen,  LLP  on  any  matter  of  accounting
principles or practices,  financial statement  disclosure,  or auditing scope or


                                      -19-


<PAGE>



procedure, which disagreement,  if not resolved to the satisfaction of McGladrey
and Pullen, LLP, would have caused it to make reference to the subject matter of
the disagreement in connection with its report.

     MEDY has provided the former  accountant,  McGladrey & Pullen,  LLP, with a
copy of the foregoing disclosures. A letter, addressed to the Commission, by the
former accountants stating that it agrees with the above statements made by MEDY
is attached hereto as an exhibit.

     During the two most recent fiscal years and the  subsequent  interim period
preceding McGladrey & Pullen, LLP's dismissal, MEDY was not advised by McGladrey
& Pullen,  LLP that internal  controls  necessary  for MEDY to develop  reliable
financial statements do not exist nor that information has come to its attention
that led it to no longer be able to rely on management's representations or that
has made it unwilling to be associated with the financial statements prepared by
management.  MEDY has not been advised by McGladrey & Pullen, LLP of the need to
expand  significantly  the scope of MEDY's audit, nor has MEDY been advised that
during the two most  recent  fiscal  years and the  subsequent  interim  periods
preceding its  dismissal,  information  has come to the attention of McGladrey &
Pullen,  LLP that if  investigated  may (i)  materially  impact the  fairness or
reliability  of  either a  previously  issued  audit  report  or the  underlying
financial  statements,  or  the  financial  statements  issued  or to be  issued
covering the fiscal periods  subsequent to the date of the most recent financial
statements  covered  by an audit  report  (September  30,  1995),  or (ii) cause
McGladrey & Pullen, LLP to be unwilling to rely on management's  representations
or be associated with MEDY's financial statements.

     MEDY has not been advised by McGladrey & Pullen,  LLP that  information has
come to its attention that it has concluded  materially  impacts the fairness or
reliability  of either (i) a previously  issued  audit report or the  underlying
financial  statements  or (ii) the financial  statements  issued or to be issued
covering the fiscal periods subsequent to September 30, 1995.

     No consultations  occurred  between MEDY and Hein + Associates,  LLP during
the two most recent  fiscal  years and any  subsequent  periods  prior to Hein +
Associates,   LLP's   appointment,   regarding  the  application  of  accounting
principles,  the type of audit opinion, or other information  considered by MEDY
in reaching a decision as to any accounting,  auditing,  or financial  reporting
issue.


                                      -20-

<PAGE>

                                    PART III


Item 9. Directors, Executive Officers, Promoters and Control Persons of the
        Company; Compliance With Section 16(a) of the Exchange Act.
        --------------------------------------------------------------------

     (a) Identification of Directors and Executive Officers.
     -------------------------------------------------------

     The following table sets forth certain information  regarding the directors
and executive officers of MEDY:

Name                            Age        Position
----                            ---        --------

Edwin L. Adair, M.D. (1)        67         Chairman of the Board and Treasurer 
                                           of MEDY

Van A. Horsley (2)              45         Director, President, Chief Financial 
                                           Officer and Chief Executive Officer
                                           of MEDY; Director and Vice President
                                           of CADI

Daniel L. Richmond              36         Director of MEDY; Director and Chief
                                           Executive Officer of CADI

Chae U. Kim                     36         Director of MEDY; Director and 
                                           President of CADI

Pat Horsley Adair (1)           69         Director and Secretary of MEDY

I. Dean Bayne, M.D. (2)         70         Director and Assistant Secretary of
                                           MEDY

Leroy Bilanich (2)              47         Director of MEDY

Jo Brehm                        61         Vice President of MEDY


(1)  Members of the Compensation Committee.
(2)  Members of the Audit Committee

     No  arrangement  exists  between any of the above  officers  and  directors
pursuant  to which  any one of those  persons  was  elected  to such  office  or
position  except that Messrs.  Kim and Richmond were appointed to the MEDY Board
as a result of the acquisition of CADI.


                                      -21-



<PAGE>



     Directors  hold office until the next meeting of  shareholders  and until a
successor  is elected  and  qualified,  or until  their  resignation.  Executive
officers  are elected at annual  meetings of the Board of  Directors.  Each such
officer holds office for one year or until a successor has been duly elected and
qualified or until death,  resignation or removal. No director of the Company is
a director of another company having  securities  registered under Section 12 of
the Securities Exchange Act of 1934 or a company registered under the Investment
Company Act of 1940.

     Edwin L.  Adair,  M.D.  has been a director  of MEDY  since June 30,  1971,
Chairman  of the Board since  September  8, 1981 and  Treasurer  since March 27,
1973.  From February 6, 1986 until July 13, 1990, Dr. Adair also served as Chief
Executive  Officer of MEDY.  Dr. Adair  received B.S. and M.D.  degrees from the
University  of Colorado in 1951 and 1955,  respectively.  He practiced  medicine
from 1956 until 1983 and is a  board-certified  urologist who  discontinued  the
practice of medicine due to a physical  disability  resulting  from an accident.
Dr.  Adair has  published  articles  in medical  journals  and has taught at the
University of Colorado School of Medicine. Dr. Adair is a member of the American
Medical Association,  American Board of Urology, the American Urological Society
and the American College of Surgeons.  MEDY currently carries a $100,000 key man
life insurance  policy on Dr. Adair,  reduced from  $1,100,000 as a cost savings
measure during fiscal 1996.

     Van A. Horsley has been a director,  President and Chief Executive  Officer
of MEDY since July 13, 1990. From March 1, 1990 until July 13, 1990, Mr. Horsley
served as Chief  Financial  Officer.  Mr.  Horsley  holds a  B.S.B.A.  degree in
finance from the  University of Denver and a graduate  degree from the School of
Banking at the University of Colorado. From 1974 to February,  1990, Mr. Horsley
was employed in various capacities by Affiliated Denver National Bank in Denver,
Colorado and from 1985 through February, 1990 served as executive vice president
- head of lending.

     Pat Horsley Adair has been a director and Secretary of MEDY since September
8, 1981. Mrs. Adair attended McMurray College in Abilene,  Texas, taking courses
in English and business  which did not lead to a degree.  From June 1974 to July
1983, Mrs. Adair was employed by MEDY as office  manager.  Since that time, Mrs.
Adair has served as Corporate  Secretary to MEDY.  From 1964 to 1975, Mrs. Adair
served as executive  director of the Arapahoe  County  Medical  Society and from
1976 to 1980 she served as executive director of the Metro Denver Foundation for
Medical Care, an organization which serves Arapahoe,  Denver, Boulder, Jefferson
and Adams counties, Colorado.

     I.  Dean  Bayne,  M.D.  has been a  director  of MEDY  since  July 1987 and
Assistant Secretary since October 1988. Dr. Bayne received B.S. and M.D. degrees
from Louisiana  State  University in 1949 and 1953,  respectively,  and has been
engaged in private  medical  practice  since 1958.  Dr.  Bayne was a resident in
obstetrics  at Herman  Kiefer  Hospital,  Detroit,  Michigan,  and a resident in
gynecology at Detroit Receiving Hospital,  Detroit,  Michigan. He is a member of
the Board of Obstetrics and  Gynecology  and the American  College of Obstetrics
and Gynecology.

                                      -22-


<PAGE>

     Leroy Bilanich, Ed.D. has been a director of MEDY since September 13, 1990.
Dr. Bilanich has a B.S. in journalism and broadcasting from  Pennsylvania  State
University,  an M.A. in communication from the University of Colorado and has an
Ed.D. in organizational behavior from Harvard University. Dr. Bilanich currently
works as a  consultant  to  large  corporations  in the  area of  organizational
development  and in the past has held various  positions  in the Human  Resource
Departments at Pfizer, Inc. from 1983 to March of 1988 and the Olin Corporation.

     Daniel L.  Richmond has been a director of MEDY since October 1997. In June
1984,  Mr.  Richmond  graduated  from UCLA with a B.S.  degree in  Math/Computer
Science.  From 1983  through  1985,  Mr.  Richmond  founded  and then  served as
President of Compulink,  a software company that sells to retail jewelry stores.
From 1986  until  1987,  Mr.  Richmond,  along  with Mr.  Chae Kim headed up the
technical  team  for  Emory  &  Associates,   a  software   development  company
specializing  in  custom  accounting   packages  for  large   manufacturers  and
distributors.  In June 1987 Mr. Richmond co-founded CADI. He has served as Chief
Executive Officer of CADI from June 1987 until present.

     Chae U. Kim has been a director of MEDY since  October  1997. In June 1985,
Mr. Kim Graduated from UCLA with a B.A. degree in Biology. From 1986 until 1987,
Mr.  Kim,  along  with Dan  Richmond  headed up the  technical  team for Emory &
Associates,  a software  development  company  specializing in custom accounting
packages  for  large  manufacturers  and  distributors.  In June  1987  Mr.  Kim
co-founded  CADI.  He has  served as  President  of CADI  from  June 1987  until
present.

     Jo Brehm is Vice President - Sales and Administration of MEDY. She has been
an employee of MEDY since 1973. From December 1984 to September 1988, Mrs. Brehm
served as Vice  President of MEDY.  From  September  1988 until July 1990,  Mrs.
Brehm served as President of MEDY.

     (b) Identification of Certain Significant Employees.
     ----------------------------------------------------

     There are no significant  employees who are not also directors or executive
officers, described above.

     (c) Family relationships.
     -------------------------

     Dr. Edwin L. Adair and Pat Horsley Adair are married. Van A. Horsley is the
son of Pat Horsley  Adair.  There are no other  family  relationships  among the
officers or directors.


                                      -23-


<PAGE>



     (d) Involvement in Certain Legal Proceedings.
     ---------------------------------------------

     During the past five years, no director or officer of the Company has:

          (1) Filed or has had filed against him a petition under the
federal bankruptcy laws or any state insolvency law, nor has a receiver,  fiscal
agent or similar  officer been appointed by a court for the business or property
of such person,  or any  partnership in which he was a general  partner,  or any
corporation or business  association of which he was an executive  officer at or
within two years before such filings;

          (2) Been convicted in a criminal proceeding or is a named subject of a
pending  criminal  proceeding  (excluding  traffic  violations  and other  minor
offenses);

          (3)  Been  the  subject  of  any  order,   judgment,  or  decree,  not
subsequently  reversed,   suspended  or  vacated,  of  any  court  of  competent
jurisdiction,   permanently  or  temporarily  enjoining  such  person  from,  or
otherwise  limiting  his  involvement  in any type of  business,  securities  or
banking activities.

          (4) Been found by a court of competent jurisdiction in a civil action,
the  Securities  and  Exchange  Commission  or  the  Commodity  Futures  Trading
Commission to have violated any federal or state  securities or commodities law,
which judgment has not been reversed, suspended, or vacated.

Compliance with Section 16(a) of the Exchange Act

     Section 16(a) of the Securities  Exchange Act of 1934 (the "Exchange  Act")
requires the Company's  directors and officers and persons who own more than ten
percent of the  Company's  equity  securities,  to file reports of ownership and
changes in ownership with the Securities  and Exchange  Commission  (the "SEC").
Directors,  officers and greater than ten- percent  shareholders are required by
SEC  regulation  to furnish the Company with copies of all Section 16(a) reports
filed.

     Based  solely on its review of the copies of the reports it  received  from
persons  required  to file,  the  Company  believes  that during the period from
October 1, 1996 through December 1, 1997 all filing  requirements  applicable to
its officers,  directors and greater than ten-percent shareholders were complied
with.


                                      -24-


<PAGE>

Item 10.  Executive Compensation.
          ------------------------

(a)  Summary Compensation Table

     The following table sets forth information  regarding  compensation paid to
the chief  executive  officer of MEDY for the three  years ended  September  30,
1997.  No other  person who is  currently  an  executive  officer of MEDY earned
salary and bonus compensation exceeding $100,000 during any of those years.

<TABLE>
<CAPTION>


                               Annual Compensation ($$)      Long Term Compensation
                               ------------------------      ----------------------
                                                               Awards        Payouts
                                                               ------        -------
       (a)             (b)   (c)        (d)        (e)     (f)      (g)        (h)         (i)
                                   Restricted
     Name and                                             Stock   Options    LTIP         Other
     Position         Year  Salary     Bonus      Other   Awards  & SARs     Payouts   Compensation
     --------         ----  ------     -----      -----   ------  ------     -------   ------------
                             ($$)       ($$)      ($$)     ($$)     (##)       ($$)       ($$)

<S>                   <C>   <C>          <C>       <C>     <C>       <C>        <C>       <C>
Van A. Horsley        1997  110,000     -0-       -0-     -0-       -0-        -0-        272
President and         1996  105,000     -0-       925     -0-      87,174      -0-        260
Chief Executive       1995  105,000     -0-       925     -0-      40,900      -0-        559
Officer
</TABLE>


     401(k)  Plan.  On January 1, 1990,  MEDY  adopted an employee  benefit plan
under Internal Revenue Code Section 401(k).  The 401(k) plan is a profit sharing
plan under which both employees and MEDY are entitled (at their own  discretion)
to  contribute  a  portion  of  compensation  and  earnings,   respectively,  to
investment funds to supplement  employee retirement  benefits.  At September 30,
1997, MEDY's matching  contributions to the plan for the accounts of Van Horsley
and Jo Brehm totaled  approximately $400 and the matching contribution under the
plan for the accounts of all executive  officers as a group totaled $400.  These
amounts are included in column (i) of the Summary Compensation Table.

     Employment  Agreements.  On October 1, 1997 the Registrant,  in conjunction
with its purchase of Computer Age Dentist, Inc. (CADI),  entered into employment
agreements  with Dan Richmond  (CEO) and Chae Kim  (President).  The term of the
agreements are five years and call for annual compensation of $105,000 each, car
allowances of $500 per month and other  benefits  customarily  extended to other
CADI employees.  In both cases, the employment agreements define their duties to
include a continuation  of their present  positions with CADI, and for a default
under the  employment  agreements if the employee is not re-elected to the Board
of Directors of MEDY or if the Board of Directors of MEDY is expanded  otherwise
than as the result of an increase approved by a vote of a majority of the Board.


                                      -25-


<PAGE>



     (b) Stock Option Plans.

     Options and Option Plans.  Until April 10, 1988 MEDY had two plans pursuant
to which stock options  could be granted to its  directors  and officers.  These
plans were the 1981 NonQualified  Consultants' Plan and the 1981 Incentive Stock
Option  Plan  (the  "Old  Plans").  On April 10,  1988,  the Board of  Directors
canceled  the  Old  Plans  to the  extent  that  shares  reserved  for  issuance
thereunder were not then under option, and adopted and authorized the 1988 Stock
Option Plan (the "1988 Plan") and directed that management prepare the documents
formally  defining the plan. At that time the Board also authorized the issuance
of certain  options under the 1988 Plan.  The Board  formally  approved the 1988
Plan on July 14, 1988 and the  shareholders  approved the 1988 Plan on September
28, 1988.

     Allocations  of options  under  MEDY's  stock  option plans are made by the
Compensation  Committee  based on the  duties,  contributions  and  value of the
services  of the  respective  optionee.  The  Committee  has  the  authority  to
determine  to whom options were  granted,  the number of shares  covered by each
option, when each option was to be granted, date of initial ability to exercise,
exercise  price and certain other terms and to prescribe,  interpret,  amend and
rescind rules and regulations relating to each plan. Any options canceled or not
exercised  within the option period  became  available for grants of new options
under the plans. The Board also has the power to select committees consisting of
not less than two members to  administer  each plan.  The 1988 Plan contains the
same provisions for administration as were contained in the Old Plans.

     Under the 1988 Plan, MEDY reserved an aggregate of 1,000,000  shares of its
common stock for issuance to employees  (including  officers),  consultants  and
directors  of MEDY or any  subsidiary.  The plan  contains  restrictions  on the
number of options  granted to officers and directors,  exercise  price,  maximum
term and transferability.  On May 14, 1991, MEDY filed a registration  statement
under the  Securities  Act of 1933 on Form S-8 which  registered  the  shares of
common stock  underlying  options  granted under the 1988 Plan. As such,  shares
issued  upon  exercise of  outstanding  options can be traded on the open market
with limited restriction.

     All of the  options  granted  under  the Old Plans and the 1988 Plan may be
exercised  through  payment of the exercise  price with shares of MEDY's  Common
Stock or cash, or both.  The ability to exercise  options  through  surrendering
shares of Common Stock enables  holders of options to exercise the entire amount
of an  option  by first  exercising  a small  number  of  options,  followed  by
successively  larger  option  exercises  which the optionee is able to effect by
surrendering the increasing number of shares obtained thereby.  For little or no
initial cash payment, repeated exercises of options by surrendering stock having
a market  price in excess of the option  exercise  price,  enable an optionee to
provide  sufficient  consideration  to MEDY to exercise his entire stock option.
The exercise of options might otherwise require  substantial cash consideration.
This procedure is often referred to as pyramiding.


                                      -26-


<PAGE>



     The following table sets forth certain information  regarding stock options
granted by MEDY to the Chief Executive  Officer and no other executive  officers
received  total annual  salary and bonus in excess of $100,000  during 1997.  No
stock appreciation rights were granted.

Option Grants in Fiscal 1997
----------------------------

<TABLE>
<CAPTION>


(a)                                  (b)                    (c)                     (d)                (e)
                                                        % of Total
                                                      Options Granted           Exercise or
                                   Options          to Empl. / Cons. in         Base Price          Expiration
Name                             Granted (#)            Fiscal Year               ($/sh)              Date
----                             -----------            -----------               ------              ----

<S>                               <C>    
Van A. Horsley                     None
</TABLE>

Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End
Option Values.
--------------------------------------------------------------------

     The  following  table  sets  forth  information   regarding  stock  options
exercised by the chief executive officer and certain other officers or directors
during the 1997 fiscal year as well as the year-end  value of options being held
by such persons on September  30, 1997: No Stock  Appreciation  Rights have been
granted, or are held by, any such person:

<TABLE>
<CAPTION>


(a)                            (b)               (c)                   (d)                      (e)
                                                                   Number of                 Value of
                                                                   Unexercised             In-the-Money
                              Shares                                Options at               Options at
                             Acquired                                 FY End                   FY End
                                on               Value             (Exercisable/            (Exercisable/
Name                         Exercise          Realized           Unexercisable)           Unexercisable)
----                         --------          --------           --------------           --------------

<S>                             <C>              <C>              <C>                   <C>            
Van A. Horsley                  3,958            $3,216           220,680 / 0           $279,602 /      0
Edwin L. Adair                 65,000           $16,855           295,000 / 0           $241,872 /      0
I. Dean Bayne                     -0-                $0            20,000 / 0           $      0 /      0
Leroy Bilanich                    -0-                $0            20,000 / 0           $ 30,132 /      0
Jo Brehm                       50,000          $132,438                 0 / 0           $      0 /      0
</TABLE>

     (c) Long Term Incentive Compensation Plans
     ------------------------------------------
      
     MEDY has no long term incentive compensation plans.

     (d) Other Compensation
     ----------------------

     There are no plans to pay bonuses or deferred  compensation to employees of
the Company.

     The Company has adopted a medical and life insurance plan for its employees
at the Company's cost and provides a discretionary disability,  dental and other
insurance plans for the benefit of its employees at their expense.

                                      -27-


<PAGE>


     (e) Compensation of Directors
     -----------------------------

     General.   MEDY's  directors  are  authorized  to  receive  $200  for  each
directors'  meeting  attended by them. To date,  the directors have waived their
right to receive  directors  fees. In September  1990,  certain  directors  were
granted  options  under the 1988 Stock Option Plan.  Dr. Bayne owns an incentive
stock  option to  acquire  20,000  shares of  common  stock at $4.00 per  share,
expiring June 11, 2003. Leroy Bilanich owns an incentive stock option to acquire
20,000 shares of common stock at $1.50 per share, expiring June 11, 2003.

     No options were granted during fiscal 1997 to board members.

     Royalty  Agreements.  Dr. Adair and Dr. Bayne,  directors of MEDY, are each
entitled to receive  royalties equal to two percent of the net sales of products
each  assigned to the  Company.  No  royalties  have been accrued or paid to Dr.
Bayne,  however,  $600,000 has been paid to Dr. Adair  through the end of fiscal
1995. No cash amounts have been paid to Dr. Adair subsequently.  In an effort to
help reduce  negative cash flow during fiscal 1996, Dr. Adair  accepted  120,000
common  stock  options  priced at $1.00 per share in  substitution  for his cash
royalty  payment for the 1996 fiscal  year.  During 1997 Dr. Adair and MEDY made
certain  changes to the license  agreement  which included an elimination of the
minimum  annual  royalty,  effective  for the 1997  fiscal  year.  See Item 13 -
"Certain   Relationships  and  Related  Transactions"  for  further  information
regarding the royalty agreement.

     Indemnification   Agreements.   MEDY  has  entered   into   indemnification
agreements with each of its directors and officers providing for indemnification
of each such  director  by MEDY to the full  extent  permitted  by the  Colorado
Corporation  Code. The agreements  provide that in all  circumstances in which a
director or officer may receive indemnification by statute, such indemnity shall
be provided.

     Officer's Life  Insurance.  MEDY currently  maintains a $100,000 whole life
key-man insurance policy on its Chairman which was acquired in 1985.

     MEDY has no  other  arrangements  pursuant  to  which  it  compensates  its
directors for acting in their capacities as such.

     (g) MEDY has no employment  contracts with any executive  officer except as
described  above  with  Messrs.  Kim  and  Richmond.  MEDY  has no  compensatory
arrangement which may result from a change-of-control of MEDY or a change in any
executive officers responsibilities.

     (h) No options were repriced during the fiscal year.


                                      -28-


<PAGE>

Item 11. Security Ownership of Certain Beneficial Owners and Management.
         ---------------------------------------------------------------

     (a) and (b) Security ownership of certain beneficial owners and management.
     ---------------------------------------------------------------------------

     At  September  30,  1997,  MEDY had only one  class of  outstanding  voting
securities,  its common stock. The following table sets forth  information as of
October 31, 1997 with respect to the ownership of the Company's Common Stock for
all  directors,  individually,  all officers and  directors as a group,  and all
beneficial  owners of more than five percent of the Common Stock.  The following
shareholders  have sole voting and investment  power with respect to the shares,
unless it has been indicated otherwise.


                                          Shares owned              * Percent
Name of beneficial owner                beneficially (1)            of class
------------------------                ----------------            --------

Edwin L. Adair, M.D.                        1,174,298 (2)            12.7%
and Pat Horsley Adair
317 Paragon Way
Castle Pines Village
Colorado   80104

Daniel L. Richmond                            647,760 (5)              7.0%
6500 Baird Av
Reseda, CA.  91335

Chae U. Kim                                   647,760 (5)              7.0%
3231 Chevio Vista Place
Los Angeles, CA.  90034

I. Dean Bayne, M.D.                            20,000                 0.2%

Van A. Horsley                                305,586 (3)             3.3%

Leroy Bilanich, Ed.D.                          20,000                 0.2%

All officers and                            2,825,404 (4)            30.5%
directors as a
group (8 persons)

* Percent of class based upon post acquisition shares of 9,255,736.

(1)  As used in this section,  the term  beneficial  ownership with respect to a
     security is defined by Rule 13d-3 under the Securities Exchange Act of 1934
     as consisting of sole or shared voting power  (including  the power to vote
     or direct the vote) and/or sole or shared  investment  power (including the
     

                                      -29-


<PAGE>



     power to dispose or direct the  disposition)  with  respect to the security
     through  any  contract,   arrangement,   understanding,   relationship   or
     otherwise.  Unless otherwise  indicated,  beneficial ownership is of record
     and consists of sole voting and investment power.

(2)  Includes  175,000  stock  options  issued to the  Chairman of which all are
     presently exercisable. Also includes 120,000 options issued to Dr. Adair in
     December,  1995 in  consideration  for  cancellation of fiscal 1996 royalty
     payments due him totaling $120,000, also presently exercisable.

(3)  Includes 220,680 shares under presently exercisable stock options. Does not
     include  options to acquire  150,000  shares  exercisable at prices ranging
     from $2.75 to $3.75 per share  which vest  based upon  defined  performance
     goals.

(4)  Includes shares  referenced in notes (2) through (5) and 10,000  additional
     shares and  options  held by one  officer (Jo Brehm) who is not a director,
     all of which are presently exercisable. Does not include options to acquire
     60,000 shares  exercisable  at prices ranging from $2.75 to $3.75 per share
     which vest based upon defined performance goals.

(5)  Does not include  options to acquire  600,000  shares  exercisable at $3.25
     which vest upon defined performance goals.

     (c) Changes in Control.
     -----------------------

     The  Company  knows of no  arrangement,  the  operation  of which may, at a
subsequent date, result in change in control of the Company.

Item 12. Certain Relationships and Related Transactions.
         -----------------------------------------------

     (a) and (b) Transactions With Management and Others.
     ----------------------------------------------------

     MEDY has  engaged  in  certain  transactions  with  members of its Board of
Directors.  In each case, the Board believed that the  transaction was in MEDY's
best  interests  and the  terms  of the  transaction  were at  least  as fair to
Registrant  as could have been  obtained  from an  independent  person,  and the
transaction  was  approved  by  the  disinterested  directors.  Registrant  will
continue to follow this procedure in approving any transactions  with affiliated
persons. No such transactions are contemplated at this time.

     License Agreement with Dr. Adair. MEDY entered into an exclusive  revocable
license  agreement  with Dr.  Edwin Adair  effective  June 3, 1987,  as amended,
relating to use of certain  technology  invented  and  developed  by Dr.  Adair.
Before an amendment  negotiated in September 1997, MEDY was obligated to pay Dr.
Adair a  minimum  annual  royalty  of  $120,000.  Additionally,  Dr.  Adair  was
obligated  to give  MEDY a right of first  refusal  for his  inventions.  Actual


                                      -30-


<PAGE>

royalties never exceeded the minimum annual royalty. As a result of negotiations
between the  disinterested  directors and Dr. Adair, the parties agreed to amend
the license agreement to waive the minimum annual royalty due September 30, 1997
for the year then ended and any future minimum annual royalty,  and to waive Dr.
Adair's  obligation  to  provide  MEDY with a right of first  refusal  on future
technology.

     Distribution  Agreement.  MEDY entered into a  distribution  agreement with
Micro- Medical Devices,  Inc. ("MMD"),  a corporation  wholly-owned by Dr. Adair
during  June of fiscal  year  1995.  The  distribution  agreement  includes  all
products  developed  by Dr. Adair  related to his  Universal  Sterile  Endoscopy
System(TM) ("USES").

     MMD has appointed MEDY as its exclusive worldwide  distributor for the USES
products  through June 30, 2000.  MMD also granted MEDY a right of first refusal
to  distribute  any  further  products  MMD may  develop.  There are no  minimum
performance  requirements under the distribution  agreement,  and MEDY need only
purchase products it has already sold to third parties.

     MMD also agreed to sublease space from MEDY for administration  purposes at
cost. The rental payment and reimbursement to MEDY for employees MMD may utilize
are intended to compensate MEDY for all associated expenses, including rent on a
per-  square-foot  basis.  During the fiscal year ended September 30, 1997, MEDY
purchased  $12,760 in products from MMD, and MMD has not needed any  significant
leased space.

Other Related Party Transactions.
---------------------------------

     MEDY  employs  two sons of Dr.  Adair and one son of Pat  Horsley  Adair at
annual salary rates of approximately $45,600,  $45,600, and $115,000. During the
most recently completed fiscal year those persons received no other compensation
from MEDY in addition to their salaries.

     Except as otherwise stated above,  since October 1, 1995, MEDY has not been
a party to any transaction involving in excess of $60,000, in which any director
or executive  officer,  nominee for election as a director,  security  holder of
record  or  beneficially  of more  than  five  percent  of any  class of  MEDY's
securities,  or any member of the immediate  family of the foregoing had or will
have a direct or indirect material interest.

     MEDY is not aware of any other  relationship  between nominees for election
as directors or its  directors  and MEDY that are similar in nature and scope to
those relationships listed in this Item 12.

     (c) Parents of the Company
     --------------------------

     Not applicable, inasmuch as there are no "Parents" of MEDY.


                                      -31-


<PAGE>



     (d) Transactions with Promoters
     -------------------------------

     Not applicable,  inasmuch as the Company was organized more than five years
ago.


Item 13. Exhibits and Reports on Form 8-K.
         ---------------------------------

     (a) Exhibits
     ------------

     The following is a complete  list of exhibits  filed as part of this Annual
Report on Form 10-KSB, which Exhibits are incorporated herein.

Exhibit
 Number                    Description
 ------                    -----------

 3.1(k)                    Restated Articles of Incorporation
                           (December 30, 1988)

3.2(n)                     Bylaws, as amended

10.1(m)                    Amendment Number Five to Lease
                           Agreement - Englewood Office Space

10.2(a)                    Stock Option Plan - Consultant's

10.3(j)                    1988 Stock Option Plan

10.4(d)                    Sales Representative Agreement
                           - Form

10.5(e)                    International Distributor Agreement

10.6(f)                    Indemnification Agreement - Edwin L.
                           Adair, M.D.

10.7(f)                    Indemnification Agreement - Pat
                           Horsley Adair

10.8(h)                    Indemnification Agreement - I. Dean
                           Bayne

10.9(b)                    Indemnification Agreement - Van A.
                           Horsley


                                      -32-


<PAGE>

10.10(b)                   Indemnification Agreement - Leroy A.
                           Bilanich

10.11(a)                   Employee Confidentiality Agreement -
                           Form

10.12(b)                   Section 125 Cafeteria Plan

10.13(h)                   Patent Assignment - Bayne Pap Brush

10.14(o)                   Amended and restated License Agreement with
                           Edwin L. Adair

10.15(n)                   401(k) Plan

10.16(p)                   Agreement and Plan of Merger by and between Medical
                           Dynamics, Inc., CADI Acquisition Corp., and Computer
                           Age Dentist, Inc., dated as of October 1, 1997

10.17(p)                   Form of Registration Rights Agreement between Medical
                           Dynamics, Inc., Daniel L. Richmond, Chae U. Kim and
                           James DeVico, Jr.

10.18(p)                   Purchase Agreement between Medical Dynamics, Inc. and
                           The Tail Wind Fund, Ltd.

10.19(p)                   Form of Convertible Debenture

10.20(p)                   Registration Rights Agreement between Medical
                           Dynamics, Inc. and The Tail Wind Fund, Ltd.

10.21(p)                   Common Stock Purchase Warrant issued to The Tail Wind
                           Fund Ltd.

21.1                       Subsidiaries of MEDY:
                           MedPacific Corporation, a Washington corporation
                           Computer Age Dentist, Inc., a California corporation

23.1*                      Consent of Hein + Associates, LLP

* Filed herewith.

(a)                        Incorporated by reference from Registration Statement
                           on Form S-1, SEC File No. 2-82856.


                                      -33-

<PAGE>

(b)                        Incorporated  by reference  from MEDY's Form 10-K for
                           the period ended September 30, 1991.

(d)                        Incorporated  by reference  from MEDY's Form 10-K for
                           the year ended September 30, 1984.

(e)                        Incorporated   by  reference  from  MEDY's  Form  8-K
                           reporting an event of February 8, 1985.

(f)                        Incorporated  by reference  from MEDY's Form 10-K for
                           the year ended September 30, 1986.

(h)                        Incorporated  by reference  from MEDY's Form 10-K for
                           the fiscal year ended September 30, 1987.

(j)                        Incorporated   by  reference  from  MEDY's  Form  8-K
                           reporting an event of October 12, 1988.

(k)                        Incorporated  by reference  from MEDY's Form 10-Q for
                           the quarter ended December 31, 1988.

(m)                        Incorporated by reference from Amendment No. 1 to
                           Registration Statement on Form S-1, Commission File
                           No. 33-29497, filed with the Commission on July 26,
                           1989.

(n)                        Incorporated  by reference  from MEDY's Form 10-K for
                           the fiscal year ended September 30, 1990.

(o)                        Incorporated by reference from MEDY's Form 10-QSB for
                           the quarter ended June 30, 1995.

(p)                        Incorporated   by  reference  from  MEDY's  Form  8-K
                           reporting an event of October 23, 1997



                                      -34-


<PAGE>




(b) Reports on Form 8-K
-----------------------

     During  the fourth  quarter  of fiscal  1997 up to  December  1, 1997,  the
Company filed the following reports on Form 8-K:

     October  23,  1997,  reporting  an  event  under  Item 2 -  Acquisition  or
Disposition  of Assets  and Item 5 -- Other  Events,  and an  amendment  thereto
including the financial information and pro forma financial information required
by Item 7.

                                   SIGNATURES
                                   ----------

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

                                              MEDICAL DYNAMICS, INC.


                                              By:/s/ Van A. Horsley
                                                 -------------------------------
                                                 Van A. Horsley,
                                                 President

December 12, 1997


                                      -35-


<PAGE>



     In accordance with the requirements of the Securities Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
Company and in the capacities and on the dates indicated.



December 12, 1997                   /s/ Van A. Horsley
                                    ------------------
                                    Van A. Horsley, Principal Executive
                                    Officer, Principal Financial Officer, and
                                     Director

December 12, 1997                   /s/ Edwin L. Adair
                                    ------------------
                                    Edwin L. Adair, M.D., Chairman
                                    of the Board and Director

December 12, 1997                   /s/ Daniel L. Richmond
                                    ----------------------
                                    Daniel L. Richmond, Director


December 12, 1997                   /s/ Chae U. Kim
                                    ---------------
                                    Chae U. Kim, Director


December 12, 1997                   /s/ I. Dean Bayne
                                    -----------------
                                    I. Dean Bayne, M.D., Director

December 12, 1997                   /s/ Pat Horsley Adair
                                    ---------------------
                                    Pat Horsley Adair, Director


December 12, 1997                   /s/ Leroy Bilanich
                                    Leroy Bilanich, Director


                                      -36-
<PAGE>



                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



                                                                          PAGE
                                                                          ----

Independent Auditor's Report..............................................F-2

Consolidated Balance Sheet - September 30, 1997...........................F-3

Consolidated Statements of Operations - For the Years Ended
         September 30, 1997 and 1996......................................F-4

Consolidated Statements of Stockholders' Equity - For the Years Ended
         September 30, 1997 and 1996......................................F-5

Consolidated Statements of Cash Flows - For the Years Ended
         September 30, 1997 and 1996......................................F-6

Notes to Consolidated Financial Statements................................F-7




                                       F-1

<PAGE>

                          INDEPENDENT AUDITOR'S REPORT



Board of Directors
Medical Dynamics, Inc.
Englewood, Colorado

We have audited the accompanying consolidated balance sheet of Medical Dynamics,
Inc. and  subsidiary  (the  "Company") as of September 30, 1997, and the related
consolidated statements of operations,  stockholders' equity, and cash flows for
the years ended September 30, 1997 and 1996. These financial  statements are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
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 financial  position of Medical Dynamics,
Inc.  and  subsidiary  as of  September  30,  1997,  and the  results  of  their
operations and their cash flows for the years ended September 30, 1997 and 1996,
in conformity with generally accepted accounting principles.

As  discussed  in Note 1, the  Company  changed  its  method of  accounting  for
long-lived assets during 1997.




HEIN + ASSOCIATES LLP

Denver, Colorado
November 20, 1997



                                       F-2

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEET
                               SEPTEMBER 30, 1997



                                     ASSETS
                                     ------

CURRENT ASSETS:
    Cash and equivalents                                        $    836,400
    Restricted cash                                                   50,000
    Trade receivables, less allowance for
     doubtful accounts of $5,000                                     127,500
    Inventories                                                      683,400
    Prepaid expenses and other                                        15,700
                                                                ------------
             Total current assets                                  1,713,000
                                                                ------------
PROPERTY AND EQUIPMENT:
    Demonstration equipment                                          296,700
    Machinery and equipment                                          334,300
    Furniture and fixtures                                           221,300
    Leasehold improvements                                            54,500
                                                                ------------
                                                                     906,800
    Less accumulated depreciation and amortization                  (830,600)
                                                                ------------
         Property and equipment, net                                  76,200
                                                                ------------

OTHER ASSETS:
    Inventories                                                       32,000
    Patents, patents pending, and trademarks, net
         of accumulated
         amortization of $740,900                                     49,700
    Deposits and other                                                46,000
                                                                ------------
             Total other assets                                      127,700
                                                                ------------

TOTAL ASSETS                                                    $  1,916,900
                                                                ============


                      LIABILITIES AND STOCKHOLDERS' EQUITY
                      ------------------------------------

CURRENT LIABILITIES:
    Accounts payable                                           $    297,600
    Accrued expenses                                                 61,100
    Warranty reserve                                                 11,000
                                                               ------------
             Total current liabilities                              369,700
                                                               ------------

COMMITMENTS AND CONTINGENCIES (Notes 4, 7, and 11)

STOCKHOLDERS' EQUITY:
    Preferred stock, $.001 par value;  authorized
         5,000,000 shares; none issued
    Common stock, $.001 par value; authorized
         15,000,000 shares, issued and
         outstanding 7,627,300 shares                                7,600
    Additional paid-in capital                                  18,811,100
    Accumulated deficit                                        (17,271,500)
                                                              ------------
             Total stockholders' equity                          1,547,200
                                                              ------------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                    $  1,916,900
                                                              ============











       See accompanying notes to these consolidated financial statements.

                                       F-3

<PAGE>
<TABLE>
<CAPTION>

                            MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                            CONSOLIDATED STATEMENTS OF OPERATIONS


                                                                          FOR THE YEARS ENDED
                                                                             SEPTEMBER 30,
                                                                  ------------------------------------
                                                                      1997                    1996
                                                                  -----------              -----------

<S>                                                               <C>                      <C>        
NET SALES                                                         $   982,800              $   667,800

COST OF GOODS SOLD                                                    650,700                  371,000
                                                                  -----------              -----------

GROSS PROFIT                                                          332,100                  296,800
                                                                  -----------              -----------

OTHER OPERATING REVENUE                                                81,100                  102,800
                                                                  -----------              -----------

OPERATING EXPENSES:
    Selling, general and administrative                             1,115,600                1,159,600
    Stock-based compensation                                          109,400                  525,000
    Research and development                                          200,300                  206,900
    Depreciation and amortization                                     173,300                  207,600
    Provision for obsolete and slow-moving inventories                346,800                   87,300
    Loss on impairment of demonstration equipment                      70,600                     --
                                                                  -----------              -----------
         Total operating expenses                                   2,016,000                2,186,400
                                                                  -----------              -----------

OPERATING LOSS                                                     (1,602,800)              (1,786,800)
                                                                  -----------              -----------

OTHER INCOME (EXPENSE):
    Gain on sale of demonstration equipment                              --                      7,400
    Interest income                                                    55,000                   39,000
    Interest expense                                                     (200)                  (1,400)
                                                                  -----------              -----------

NET LOSS                                                          $(1,548,000)             $(1,741,800)
                                                                  ===========              ===========

NET LOSS PER COMMON SHARE                                         $      (.21)             $      (.25)
                                                                  ===========              ===========

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING                       7,523,200                6,898,300
                                                                  ===========              ===========



                           See accompanying notes to these consolidated financial statements.

                                                           F-4

</TABLE>


<PAGE>
<TABLE>
<CAPTION>
                                                           

                                             MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                                        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                        FOR THE YEARS ENDED SEPTEMBER 30, 1997 AND 1996

                                                                                
                                          COMMON STOCK          Additional                        Treasury Stock
                                      ---------------------      Paid-in        Accumulated    --------------------
                                        Shares       Amount      Capital          Deficit       Shares      Amount         Total
                                      ---------    ---------   ------------    ------------    --------   ---------     ------------

<S>                                   <C>          <C>         <C>             <C>              <C>       <C>          <C>         
BALANCE, October 1, 1995              6,895,400    $   6,900   $ 16,585,500    $(13,981,700)    15,900    $ (79,300)   $  2,531,400

    Exercise of options                   
           common stock to purchase     284,800          300        611,400            --         --           --           611,700
    Issuance of common stock
           options for:
             Royalty obligation            --           --          120,000            --         --           --           120,000
             Employee compensation         --           --          271,400            --         --           --           271,400
             Marketing arrangements        --           --           78,500            --         --           --            78,500
             Other services                --           --           55,100            --         --           --            55,100
    Net loss                               --           --             --        (1,741,800)      --           --        (1,741,800)
                                     ----------    ---------   ------------    ------------   --------    ---------    ------------

BALANCE, September 30, 1996           7,180,200        7,200     17,721,900     (15,723,500)    15,900      (79,300)      1,926,300

    Exercise of options to purchase                                                                                       
           common stock                 463,000          400      1,059,100            --         --           --         1,059,500
    Retirement of treasury stock        (15,900)        --          (79,300)           --      (15,900)      79,300            --
    Issuance of common stock                                                                                               
           options for services            --           --          109,400            --         --           --           109,400
    Net loss                               --           --             --        (1,548,000)      --           --        (1,548,000)
                                     ----------    ---------   ------------    ------------   --------    ---------    ------------


BALANCE, September 30, 1997           7,627,300    $   7,600   $ 18,811,100    $(17,271,500)      --      $    --      $  1,547,200
                                     ==========    =========   ============    ============   ========    =========    ============






                              See accompanying notes to these consolidated financial statements.

                                                              F-5
</TABLE>

<PAGE>
<TABLE>
<CAPTION>


                            MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                            CONSOLIDATED STATEMENTS OF CASH FLOWS


                                                                      FOR THE YEARS ENDED
                                                                         SEPTEMBER 30,
                                                                  --------------------------
                                                                      1997           1996
                                                                  -----------    -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                               <C>            <C>         
    Net loss                                                      $(1,548,000)   $(1,741,800)
    Adjustments to reconcile net loss to net cash used in
        operating activities:
            Common stock options granted for:
                  Royalty obligation                                     --          120,000
                  Compensation and other services                     109,400        405,000
            Depreciation                                              113,800        130,400
            Amortization                                               59,500         77,200
            Bad debt expense                                           35,700           --
            Loss on impairment of demonstration equipment              70,600           --
            Provision for obsolete and slow-moving inventories        346,800         87,300
            Decrease in warranty reserve                               (4,000)       (10,000)
            Gain on sale of demonstration equipment                      --           (7,400)
            Changes in operating assets and liabilities:
                  Decrease (increase) in:
                     Trade receivables                                 18,400        170,000
                     Inventories                                     (369,900)        (1,700)
                     Prepaid expenses                                  (6,300)        25,700
                  Increase (decrease) in:
                      Accounts payable                                 79,700         29,500
                      Accrued expenses                                (16,400)        26,600
                      Accrued royalties                                  --          (90,000)
                                                                  -----------    -----------
            Net cash used in operating activities                  (1,110,700)      (779,200)
                                                                  -----------    -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
    Increase in restricted cash                                       (40,000)       (10,000)
    Proceeds from sale of demonstration equipment                        --            7,400
    Collections on note receivable - related party                       --          110,000
    Additions to patents                                              (12,500)       (18,400)
    Purchase of property and equipment                                (22,000)       (14,500)
    Deposits and other                                                (31,100)        14,500
                                                                  -----------    -----------
            Net cash provided by (used in) investing activities      (105,600)        89,000
                                                                  -----------    -----------

CASH FLOWS FROM FINANCING ACTIVITIES -
    Proceeds from exercise of options to purchase common stock      1,059,500        611,700
                                                                  -----------    -----------

NET DECREASE IN CASH AND EQUIVALENTS                                 (156,800)       (78,500)

CASH AND EQUIVALENTS, beginning of year                               993,200      1,071,700
                                                                  -----------    -----------

CASH AND EQUIVALENTS, end of year                                 $   836,400    $   993,200
                                                                  ===========    ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION -
    Cash paid for interest                                        $       200    $     1,400
                                                                  ===========    ===========

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
  FINANCING ACTIVITIES:
    Demonstration equipment transfers from inventories            $       --     $   148,500
                                                                  ===========    ===========

    Retirement of treasury stock                                  $    79,300    $      --
                                                                  ===========    ===========

    Retirement of fully depreciated demonstration equipment       $   557,000    $      --
                                                                  ===========    ===========



               See accompanying notes to these consolidated financial statements.

                                          F-6
</TABLE>

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1. SIGNIFICANT ACCOUNTING POLICIES:
   --------------------------------

     Nature of Business  Operations - Medical Dynamics,  Inc. (the "Company") is
     engaged in the design,  development,  manufacture  and marketing of medical
     and dental video cameras and surgical  disposable products for a variety of
     medical  specialties.  These  products  are sold  directly  to health  care
     professionals, hospitals, wholesalers, and original equipment manufacturers
     throughout the United States and foreign  markets.  The Company markets its
     products   primarily   through  a  group  of  sales   representatives   and
     distributors.

     Principles of Consolidation - The consolidated financial statements include
     the  accounts of the Company and its  wholly-owned  subsidiary,  MedPacific
     Corporation.  All significant  intercompany  accounts and transactions have
     been eliminated.  MedPacific  Corporation is an inactive  corporation,  and
     there was no activity during the years ended September 30, 1997 and 1996.

     Use of Estimates - The preparation of the Company's  consolidated financial
     statements in conformity  with  generally  accepted  accounting  principles
     requires  management  to make  estimates  and  assumptions  that affect the
     amounts reported in the financial  statements and  accompanying  notes. The
     actual results could differ from those estimates.

     The Company's  consolidated  financial  statements are based on a number of
     estimates, including the allowance for doubtful accounts, the provision for
     obsolete and  slow-moving  inventories,  the selection of estimated  useful
     lives of property and  equipment,  realization  of long-lived  assets,  and
     assumptions   affecting  the   valuation  of  stock   options   granted  to
     non-employees.  It is  reasonably  possible  that  estimates  affecting the
     provision  for obsolete and  slow-moving  inventories  and  realization  of
     long-lived  assets will change in the  forthcoming  year and such revisions
     could be material.

     Cash Equivalents - The Company considers all highly liquid debt instruments
     purchased  with an  original  maturity  of three  months or less to be cash
     equivalents.  At September 30, 1997, cash equivalents include a mutual fund
     that invests in money market instruments.

     Inventories  -  Inventories  are  stated  at the  lower of cost  (first-in,
     first-out method) or market.

     Property  and  Equipment  -  Property  and  equipment  is  stated  at cost.
     Depreciation is computed  principally by the straight-line  method over the
     following estimated useful lives:


                                                              Years
                                                              -----

                  Demonstration equipment                       3
                  Machinery and equipment                    3 - 10
                  Furniture and fixtures                     3 - 10


     Leasehold  improvements  are  amortized  over the lesser of the life of the
     lease or the estimated useful life of the improvement.

                                       F-7

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     Patents and  Trademarks - Patents and trademarks are stated at cost and are
     amortized over their estimated economic lives of three to ten years. In the
     event  patents  pending are not granted,  the related  costs are charged to
     operations.

     Impairment  of  Long-Lived  Assets -  Management  of the  Company  assesses
     impairment  whenever events or changes in  circumstances  indicate that the
     carrying amount of a long-lived  asset may not be  recoverable.  If the net
     carrying  value  exceeds  the  net  cash  flows,  then  impairment  will be
     recognized to reduce the carrying value to the estimated fair value. During
     the year ended  September  30,  1997,  management  determined  that certain
     demonstration  equipment was impaired, and recorded a loss on impairment of
     $70,600.

     Warranty  Reserve - The  Company  provides  a warranty  against  defects in
     materials and workmanship, generally for a period between one month and one
     year following the date of sale of the equipment. Estimated future costs of
     product warranties are included in current  liabilities in the accompanying
     balance sheet.

     Research and  Development - Research and  development  costs are charged to
     operations in the period incurred.

     Net Loss Per Share - Net loss per common  share is  calculated  by dividing
     the net loss by the  weighted  average  number of  shares  of common  stock
     outstanding   during  each  fiscal  year.  Common  stock  equivalents  were
     anti-dilutive  for  fiscal  1997  and  1996  and  were  excluded  from  the
     computation.

     Income Taxes - The Company  accounts  for income taxes under the  liability
     method,  which requires  recognition of deferred tax assets and liabilities
     for the expected future tax  consequences of events that have been included
     in the financial statements or tax returns. Under this method, deferred tax
     assets and liabilities are determined  based on the difference  between the
     financial  statement and tax bases of assets and liabilities  using enacted
     tax rates.

     Revenue  Recognition - The Company recognizes sales when finished goods are
     shipped to a customer.

     Stock-Based   Compensation   -  The  Company   accounts   for   stock-based
     compensation  for employees using the intrinsic value method  prescribed in
     Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
     Employees," and related interpretations. Accordingly, compensation cost for
     stock  options  granted to employees is measured as the excess,  if any, of
     the quoted  market price of the Company's  common stock at the  measurement
     date (generally, the date of grant) over the amount an employee must pay to
     acquire the stock.

     In October 1995,  the  Financial  Accounting  Standards  Board issued a new
     statement titled  "Accounting for Stock-Based  Compensation" (FAS 123). The
     new statement is effective for fiscal years  beginning  after  December 15,
     1995.  FAS 123  encourages,  but does not  require,  companies to recognize
     compensation  expense for grants of stock, stock options,  and other equity
     instruments to employees  based on fair value.  Companies that do not adopt
     the fair value  accounting  rules must  disclose the impact of adopting the
     new method in the notes to the financial statements. Transactions in equity

                                       F-8

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     instruments with  non-employees for goods or services must be accounted for
     by the fair value  method.  The  Company  has elected not to adopt the fair
     value accounting prescribed by FAS 123 for employees, but is subject to the
     related disclosure requirements.

     Impact of Recently  Issued  Accounting  Standards - Statement  of Financial
     Accounting  Standards  128  (FAS  128)  "Earnings  per  Share"  provides  a
     different  method of calculating  earnings per share than is currently used
     in accordance  with  Accounting  Principles  Board Opinion 15 "Earnings per
     Share." FAS 128  provides  for the  calculation  of "basic"  and  "diluted"
     earnings per share.  Basic  earnings per share  includes no dilution and is
     computed  by  dividing  income  available  to  common  shareholders  by the
     weighted  average  number  of common  shares  outstanding  for the  period.
     Diluted  earnings per share  reflects the potential  dilution of securities
     that could  share in the  earnings of an entity,  similar to fully  diluted
     earnings per share.  Statement of Financial  Accounting  Standards 129 (FAS
     129)  "Disclosure  of  Information  About an  Entity's  Capital  Structure"
     establishes standards for disclosing  information about an entity's capital
     structure.  FAS 128 and 129 are effective for financial  statements  issued
     for periods ending after  December 15, 1997.  Their  implementation  is not
     expected  to  have  a  material  effect  on  the   consolidated   financial
     statements.

     Statement  of  Financial  Accounting  Standards  130 (FAS  130)  "Reporting
     Comprehensive  Income"  establishes  standards for reporting and display of
     comprehensive    income,   its   components   and   accumulated   balances.
     Comprehensive  income is defined to include  all  changes in equity  except
     those  resulting from  investments by owners and  distributions  to owners.
     Among other disclosures,  FAS 130 requires that all items that are required
     to be  recognized  under  current  accounting  standards as  components  of
     comprehensive  income be reported in a financial  statement  that  displays
     with the  same  prominence  as other  financial  statements.  Statement  of
     Financial Accounting Standards 131 (FAS 131) "Disclosures About Segments of
     an Enterprise  and Related  Information"  establishes  standards on the way
     that public companies report financial information about operating segments
     in  annual  financial   statements  and  requires   reporting  of  selected
     information about operating segments in interim financial statements issued
     to the public.  It also  establishes  standards for  disclosures  regarding
     products and  services,  geographic  areas,  and major  customers.  FAS 131
     defines operating  segments as components of a company about which separate
     financial information is available that is evaluated regularly by the chief
     operating  decision  maker in  deciding  how to allocate  resources  and in
     assessing  performance.  FAS  130  and  131  are  effective  for  financial
     statements  for  periods  beginning  after  December  15,  1997 and require
     comparative  information  for earlier years to be restated.  Because of the
     recent  issuance of these  standards,  management  has been unable to fully
     evaluate the impact, if any, the standards may have on the future financial
     statement  disclosures.  Results  of  operations  and  financial  position,
     however, will be unaffected by implementation of these standards.

     Reclassifications  - Certain amounts in the 1996 financial  statements have
     been   reclassified   to  conform   with  the  1997   presentation.   These
     reclassifications had no effect on the 1996 net loss.



                                       F-9

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



2. LIQUIDITY:
   ----------

     The  Company  has  incurred  continued  substantial  operating  losses  and
     negative cash flows from operations. The Company's future viability depends
     on its ability to increase sales and become profitable.

     During 1996, the Company  developed  intraoral  dental cameras for use as a
     diagnostic tool for the dental profession.  During fiscal 1997, the Company
     realized  $684,000 in sales of dental products and management is optimistic
     about the prospects for additional  growth.  Additionally,  as discussed in
     Note 11, in October 1997, the Company obtained additional debt financing of
     $1.1 million and completed the acquisition of a dental practice  management
     software  company.  Management  believes the Company has  adequate  capital
     resources to carry out planned  activities  during the  forthcoming  fiscal
     year.


3. INVENTORIES:
   ------------

     Inventories consist of the following at September 30, 1997:


         Raw materials and replacement parts                        $ 723,900
         Finished goods                                               422,300
         Work in process                                              126,000
                                                                    ---------
             Total inventory                                        1,272,200
         Less provision for obsolete and slow-moving inventory       (556,800)
                                                                    ---------
             Net inventories, including $32,000 classified as       $ 715,400
                  long-term assets                                  =========
                   

     During  the year  ended  September  30,  1997,  management  of the  Company
     increased  the  provision  for  obsolete  and  slow-moving  inventories  by
     $346,800.  Substantially,  all of this provision related to medical cameras
     and related  products.  Due to the declining  level of  production  for the
     Company's  medical  video  cameras,  the  Company  incurred  under  applied
     overhead costs of  approximately  $290,800 and $281,300 for the years ended
     September  30, 1997 and 1996,  respectively.  These amounts are included in
     selling,  general and administrative expense in the accompanying statements
     of operations.

4. RELATED PARTY TRANSACTIONS AND COMMITMENTS:
   -------------------------------------------

     License Agreement - The Company has various  agreements to pay royalties to
     both a former officer and current directors of the Company. These royalties
     are based on the sales of specified  products,  some of which are no longer
     manufactured  by the  Company.  In June 1987,  the Company  entered  into a
     license  agreement  with its then CEO and  Chairman  relating to the use of
     certain  technology  invented and developed by the Chairman.  In connection
     with the  agreement,  the  Company  agreed  to pay  royalties  based on the
     

                                      F-10

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     greater  of 2% of sales of  products  which  relate to this  technology  or
     minimum  annual  royalties of $120,000.  On December 1, 1995,  the Chairman
     agreed to waive all payments due him under the above license  agreement for
     the year  ended  September  30,  1996,  in  exchange  for stock  options to
     purchase  120,000  shares of common  stock at $1.00 per share.  The Company
     recorded  $120,000  of  royalty  expense  in  1996  as  a  result  of  this
     transaction.

     During 1997,  the license  agreement  was amended to eliminate  the minimum
     annual royalty and to provide for future royalties generally equal to 2% of
     sales of the  products  that relate to the  technology.  For the year ended
     September 30, 1997, the Company did not incur any royalty  expense  related
     to this agreement.  The license agreement may be terminated by the Chairman
     in certain circumstances and the rights to the patents may revert to him if
     commercial  development  of the  related  products  does not  occur  within
     prescribed deadlines.

     Distribution  Agreement - In a related  transaction,  during the year ended
     September  30,  1995,  the Company  transferred  to an entity  owned by the
     Chairman  the  rights to  patents  with a net book  value of  approximately
     $21,000.  The patents had originally  been obtained from the Chairman under
     the license  agreement  described above,  and were transferred  because the
     Company was unable to obtain FDA approval  for products  using the patents.
     The related  entity has since obtained FDA approval and has entered into an
     exclusive  agreement  to  have  the  Company  distribute  all  products  it
     manufactures.  The agreement  expires in June 2000.  The Company  purchased
     approximately $32,000 of products under the agreement through September 30,
     1997.


5. STOCK OPTIONS:
   --------------

     Stock  Option  Plan - The  Company  has a stock  option  plan  under  which
     incentive  and  non-qualified  stock  options  may be granted to  officers,
     directors, employees, and consultants. Incentive stock options are required
     to have an exercise  price which is not less than the fair market  value of
     the stock at the date of grant.  The Company's Board of Directors  approved
     the plan on July 14,  1988 and a  majority  of the  Company's  stockholders
     approved  the plan in  October  1988.  The  maximum  term is ten  years for
     options  granted  under the plan.  An aggregate  of  1,000,000  shares were
     

                                      F-11

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     reserved  for issuance  pursuant to the terms of the plan.  Activity in the
     stock  option  plan for the years ended  September  30, 1997 and 1996 is as
     follows:

                                                                    Weighted
                                                                    Average
                                                     Number of   Exercise Price
                                                      Shares        Per Share
                                                     ---------      ---------

            Outstanding, October 1, 1995               133,100        $2.69
                Granted                                 94,300         1.49
                Exercised                              (30,000)        1.73
                Expired                                (94,300)        2.52
                                                     ---------
            Outstanding, September 30, 1996            103,100         2.02
                Granted                                 29,500         2.43
                Exercised                              (70,900)        2.36
                                                     ---------

            Outstanding, September 30, 1997             61,700         1.83
                                                     =========


     For options granted during the years ended September 30, 1997 and 1996, the
     weighted  average  market price per share of the Company's  common stock on
     the grant date was  approximately  $2.43 and $2.38,  respectively.  Options
     available for future grant at September 30, 1997 totaled 100,000 shares.

     All options outstanding under the plan are vested at September 30, 1997. If
     not previously  exercised,  options outstanding at September 30, 1997, will
     expire as follows:


                                                 Number of          Exercise
          Year Ending September 30:               Shares              Price
          -------------------------               ------              -----

                  2001                             37,200             $1.38
                  2002                             24,500              2.52
                                                   ------
                                                   61,700
                                                   ======



                                      F-12

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     Non-Qualified  Stock  Options - The Company has also granted  non-qualified
     stock  options to officers,  directors,  employees,  and  consultants.  The
     following  is a summary of activity  during the years ended  September  30,
     1997 and 1996.

                                                                    Weighted
                                                                     Average
                                                     Number of   Exercise Price
                                                      Shares        Per Share
                                                      ------        ---------

     Outstanding, October 1, 1995                     998,100        $2.68
         Granted to:
             Employees and officer                     84,300         1.45
             Director for royalty obligation             
               (Note 4)                               120,000         1.00
             Consultants                               98,800         2.56
         Performance options granted to:
             Employees                                200,000         2.88
             Officers and directors                   260,000         2.88
             Marketing consultants                    735,000         3.03
         Options expired due to:
             Repricing                                (77,100)        4.20
             End of term                              (94,300)        2.52
         Options exercised by:
             Directors                               (167,600)        2.39
             Employees and consultants                (37,200)        1.57
             Marketing consultants                    (50,000)        2.00
                                                    ---------

     Outstanding, September 30, 1996                2,070,000         2.73
         Granted to employees                          76,400         3.52
         Expired                                     (157,100)        3.50
         Exercised                                   (395,400)        2.29
                                                   ----------

     Outstanding, September 30, 1997                1,593,900         2.80
                                                   ==========



                                      F-13

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     At September 30, 1997, a total of 754,000  non-qualified  stock options are
     vested. If not previously exercised, these options expire as follows:


                                                                      Weighted
                                                                      Average
                                                Number of             Exercise
       Year Ending September 30:                  Shares               Price
       -------------------------                  ------               -----

                        1999                       50,000              $1.13
                        2000                      120,000               1.00
                        2000                       55,800               1.50
                        2001                      115,000               2.00
                        2001                      530,000               2.88
                        2001                      265,000               3.75
                        2002                       44,200               3.68
                        2003                       70,000               1.50
                        2003                      148,900               2.75
                        2003                      195,000               4.00
                                                ---------

                                                1,593,900
                                                =========


     At  September  30,  1997,   unvested  employee   performance  options  were
     outstanding  for 385,000  shares,  and unvested  non-employee  options were
     outstanding  for 425,000  shares.  If not previously  vested and exercised,
     these  options all expire during the year ending  September  30, 2001.  The
     following is a summary of key vesting  provisions  and exercise  prices for
     performance options granted to employees:


                                                    Number of       Exercise
          Performance Condition                      Shares          Price
    --------------------------------                 ------          -----

 Cumulative  revenue  for the  Company  from the 
 sale of dental products exceeds:
     $1,000,000                                      75,000          $2.75
     $4,000,000                                      75,000           3.00
     $9,000,000                                      75,000           3.75

 Annual revenue for the Company exceeds:
     $2,000,000                                      40,000           2.00
     $3,000,000                                      40,000           2.75
     $4,000,000                                      40,000           3.00
     $9,000,000                                      40,000           3.75
                                                    -------

                                                    385,000
                                                    =======



                                      F-14

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     During  the  year  ended   September  30,  1997,  the  Company   recognized
     compensation  expense of $28,900 related to employee  performance  options.
     The  ultimate  amount  of  compensation  expense  related  to the  employee
     performance  options  will be  determined  based on the market value of the
     Company's common stock on the date that the options vest.

     The  following  is a summary  of key  vesting  provisions  for  performance
     options granted to non-employees:


                                                     Number of      Exercise
                                                      Shares         Price
                                                      -------        -----
    Cumulative sales of dental products exceeds:
        $      1,000,000                               75,000        $2.75
        $      4,000,000                               75,000         3.00
        $      9,000,000                               75,000         3.75

    Cumulative  sales of dental  products to
      specific OEM customer exceeds:
        $        650,000                               50,000         3.00
        $      4,000,000                               75,000         3.25
        $      9,000,000                               75,000         3.50
                                                      -------

                                                      425,000
                                                      =======


     During the year ended  September  30, 1997,  the Company  recognized  stock
     compensation  expense  of  $61,000  related  to  non-employee   performance
     options. Assuming that all of the options eventually vest, the Company will
     recognize  an  additional  $272,000  of  expense  over the  period in which
     vesting occurs.

     The common stock  option  granted to the  director in  satisfaction  of the
     royalty  obligation in 1996 was valued based upon the $120,000  contractual
     payment in the license agreement.

     The fair value of all other options  granted to  non-employees  in 1997 and
     1996  was   estimated  on  the  date  of  grant  using  the   Black-Scholes
     option-pricing model with the following weighted average assumptions:


                                                Years Ended September 30,
                                                -------------------------
                                                  1997             1996
                                                  ----             ----

         Expected volatility                       87%              90%
         Risk-free interest rate                  6.2%             6.7%
         Expected dividends                         0%               0%
         Expected terms (in years)                3.0              2.7


     For the year ended  September 30, 1997,  options  granted to  non-employees
     resulted  in the  recognition  of  approximately  $20,000  of  compensation
     expense.

                                      F-15

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     For  non-qualified  stock options  granted to  consultants  during the year
     ended September 30, 1996, the weighted  average fair value of the Company's
     common stock on the grant date was $1.63 for 610,000  shares of performance
     options,  $3.38 for 125,000  shares of performance  options,  and $2.01 for
     98,800 shares of vested options. For non-qualified stock options granted to
     employees  in 1997  and  1996,  the  weighted  average  fair  value  of the
     Company's  common  stock on the grant date was  approximately  equal to the
     exercise price.

     In addition to the performance  options  granted to marketing  consultants,
     the Company has entered into an agreement  with a consultant  that provides
     for  payment of  commissions  for the sale of each dental  camera  which is
     attributable  to  the  consultant,   provided  that  certain  gross  margin
     requirements are met. The consulting agreement expires in October 1999.

     Pro Forma  Stock-Based  Compensation  Disclosures - The Company applies APB
     Opinion 25 and related  interpretations  in  accounting  for stock  options
     which are  granted  to  employees.  Accordingly,  no  compensation  cost is
     recognized  for grants of options to employees if the exercise  prices were
     not  less  than  the  market  value of the  Company's  common  stock on the
     measurement  dates. Had compensation cost been determined based on the fair
     value at the measurement  dates  consistent with the method of FAS 123, the
     Company's  net loss and loss per share  would have been  changed to the pro
     forma amounts indicated below.


                                            Years Ended September 30,
                                        ---------------------------------
                                             1997              1996
                                         -----------       -----------

  Net loss
       As reported                       $(1,548,000)      $(1,741,800)
       Pro forma                          (1,749,900)       (1,774,500)
  Net loss per common share:
       As reported                            $ (.21)           $ (.25)

       Pro forma                                (.23)             (.26)


     The  fair  value  of each  employee  option  granted  in 1997  and 1996 was
     estimated on the date of grant using the Black-Scholes option-pricing model
     with the following weighted average assumptions:


                                                   Years Ended September 30,
                                                   -------------------------
                                                     1997             1996
                                                     ----             ----

     Expected volatility                              87%              90%
     Risk-free interest rate                         6.1%             6.4%
     Expected dividends                                0%               0%
     Expected terms (in years)                       3.2              3.7



                                      F-16

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



6. INCOME TAXES:
   ------------

     The amounts  which give rise to the net deferred tax asset at September 30,
     1997, are as follows:


CURRENT ASSETS:
    Allowance for doubtful accounts                                 $     1,900
    Accrued expenses                                                     14,000
                                                                    -----------
           Total current assets                                          15,900
                                                                    -----------

LONG-TERM ASSETS:
    Property and equipment                                               29,700
    Patents, patents pending, and trademarks                             15,600
    Provision for obsolete and slow-moving inventories                  207,700
    Compensation expense related to stock options                       166,000
    Net operating loss carryforwards                                  6,714,000
    Research and development tax credit
      carryforwards                                                      28,000
                                                                    -----------
           Total long-term assets                                     7,161,000
                                                                    -----------

TOTAL DEFERRED TAX ASSETS                                             7,176,900

VALUATION ALLOWANCE                                                  (7,176,900)
                                                                    -----------

                                                                    $      --
                                                                    ===========


     Management has determined that a valuation  allowance equal to the deferred
     tax assets is required  since it is more likely than not that the  benefits
     of these assets will not be realized.  The valuation allowance increased by
     $625,000 and $850,000  during the years ended  September 30, 1997 and 1996,
     respectively,  due to the increase in the deferred tax asset balances which
     were completely offset by a valuation allowance at each of those dates.

     At September 30, 1997,  the Company has  approximately  $18,000,000  of net
     operating loss  carryforwards,  and  approximately  $28,000 of research and
     development  tax  credit  carryforwards,  both of which  expire in  varying
     amounts from 1998 through 2012.


7. COMMITMENTS AND CONTINGENCIES:
   -----------------------------

     Regulatory  Matters - The Company is regulated by the Federal Food and Drug
     Administration  (FDA). The Company cannot ensure that an adverse  financial
     impact will not occur should the FDA find the Company's Good  Manufacturing
     Practices are in non-compliance  with current Federal  regulations.  If the
     FDA finds that a manufacturer is not in compliance, the manufacturer may be
     prohibited   from  marketing  the  products  for  which  they  are  not  in
     compliance,   until  such  time  as  the  manufacturer  complies  with  the
     applicable  FDA  regulation.   The  Company  has  recently  had  difficulty
     

                                      F-17

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     obtaining  FDA  approval on new products  due to past  findings  during FDA
     inspections.  However,  the Company does not expect  problems in the future
     due to a change in FDA policy.

     Operating  Leases  -  The  Company  conducts  its  operations  from  leased
     facilities and leases certain equipment.  The terms of the facilities lease
     require the Company to pay all maintenance,  utilities,  property taxes and
     insurance. Rent expense has been recorded on a straight-line basis over the
     life of the lease.  Following is a schedule of future  minimum  commitments
     under operating leases having an initial or remaining term of more than one
     year.


         Years Ending September 30,
         --------------------------

                   1998                                 $171,100
                   1999                                   41,500
                                                        --------

                                                        $212,600
                                                        ========


     Total rent expense was $158,800 and $163,000 for the years ended  September
     30, 1997 and 1996, respectively.

     Letter-of-Credit  - At  September  30,  1997,  the  Company  had a  standby
     letter-of-credit  (LOC)  for  $50,000  which  was  required  by  one of its
     vendors.  The LOC can be accessed by the vendor if the Company does not pay
     amounts owed to the vendor on a timely basis. The LOC bears interest at the
     prime rate plus 2% and expires in June 1999. The LOC is collateralized by a
     certificate of deposit for $50,000, which is included in restricted cash in
     the accompanying  balance sheet. There was no balance outstanding under the
     LOC at September 30, 1997.


8. FOREIGN SALES:
   -------------

     The Company  had export  sales  $235,400,  or 35% of net sales for the year
     ended  September  30, 1996.  Export sales for the year ended  September 30,
     1997 were less than 10% of net sales.  All sales were  transacted in United
     States dollars.


9. SIGNIFICANT CONCENTRATIONS:
   --------------------------

     During the years ended  September 30, 1997 and 1996,  the Company had sales
     to a  single  customer  which  accounted  for  61%  and  16% of net  sales,
     respectively.  At  September  30, 1997 and 1996,  the Company had  accounts
     receivable from a single customer for $61,200 and $75,800, respectively.

     At September  30, 1997 and 1996,  the Company had an investment in a single
     mutual fund that invests in money market  instruments.  The amount invested
     is not covered by Federal  insurance  and totaled  $704,500 and $803,200 at
     September  30, 1997 and 1996,  respectively.  At September  30,  1997,  the
     Company had cash balances totaling $81,000 that were in excess of Federally
     insured limits.

                                      F-18

<PAGE>


                      MEDICAL DYNAMICS, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



10. FOURTH QUARTER ADJUSTMENTS:
    --------------------------

     During the fourth quarter of 1997, the company  increased the provision for
     obsolete   and   slow-moving   inventories   by   approximately   $260,000.
     Additionally,  the Company recognized an impairment loss of $70,600 related
     to certain demonstration equipment.


11. SUBSEQUENT EVENTS:
    -----------------

     In October 1997, the Company created a new subsidiary which acquired all of
     the  outstanding  capital  stock of Computer Age Dentist,  Inc.  (CADI) and
     satisfied an obligation to a former  shareholder  of CADI.  CADI,  which is
     located in Santa Monica,  California,  is engaged in the design,  sale, and
     support of practice  management  software  for the dental  profession.  The
     Company paid total consideration of $4,700,000 to acquire CADI,  consisting
     of $300,000 in cash, $400,000 in notes payable, and 1,600,000 shares of the
     Company's  common  stock.  The  transaction  will  be  accounted  for  as a
     purchase.

     In  connection  with the  acquisition  of CADI,  the Company  entered  into
     employment  agreements with two individuals who were officers and directors
     of CADI.  The  agreements  are  effective  for a period  of five  years and
     provide for aggregate annual  compensation of $210,000.  Additionally,  the
     Company granted options to these  individuals for an aggregate of 1,200,000
     shares of the Company's  common stock. All of these options are exercisable
     at $3.25 per share and expire in September  2004.  The  Company's  Board of
     Directors has also reserved  250,000 shares for stock options to be granted
     to other CADI employees.

     Effective  October 31,  1997,  the Company  issued  convertible  debentures
     totaling $1,100,000.  The debentures are uncollateralized and bear interest
     at 8% per annum, payable semi-annually in cash or, at the Company's option,
     in shares of the Company's  common stock valued at the fair market value as
     of the date the interest is due. The principal  balance is due October 2000
     and the holder of the  debentures  has the option to convert the debentures
     into shares of the Company's  common stock  beginning in January 1998.  Any
     unpaid principal and interest as of October 31, 2000 will  automatically be
     converted into shares of the Company's  common stock.  The conversion price
     is equal  to the  average  of the two  lowest  closing  bid  prices  of the
     Company's  common  stock as reported by NASDAQ  during the 60 trading  days
     preceding the conversion  date, not to exceed $3.45 per share.  The Company
     received net  proceeds of $986,000  from the  debentures,  after paying all
     costs related to the issuance.

     The Company also granted the Debenture  holder a warrant to purchase 84,615
     shares of the Company's  common  stock.  The warrant is  exercisable  until
     October 31, 2000 at an exercise price of $3.38.




                                      F-19