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, 1998

                                       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 $7,846,700.


The aggregate market value of the voting stock held by nonaffiliates 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 15, 1998 was approximately $22,615,195.


Class                                       Outstanding at December 15 , 1998
-----                                       ---------------------------------

Common Stock                                       10,301,667 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 ( NASDAQ Small Cap - MEDY)
incorporated in March 1971 ("MEDY" or the "Company"),  is engaged in the design,
development,  manufacture and marketing of dental intra oral cameras, disposable
products  for the  dental  and  medical  professions,  and  practice  management
products for the dental  profession.  MEDY's principal  products are small color
dental intra oral camera  systems for use in patient  diagnosis  and  education,
practice management software, multi-operatory imaging systems, patient education
systems, digital x-ray systems and a wide variety of ancillary products utilized
by the dental  profession.  MEDY has been  manufacturing some form of medical or
dental cameras since August of 1981.

     During fiscal 1998, MEDY changed its business focus  significantly  through
three acquisitions.

     Effective  October 1, 1997 MEDY  acquired 100% of the  outstanding  capital
     stock 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
     industry.

     Effective on February 1, 1998,  CADI merged with  Information  Presentation
     Systems, Inc. (IPS) of Marietta,  Georgia. IPS is an eight year old company
     supplying  customized  multimedia  systems  for use in a variety  of dental
     operatory  environments.  IPS's  product line  included the sales of MEDY's
     intra oral  camera,  video and  computer  image  storage  systems,  patient
     management systems, digital radiography and micro-abrasion instruments.

     Effective  April 1, 1998,  CADI  purchased 100% of the  outstanding  common
     stock of Command  Dental  Systems,  Inc.  of  Farmington  Hills,  Michigan.
     Command's  primary business is the development,  marketing and installation
     of dental  practice  management  systems.  Command has an in house staff of
     programmers,  sales  professionals,   installers,   trainers,  and  support
     technicians  along with 550 clients  ranging from small  dental  offices to
     large clinics.

     As a result of the  acquisitions,  MEDY is now operating  through CADI, and
CADI is operating the businesses previously operated by IPS and Command, both of
which  were  merged  into  CADI.  As a  result  of the  CADI,  IPS  and  Command
acquisitions,  MEDY has integrated the hardware and software necessary to manage
a dental practice. Since MEDY and CADI's products being offered for sale are all


                                       3

<PAGE>


Year 2000 (Y2k) compliant,  MEDY intends to market CADI's products to the dental
practices  with MS-DOS and UNIX based  software  that may not be Y2K  compliant.
MEDY 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, 1998,  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 fiscal year 1995 MEDY entered into a distribution agreement with
Micro-Medical   Devices,  Inc.  (MMD),  of  Castle  Rock,  Colorado.  MMD  is  a
corporation formed by and 100% wholly-owned by MEDYs 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.  This raises
substantial  doubt about the Company's  ability to continue as a going  concern.
During fiscal 1998, MEDY sold convertible debentures to The Tailwind Fund, Ltd.,
an  unaffiliated  entity,  pursuant  to  Regulation  D.  MEDY  sold  convertible
debentures in the amount of  $1,100,000 on October 31, 1997,  $1,100,000 on July
31,  1998 and  $400,000  subsequent  to  fiscal  year end on  November 16, 1998.
Management's further plans in regard to these matters are also described in Note
2 and in Item 6 - "Management's  Discussion and Analysis of Financial  Condition
and  Results  of  Operations".  The  financial  statements  do not  include  any
adjustments that might result from the outcome of this uncertainty.

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

     As a result of the  acquisition of CADI, IPS and Command during fiscal 1998
MEDY has two principal business segments:

     (i) The design,  development,  manufacture and marketing of medical cameras
and related  disposable  products for the medical markets ("The Medical Products
Segment").  These  products  are  used in  surgical,  diagnostic,  research  and
teaching  applications by physicians and other health care professionals and has
historically been the business of MEDY.

     (ii) The design,  development,  manufacture  and  marketing of dental intra
oral cameras,  practice  management  software,  related electronic  services and
other  technology  products to be integrated  into those  software  systems("The
Dental Products Segment"). MEDY entered this business segment as a result of its
acquisition of CADI, IPS and Command.


                                       4

<PAGE>


The Medical Products Segment

     During  the  current  fiscal  year,  MEDY  has  significantly  changed  its
corporate emphasis. While MEDY is still outsourcing  manufacturing of disposable
drapes for use in medical  operations,  MEDY has greatly expanded its operations
and has  entered  into the dental  product  segment as a result of  acquisitions
completed in fiscal 1998. Consequently,  as described below, medical cameras and
other  medical  products  have become  insignificant  to MEDY's  operations  and
financial  condition  as a whole.  Annual sales of Medical  Products  (including
ancillary  camera  equipment  and related  disposable  products) in fiscal years
ending 1997 and 1998 were $297,900  (30%)and  $271,800 (3%),  respectively.  The
principal  reasons why medical  sales  volumes have declined over the past 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 medical product operations of
MEDY to date. MEDY's medical cameras and other products are fully Y2K compliant.
If the Medical  Products segment does not become more significant in the future,
MEDY will cease accounting for it as a separate segment.

Distribution Methods. MEDY's medical products are sold principally to physicians
and  hospitals,  either  directly  or through  one of MEDY's  independent  sales
representatives.

Inventory and Raw Materials.  With the decreased sales volumes  generated by the
Medical Products segment,  MEDY's inventory requirements for this segment are an
insignificant percentage of total inventory held.

Government Regulation. The requirements of the FDA regarding the manufacture and
sale  of  Medical  Products  continues  regardless  of  sales  volumes.   MEDY's
requirements under those regulations are described in detail below in the Dental
segment.

CMOS Imaging  Chips.  MEDY is also  currently  exploring  the  development  of a
Complementary  Metal Oxide Sensor (CMOS) imaging chip for its medical and dental
cameras and endoscopes  which,  if successful,  is expected to reduce  component
costs  from  $700 to less than $50 per unit and allow  MEDY's  reentry  into the
endoscopic  capital equipment  market.  Low cost CMOS imaging chips coupled with
MEDY's  "Rotatable  Chip"  technology  would  allow  MEDY to  create  disposable
electronic  endoscopes  or  cameras  for the  medical  and  dental  markets at a
substantially  lower  transfer  price to the  market,  while  at the  same  time
maintaining gross margins and raising unit volume.  MEDY acquired the "Rotatable
Chip" technology in 1993 via a non exclusive  license  agreement,  expiring June
30, 2009, from a non affiliated company, High Tech Medical Instrumentation, Inc.
on U.S. Patent No. 4,858,001  entitled Modular  Endoscopic  Apparatus With Image
Rotation.  The license agreement was obtained by payment of $10,000 and issuance
of  30,000  shares of the  Company's  restricted  common  stock  along  with the
obligation to pay 2% royalties on any products sold. To date,  royalties paid to
HTMI have been less than $1,000 during the term of the  agreement.  Depending on
the availability

                                       5

<PAGE>



of CMOS imaging chips, and continuing  research and  development,  these devices
could be ready  for  market  during  calendar  1999,  although  there  can be no
assurance of that fact.


The Dental Products Segment

     During  fiscal  years  1996 and 1997  MEDY  applied  it's  surgical  camera
expertise  to  the  development  of  intra  oral  dental  cameras  for  use as a
diagnostic and patient education tool for the dental  profession.  MEDY believes
that the True Vision(TM) and CadCam 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.  MEDY believes that its
products are in compliance with applicable governmental regulations,  if any, in
the United States and in other countries in which such products are sold. MEDY's
dental cameras and accessories are fully Y2k compliant.

Existing  Products and New Products.  MEDY's principal dental products and their
markets,  and new products which are under development,  are as follows.  MEDY's
intraoral dental camera and multi-operatory  video systems,  practice management
software and hardware,  third party software,  digital x-ray systems and patient
education  systems are primarily  sold through  CADI's direct sales force.  To a
lesser  extent,   the  intra  oral  camera  is  sold  through  a  select  dealer
distribution  network  or on an OEM  distributor  basis.  MEDY  has  engaged  in
marketing and advertising its products at dental  conventions and through direct
sales representatives or a distributor network. During the years ended September
30, 1998 and 1997, MEDY spent  $2,078,900 and $144,600,  respectively,  on sales
promotions,   conventions  and  advertising  expenses  relating  to  its  dental
products.

True  Vision  2(TM)  and  CadCam  Intra  Oral  Dental  Camera.   MEDY  currently
manufactures  and markets  dental intra oral 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 dental profession.  The cameras' state-of-the-art  technology consists of
easy angle, high resolution viewing, a single lens format providing anatomically
correct images, and the smallest and lightest hand piece available on the market
today.  Production and sales of these cameras began in September of 1996.  Sales
of these cameras  increased from $684,900 in fiscal 1997 to $1,040,000 in fiscal
1998. The principal market for the True Vision and CadCam cameras are dentists.

Intra Oral Dental Cameras  incorporating  CMOS imaging  chips.  Due to the lower
costs of the CMOS imaging chips discussed  above,  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,  although the Company's  ability to meet this time frame is dependant on a
number of factors,  such as  identification  of  suppliers of CMOS chips and the
design  and  development  of a new  intra  oral  camera  incorporating  the CMOS
technology,  some of which are beyond the Company's  control and no assurance of
the Company meeting that time frame can be given.

                                       6

<PAGE>


Practice  Management  Software.  With its October 1997  purchase of Computer Age
Dentist,  Inc. (CADI), and the subsequent  acquisitions of IPS and Command, MEDY
now offers  software for the dental  office that  provides  patient  scheduling,
patient  education,   graphical  charting,   image  capture,   word  processing,
accounting,  camera  and  digital  x-ray  integration,  and  insurance  benefits
database.  In  addition to its own brand of intra oral  camera  integrated  with
multi operatory video systems, the Company also offers third party products that
it resells and integrates with the practice  management software it sells. These
products  consist of computer  hardware,  digital x-ray  systems,  image capture
software and patient education systems.

     The software  allows the  scheduling of patients and dental  professionals,
and ties scheduled  patients  directly to their dental records;  integrates with
all intra oral  dental  cameras,  allowing  the  dentist  to include  intra-oral
pictures  directly on the patient's  computerized  chart;  provides for computer
based  charting  and  digitized  x-rays  to be  automatically  attached  to  the
patient's  chart for easy viewing and printing;  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  provides  the ability to submit  claims to
insurance companies electronically,  tracks laboratory requests and results, and
many other services useful to the modern dental office.

     CADI's current  product is a Windows  95/98/NT based  application  and is a
flexible  open  architecture  design and 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.  This  product  is fully  Y2k
compliant.

No Principal Customers.  CADI has over 4,500 customer  installations  throughout
the  United  States  serving  in  excess  of  7,000  dental  professionals  and,
therefore, it is not dependent on sales to any principal customer.

Inventory  and Raw  Materials  Requirements.  In the intra oral  camera  product
category,  MEDY is  required to carry  significant  quantities  of raw  material
inventory to meet rapid delivery  requirements  of customers or to assure itself
of a continuous  allotment of raw materials from  suppliers.  The finished goods
segment of intra  oral  cameras is much less  significant  due to the  Company's
efforts to produce only  sufficient  quantities of finished goods to satisfy one
current  months  demand for  product.  In cases where CADI  provides  the dental
office with the  computer  hardware to support its  software  applications,  the
Company is required to inventory those computer hardware  components.  Currently
the  inventory  is  ordered on a "just in time  basis" and is only  ordered on a
custom basis for each sales order  received.  As sales  revenues  increase,  the
inventory component required will increase proportionately..

     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  exclusively  from  Panasonic  Industrial  Company - Audio Video Systems
Group  ("Panasonic").  Although  Panasonic  is still  the  primary  supplier  of
cameras,  MEDY now procures cameras from additional sources without  sacrificing
product or picture quality.

                                       7

<PAGE>


Distribution  Methods.  Distribution for CADI's software,  intra oral camera and
related  third party  products is  conducted  with  direct  sales  professionals
employed by the Company. The Windows 95/98/NT based multi-user product sells for
approximately  $7,000 each.  Upgrades to CADI's most recent  CadWin  product are
provided to  customers  at no charge  provided the customer is under a technical
support  contract.  Activities by CADI, IPS and Command Dental during the period
before their fiscal 1998 acquisition by MEDY are useful in understanding  MEDY's
proposed distribution methods.

     In CADI's  previous  fiscal year ended  September  30,  1997,  prior to its
     acquisition by MEDY, it had approximately $2.9 million of revenue.

     In IPS's  previous  fiscal  year  ended  December  31,  1997,  prior to its
     acquisition by MEDY, it had approximately $3 million of revenue.

     In Command Dental's previous fiscal year ended September 30, 1997, prior to
     its acquisition by MEDY, it had approximately $1.4 million of revenue.

     It is Management's  intention to increase those revenues over time with the
addition  of capital  for future  R&D,  marketing,  additional  acquisitions  of
companies in similar  businesses and an expanded national sales and 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.  Utilizing the previous years sales of each of those
acquisitions  taken from the point in time of their acquisition and applying the
commensurate  percentage of the year in which they  contributed to total revenue
in fiscal 1998,  totals  approximately  $5.6 million in aggregate sales revenue.
With total sales of $7.6 million  exclusive of medical  products in fiscal 1998,
then the combined entities generated an approximate internal growth rate of 36%.

Competition.  Principal  competitors  in the dental  camera field are  Patterson
Dental, Dentsply and Dental/Medical Diagnostic Systems. Principal competitors in
the dental  software  business are Dentrix,  Softdent  and  Practice  Works.  In
addition,  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 available to the dental office.  Management  believes
CADI's software and related hardware products are equitably priced in comparison
to that of its primary  competitors which offer similar  features.  Furthermore,
the  software  offered by some  smaller  competitors  may not be Y2k  compliant,
whereas the dental practice  management  software offered by CADI is believed to
be fully Y2k compliant.

Research and  Development.  During the fiscal years ended September 30, 1998 and
1997,  MEDY  spent  approximately   $46,700  and  $200,300,   respectively,   on
company-sponsored  research and development  activities related primarily to the
dental intra oral camera product line.  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  cases,   startling  new  designs  (such  as  the  changes  from  DOS-based

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<PAGE>


applications to Windows, and from Windows 3.1 to Windows 95). CADI must keep its
software  current for new versions of software being published by third parties,
as well as maintain  existing  software which may be running on older computers.
CADI has spent approximately  $268,200 on research and development,  in the form
of programming salaries in the fiscal year ended September 30, 1998.

Warranty.  MEDY's medical and dental cameras are warranted for a one-year period
with respect to parts and labor  required as a result of defects in material and
workmanship.  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  records  the  estimated  cost into its  results  of
operations based upon historical experience and revenues currently reported. The
estimated  warranty  reserve for  medical  and dental  camers at fiscal year end
September 30, 1998 and 1997 was $31,000 and $11,000, respectively.

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 the medical and dental 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. MEDY currently has only two products, the dental intra oral camera and
CamWrap  that fall under the purview of the FDA  regulations.  With the shift in
the Company's  focus to non regulated  products,  the percentage of revenue from
FDA regulated products will continue to become less significant.

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MEDY's last  inspection  by the FDA was in  December  1997.  While some  adverse
practices/conditions were observed during the inspection,  according to the FDA,
they did not warrant  consideration of any regulatory follow-up by the agency at
that time.

     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 these requirements.

Other Information

Principal  Customers.  MEDY had no customer who contributed 10% or more of total
revenues during the fiscal year ended September 30, 1998 and one who contributed
more  than  10%  in  the  1997  fiscal  year.   Gross  billings  to  Information
Presentation Systems, Inc.(IPS) of Marietta, GA. during the 1997 fiscal year was
$599,500 or 61% of Company's  revenues.  IPS markets and  installs  dental intra
oral cameras,  multi  operatory  image systems,  digital x-ray systems and other
related dental products.  MEDY (through CADI) acquired IPS in February 1998 and,
therefore, IPS is no longer a significant customer of MEDY.

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 its 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 Eyepiece"               4/12/88          4,736,733
"Gas Insufflation Needle with Instrument
Port" (Adair Veress Needle)                       9/26/89          4,869,717
"Rigid Video Endoscope with Heat
Sterilizable Sheath" (EVL and lap-Wrap)           11/7/89          4,878,485
Reissue                                           3/24/92          RE 33,854
"Deformable and Removable sheath for
Optical Catheter"                                 3/30/93          5,197,457
"Deflectable Sheath for Optical Catheter"         6/30/92          5,125,395
"Heat Sterilizable Electronic Video
Endoscope" (Autoclavable EVL)                     2/23/93          5,188,094
Steerable sheath for Use With Selected
Removable Optical Catheter"                       7/5/94           5,325,845
"Imaging Tissue or Stone Removal Basket"          5/17/94          5,311,858
"Stereoscopic Endoscope" (3-D EVL)                1/17/95          5,381,784
"Stereoscopic Endoscope With Miniaturized
  Electronic Imaging Chip"                        2/27/96          5,494,483
"Miniaturized Electronic Imaging Chip"         
  (For Reduced Diameter Electronic
  Endoscopes)                                     2/27/96          5,495,114

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<PAGE>


The Bayne Pap  Brush(TM)  is subject to United  States  Patents  No.  4,762,133,
4,754,764 and 4,873,992  expiring  August 9, 2005 through  October 17, 2006. Dr.
Bayne,  a director of MEDY,  assigned  these  patents to MEDY and is entitled to
receive a royalty of two percent of net sales of the product  after  recovery of
certain  expenses.  No royalties  have been accrued or paid to Dr. Bayne on this
product, and MEDY is no longer marketing this product.

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.  CADI holds  United  States  Trademark,
registration  numbers 2,034,684 and 1,930,685 which relate to the name "Computer
Age Dentist" and "O.M.S. Plus", respectively, and were registered on February 4,
1987 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 December 9, 1998,  MEDY (not including CADI) employed 13 persons,
including 4 persons engaged in general administration,  and 9 persons engaged in
production, distribution, and customer service of MEDY's products. At that date,
CADI  employed  approximately  120  people  in  sales,  training,  installation,
customer service,  and  administrative  functions.  These employees are based in
CADI's offices in Los Angeles,  California,  Marietta,  Georgia,  and Farmington
Hills,  Michigan  as  well  as  salespeople  located  in  the  territories  they
represent.

Item 2. Description of Property.

     MEDY  leases  18,358  square  feet of  space  at  $13,845  per  month 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 on only 11,085  square  feet  through
December 31, 2000 at a base rental rate (during 1999) of $7,390 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,  Suite 600.  The lease runs for five
years from  November,  1997 to October,  2002 at a rate of  $9,003.60  per month
which includes  parking,  operating costs and property  taxes.  CADI also leases
1600 square  feet in Orange  County,  California,  at $880 per month from August
1998 through  August of 1999,  3,610 square feet in Marietta,  Georgia at $1,952
per month,  from June 1, 1997  through May 31,  2000,  and 3,480  square feet in
Farmington Hills,  Michigan at $5,800 per month from April 1, 1998 through March
31, 2003.

Item 3.  Legal Proceedings.

     There are no material pending legal or regulatory  proceedings against MEDY
or CADI, and neither is 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, 1998.

                                       12



<PAGE>


                                     PART II

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

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

     For more than the past twenty years,  MEDY's common stock has been publicly
traded under the symbol "MEDY" on the Nasdaq  SmallCap  Market which is operated
by the National  Association  of  Securities  Dealers,  Inc. The Nasdaq  SmalCap
Market is one of two distinct  market tiers  comprising  the Nasdaq Stock Market
which is a highly regulated electronic services market utilizing a sophisticated
computer and telecommunications  network, Market participants comprise competing
Market Makers, independent dealers who commit capital to stocks and compete with
each other for orders, and Electronic  Communications Networks,  trading systems
recently  integrated into Nasdaq which bring additional  orders into the market.
The  market   structure   provides   visibility  of  orders  and  allows  market
participants to compete for order flow. Trading is supported by a communications
network  linking the market  participants  to  quotations  dissemination,  trade
reporting and order  execution  systems.  This market also provides  specialized
automation  services  for screen  based  negotiations  of  transactions,  online
comparison of transactions,  and a range of information services tailored to the
needs of the securities industry, investors and issuers.

     The quotations  shown below were compiled by MEDY from monthly  statistical
reports supplied by NASD. All quotes represent inter-dealer quotations,  without
retail markup,  mark-down or commission and may not necessarily represent actual
transactions in common stock.

                                     High Bid                   Low Bid
                               ---------------------     -----------------------
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

Fiscal Year Ended
September 30, 1998

First Quarter                        $  3.94                    $ 2.13
Second Quarter                          3.50                      3.06
Third Quarter                           3.00                      2.13
Fourth Quarter                          3.00                      2.00

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

The number of record holders of the Common Stock,  as of September 30, 1998, was
approximately  12,500 not including an unknown  number of beneficial  holders in
street name.

                                       13

<PAGE>


     (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.

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

     There are  contractual  restrictions  on the  Company's  present  or future
ability to pay  dividends in MEDY's  Convertible  Debenture  Agreement  with The
Tailwind  Fund,  Ltd.  and in MEDY's loan  agreement  with its  lender,  Norwest
Business Credit, Inc.

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

     This report on form  10-KSB,  including  the  information  incorporated  by
reference herein, contains forward-looking  statements within the meaning of the
Private Securities  Litigation Reform Act of 1995. Certain statements  contained
in this report  using the term "may",  "expects  to",  and other terms  denoting
future possibilities,  are forward looking statements. These statements include,
but  are not  limited  to,  those  statements  relating  to  development  of new
products,  the financial condition of MEDY, the ability to increase distribution
of MEDY's  products,  integration of new businesses MEDY has acquired during the
1998 fiscal year,  approval of MEDY's  products as and when required by the Food
and Drug  Administration  ("FDA") in the United  States and  similar  regulatory
bodies in other countries. The accuracy of these statements cannot be guaranteed
as they are subject to a variety of risks which are beyond the Company's ability
to predict or control and which may cause  actual  results to differ  materially
from the projections or estimates contained herein. These risks are described in
this Item 6, and also in Item 1 and Part III of this form 10-K. The business and
economic risks faced by MEDY and MEDY's actual  results could differ  materially
from  those  anticipated  in these  forward-looking  statements  as a result  of
certain factors as described herein.

     As  discussed  in  Note 2 to the  financial  statements,  the  Company  has
suffered  recurring  losses,  negative cash flows from  operations and resulting
working  capital  shortages.  Unless the Company can obtain  additional  debt or
raise  additional  equity,  this raises  substantial  doubt as to the  Company's
ability to continue as a going  concern.  Management's  plans in regard to these
matters  are  described  in  this  item 6 and  also in  Note  2.  The  financial
statements do not include any adjustments  that might result from the outcome of
this uncertainty.

     The 1998 financial  statements  reflect the revaluation of the common stock
issued as consideration for the three acquisitions that were completed in fiscal
1998. The impact of this revaluation was to increase software  development costs
by  $513,510   and  goodwill  by   $1,552,038,   resulting  in  an  increase  in
stockholders'  equity of $2,065,548.  The revaluation  also increased the fiscal
1998 net loss by $166,843 due to higher amortization  expense.  The valuation of

                                       14

<PAGE>


the common stock  reflected in the Company's  1998 interim  statements was based
upon the report of an independent valuation expert. However, based upon comments
recently received from the Securities and Exchange Commission,  the value of the
shares issued in each of the  acquisitions  was increased.  By January 15, 1999,
the Company  intends to amend its 1998 interim  financial  statements to reflect
the impact of the revaluation.

Liquidity and Capital Resources.
--------------------------------
     During the fiscal year ended September 30, 1998, the  Registrant's  current
ratio  declined to 1.2 as compared to 4.6 at  September  30,  1997.  Net working
capital  decreased from  $1,343,300  September 30, 1997 to $448,900 at September
30, 1998.  Likewise,  the  company's  cash balances  decreased  from $836,400 at
September 30, 1997 to $553,100 at September 30, 1998.

     Principal  changes in the components of net working  capital for the fiscal
year ended  September  30, 1998 as compared to fiscal year ended  September  30,
1997 consist of:

<TABLE>
<CAPTION>

                                                        1998                    1997               W/C Effect
                                                        ----                    ----               ----------
<S>                                                 <C>                    <C>                    <C>         
Cash and Cash Equivalents                           $   603,100            $   886,400            $  (283,300)
Trade Receivables                                       879,400                127,500                751,900
Inventories                                             879,600                683,400                196,200
Pre-paid Expenses                                        24,800                 15,700                  9,100
                                                    -----------            -----------            -----------

   Current Assets:                                    2,386,900              1,713,000                673,900

Current Maturities of  Notes Payable                    546,100                   --                  546,100
Current Maturities of Capital Leases                     40,000                   --                   40,000
Accounts Payable                                        565,800                297,600                268,200
Accrued Expenses                                        385,000                 61,100                354,900
Unearned Revenue                                        370,100                   --                  370,100
Warranty Reserves                                        31,000                 11,000                 20,000
                                                    -----------            -----------            -----------
   Current Liabilities:                               1,938,000                369,700              1,568,300

Working Capital:                                    $   448,900            $ 1,343,300            $  (894,400)
                                                    ===========            ===========            ===========
</TABLE>


     The principal reason for the significant decrease in working capital during
1998  include  negative  cash flows from  operating  activities  of  $1,239,000,
payment  of the cash  portions  of the  consideration  for the  acquisitions  of
Computer Age Dentist,  Inc. (CADI) and Information  Presentation  Systems,  Inc.
(IPS) of $300,000 and $200,000  respectively,  and payment of acquisition  costs
associated with the  acquisitions  of CADI, IPS, and Command of $122,600.  Short
and long term debt was also  incurred in the  acquisition  of CADI and  Command,
resulting  in an increase in current  maturities  of Notes  Payable of $546,100.
During the fiscal  year ended  September  30,  1998 the  company  also  incurred
capital expenditures of $238,100 for additional software development  activities
and $266,600 for property and equipment.

                                       15
<PAGE>

     During  the fiscal  year ended  September  30,  1998 MEDY also  experienced
decreased working capital as it built up inventory and trade receivables,  since
cash receipts from MEDY's increased sales activities trailed some months behind.
In addition to debt incurred to finance acquisitions in fiscal 1998, the Company
also entered into a capital lease financing arrangement that provided $87,600 of
cash.  During fiscal 1998, the company made principal  payments on debt totaling
$52,600.

Tailwind Convertible Debentures.
--------------------------------

     Offsetting  the  expenditures  of cash  used for  operating  and  investing
activities, were net proceeds of $1,989,300 received from the sale of $2,200,000
of convertible debentures. (Subsequent to fiscal year end on November16, 1998 an
additional $400,000 of convertible debentures were sold to the same unaffiliated
company.)  During  the  year  ended  September  30,  1998,  the  holder  of  the
outstanding  debentures  elected to convert $660,000 of the debentures to common
stock,  resulting in an outstanding  principal balance on debentures  (excluding
discount) of  $1,540,000  at the fiscal year ended  September  30, 1998. In each
case, the debentures contain a contractual  restriction preventing Tailwind from
converting the  debentures or exercising  warrants such that at any time it owns
more than 4.99% of the Company's  outstanding  common stock.  Terms of the three
series of debentures  purchased by Tailwind  during and after fiscal 1998 are as
follows:

The Tailwind  Fund,  LTD.  #1.  $1,100,000,  8%  Convertible  Debentures  issued
pursuant to Regulation D.
Dated  October 31,  1997,  due October 31,  2000.  As of October 31, 1998 all of
these debentures,  and the related accrued interest,  have been converted into a
total of 585,270 shares of MEDY common stock (including  debentures for $440,000
which was converted after fiscal year end). The debenture holder was also issued
warrants to purchase  84,615 shares of MEDY common stock at an exercise price of
$3.375 per share.

The Taillwind  Fund,  LTD. #2.  $1,100,000,  8%  Convertible  Debentures  issued
pursuant to  Regulation  D.
Dated July 31, 1997, due July 31, 2002. Debentures  outstanding at maturity will
automatically convert into common stock, at the Company's option.
Interest  payable in cash or MEDY common stock at  Company's  option on each 5th
day of January and July during the term.
Debenture is  convertible  into MEDY common stock in  increments of one third of
the total on November 30, 1998, January 30, and March 31, 1999 respectively.
Debenture is convertible into MEDY common stock at 100% of the "Market Price" on
the date of  conversion  which is defined as "the average of the two low closing
bid prices of the Company's  stock during the previous 60 trading days",  not to
exceed the "Ceiling  Price" defined as 105% of the average  closing bid price of
the Common Stock for the twenty  trading days prior to the effective date of the
registration  statement.  That "Ceiling Price" shall be adjusted  effective upon
the second  anniversary of the Purchase Agreement to 105% of the Market Price on
such date,  if such  adjustment  would result in a lower price,  but in no event
shall the Ceiling Price be adjusted to an amount less than $2.25.
Debenture  holder was issued warrants to purchase  110,000 shares of MEDY common
stock at an exercise price of $2.58.

                                       16

<PAGE>


The Company was required to file a Registration Statement with the SEC within 30
days of the Closing Date and obtain effectiveness within 120 days of the Closing
Date (the  Registration  Date). The  Registration  Statement has been filed, but
effectiveness  has not been obtained within the prescribed time period.  The SEC
has selected this registration statement for a full review and the Company is in
the  process  of  providing  the SEC  with all of  their  requested  information
(including this 10-KSB document) and continuing to seek approval. The Company is
potentially liable for penalties in the amount of 2% of the aggregate  principal
amount  of the  debenture  for  each  month or  portion  thereof  following  the
Registration Date during which the registration is not effective. As of December
29, that  penalty  would be in the  approximate  amount of $22,000.  Among other
covenants within the convertible debenture the Company has agreed to: maintain a
sufficient  number  of  authorized  shares  to  effect  the  conversion  of  the
debenture,  limit  conversions  of the debenture in the event it would result in
the holder  owning more than 4.99% of the issued and  outstanding  shares of the
Company's  common stock,  the Company must be in compliance  with all applicable
NASDAQ  Small Cap  Market  continued  listing  requirements,  commencing  on the
closing date and  continuing  for a period of one year  following  the effective
date of the  registration  statement,  the  Company  agrees  that it shall  not,
without first obtaining the investors consent, acquire any company with an after
tax loss in excess of $100,000 for the previous four quarters, the Company shall
not issue or sell any equity or debt securities that are convertible into Common
Stock based upon or varies with the trading prices of the Company's Common Stock
("Variable Rate Transactions"),  and the Company agrees that for a period of one
year following the effective  date of the  registration , the Company shall give
thirty days advance written notice to the investor prior to any offer or sale of
any of its equity securities or any securities  convertible into or exchangeable
or exercisable for such securities. In the opinion of Management, the Company is
in  compliance  with  substantially  all  covenants  with the  exception  of the
registration  requirement  mentioned above. The Company has requested in writing
that the holder waive or extend the time period by which the Company must effect
the  registration  due  to  the  late  manner  in  which  the  Company  received
information necessary to file the registration statement. To date the holder has
not responded to that request.

The Tailwind Fund, LTD. #3. $400,000, 8% Convertible  Debentures issued pursuant
to  Regulation  D.
Dated  November 16, 1998,  due November  16,  2003.  Debentures  outstanding  at
maturity will automatically  convert into common stock, at the Company's option.
Interest  payable in cash or MEDY common stock at  Company's  option on each 5th
day of January and July during the term.
Debenture is  convertible  into MEDY common stock in  increments of one third of
the total on March 16,  May 16, and July 16,  1999  respectively.  Debenture  is
convertible  into MEDY common stock at 100% of the "Market Price" on the date of
conversion which is defined as "the average of the two low closing bid prices of
the  Company's  stock  during the previous 60 trading  days",  not to exceed the
"Ceiling  Price" defined as 105% of the average  closing bid price of the Common
Stock  for  the  twenty  trading  days  prior  to  the  effective  date  of  the
registration  statement.  That "Ceiling Price" shall be adjusted  effective upon
the second  anniversary of the Purchase Agreement to 105% of the Market Price on
such date,  if such  adjustment  would result in a lower price,  but in no event
shall the Ceiling Price be adjusted to an amount less than $2.25.

                                       17

<PAGE>


The  debenture  holder was issued  warrants  to purchase  40,000  shares of MEDY
common stock at an exercise price of $2.58.
The Company was required to file a Registration Statement with the SEC within 30
days of the Closing Date and obtain effectiveness within 120 days of the Closing
Date (the  Registration  Date). The  Registration  Statement has been filed, but
effectiveness has not yet been obtained.  The SEC has selected this registration
statement  for a full review and the Company is in the process of providing  the
SEC with all of their requested information (including this 10-KSB document) and
continuing to seek  approval.  The Company is liable for penalties in the amount
of 2% of the  aggregate  principal  amount of the  debenture  for each  month or
portion thereof following the Registration Date during which the registration is
not effective. As of December 29, there are no penalties accrued to this portion
of the debenture.
Among other covenants  within the  convertible  debenture the Company has agreed
to: maintain a sufficient  number of authorized  shares to effect the conversion
of the  debenture,  limit  conversions  of the  debenture  in the event it would
result in the holder owning more than 4.99% of the issued and outstanding shares
of the  Company's  common  stock,  the Company  must be in  compliance  with all
applicable NASDAQ Small Cap Market continued listing requirements, commencing on
the closing date and continuing for a period of one year following the effective
date of the  registration  statement,  the  Company  agrees  that it shall  not,
without first obtaining the investors consent, acquire any company with an after
tax loss in excess of $100,000 for the previous four quarters, the Company shall
not issue or sell any equity or debt securities that are convertible into Common
Stock based upon or varies with the trading prices of the Company's Common Stock
("Variable Rate  Transactions"),  and the Company agree that for a period of one
year following the effective  date of the  registration , the Company shall give
thirty days advance written notice to the investor prior to any offer or sale of
any of its equity securities or any securities  convertible into or exchangeable
or exercisable for such securities. In the opinion of Management, the Company is
in compliance with substantially all covenants.

     If the current  balance of  $1,500,000  of  debentures  plus  approximately
$40,000 of accrued  interest were  converted  today at a "Market Price" of $2.00
per share,  the resulting  issuance of  additional  common stock would be in the
amount of 770,000 shares.

Line of Credit. After the end of fiscal 1998, MEDY obtained a $1,000,000 line of
credit with a three year term from Norwest Business Credit, Inc. with borrowings
based  upon  80% of  eligible  accounts  receivable.  The  Company  has  pledged
substantially  all of its assets to the loan,  but to date has only been able to
borrow  approximately  $350,000 at any given time.  The debt  currently  accrues
interest at Prime plus 3% and  required a 1.5%  commitment  fee payable  $10,000
upon closing and $5,000 on the facility's first anniversary.  There is a minimum
interest  charge  monthly of $2,750,  which when  applied  against  the  minimal
borrowings  able to be utilized by the Company  creates a  significantly  higher
interest  cost to the Company  than the  designated  Prime plus 3%.  Among other
covenants, the loan agreement has affirmative covenants requiring the Company to
maintain  certain levels of net worth and limit negative EBITDA (Earnings Before
Interest Taxes  Depreciation and Amortization) to certain levels. As of December
15, 1998 the lender has  informed  the Company  that the Company is in technical
default of the net worth covenant of the credit  agreement.  Without waiving the
existence of the technical  default,  the lender has agreed to allow the Company
to utilize the credit facility up to a limit of $400,000,  accruing  interest at

                                       18

<PAGE>



the default rate of Prime plus 6%, with line availability  decreasing at $10,000
per week until  March 1, 1999 at which time the lender will  determine  its next
course of action.  At that time, if the default continues  to exist,  the lender
could  choose to request  payment in full or extend the  facility  on similar or
different terms.

     Also,  there are 1,685,952  vested common stock options  outstanding  as of
December 15, 1998, at prices ranging from $1.00 to $5.00 per share. If exercised
(of which there can be no  assurance),  these options  would provide  additional
working capital to MEDY.

     The  acquisitions of CADI, IPS, and Command  together with the placement of
convertible  debentures in 1998 are unique transactions that have no parallel in
the comparable prior fiscal period. Due to the fundamental  requirement for MEDY
to achieve positive cash flow from operations and positive net income, MEDY will
continue to direct it's efforts  toward  reviewing and improving  product profit
margins,  and  increasing  revenues from the sale of products with higher profit
margins such as those now offered by CADI.

     To continue MEDY's objective of curtailing operating losses,  negative cash
flow from operations and further  liquidity  erosion,  management is continually
reviewing product profit margins and general expense  accounts,  and will reduce
or eliminate all non-essential  expenditures.  Purchasing procedures are also in
place to ensure minimized  product costs and to avoid excess  inventory  levels.
The company also entered into a revised  license  agreement with Dr. Edwin Adair
during fiscal 1997 resulting in reduced patent  maintenance and other associated
costs as well as eliminating minimum royalty payments.

     The Company  anticipates  negative cash flow from  operations for the first
and second quarters of fiscal 1999 and possibly beyond. During fiscal 1998, cash
flow deficits were funded by the sale of convertible  debentures.  The Company's
ability  to  fund  its  future  operations  will  be  dependent  upon  achieving
profitability,  generating  positive  cash flow from  operations  or by  raising
additional debt or equity.  Unless the Company is able to accomplish one or more
of the above, it may be facing significant  working capital shortages  beginning
in fiscal  1999.  Management  of the Company  does not believe that its existing
capital  resources  are  sufficient  for the 1999 fiscal year if it continues to
grow revenues and expenses in proportion  to what it  experienced  during fiscal
1998. To not interrupt that continuing  growth, the Company is currently seeking
additional  debt or equity  capital to augment  its  working  capital  position,
although no assurances can be made as to the availability of such debt or equity
capital  or if it can be  obtained  at  prices  and  terms  that are in the best
interest of the Company  and its  shareholders.  If the Company is able to raise
additional  debt or equity  capital,  it would allow the the Company to fund its
operating losses until such time as its expanded  efforts in marketing,  R&D and
acquisitions  continues to increase  revenues to a level of break even cash flow
or profitability, although no assurance of that fact can be given.

     If the Company is not able to obtain  additional  debt or equity capital it
will  most  likely  need  to  reduce  the  size  and  operating  expense  of the
organization in the form of personnel and facilities in order to slow its growth
and downsize the operation to such an extent that it can continue to operate off
its own  internally  generated  cash flow.  No assurance  can be given as to the
success of such measures or whether they could be  accomplished  in a time frame
that would allow the Company to remain an ongoing entity.

                                       19

<PAGE>


Results  of  Operations.  As  previously  discussed,  MEDY has made  significant
changes to its  operations in fiscal 1998.  With the purchases of CADI,  IPS and
Command,  MEDY has added  several new  product  lines,  such as dental  practice
management software, software support, multi-operatory video / digital networks,
and digital  x-ray  systems.  MEDY has also used these  purchases to enhance the
sales of its dental  cameras.  These new product  lines have  greatly  increased
MEDY's gross  profits as these new product lines have greater gross margins than
the products MEDY sold prior to the acquisitions.

     Additionally,  as an aid  to  understanding  trends  of  the  Company,  the
following  ratios  describe  historical  summaries  of  liquidity,  activity and
profitability for the fiscal years ended September 30, 1998 and 1997.

                                                    1998               1997
                                                    ----               ----
Liquidity
----------
Current Ratio                                        1.2               4.6
Current Ratio less inventory                         0.8               2.8

Activity
--------
Trade receivables turnover                           8.9               7.7
Inventory turnover                                   8.9               1.4

Profitability
-------------
Return on assets                                   (27.5)%           (80.8)%
Return on equity                                   (46.1)%           (100.1)%
Return on sales                                    (32.1)%           (157.5)%


Revenue.  Software,  Training and  Installation  sales were  $2,906,900  for the
fiscal years ended  September  30, 1998.  Software  Support sales for the fiscal
years  ended  September  30,  1998  were  $1,831,300.  All of these  sales  were
attributable  to CADI  (as an  integrated  subsidiary  - CADI,  IPS &  Command),
therefore,  there were no  software,  training,  installation  or support  sales
during the comparable period of fiscal 1997.

     Medical  product  sales for the fiscal years ended  September  30, 1998 and
1997 were $271,800 and $297,900 respectively, for a decrease of $26,100 or 8.8%.
Medical  product  sales  account  for 30.3% of total  sales in fiscal  year 1997
whereas in fiscal  year 1998  medical  products  account  for only 3.5% of total
revenue.

     Dental  sales for the fiscal years ended  September  30, 1998 and 1997 were
$2,836,700 and $684,900  respectively,  for an increase of $2,151,800 or 314.2%.
The  increase  in  sales  was due to  MEDY's  sale of  dental  related  computer
hardware,  intra oral cameras,  multi-operatory  video / digital  networks,  and
digital x-ray systems ("hardware"), which, other than intra oral cameras are new
product lines  resulting from the  acquisition  of IPS, CADI and Command.  Other
than intra oral  camera  sales  there were no sales of dental  related  hardware
during the comparable period of fiscal 1997.

                                       20

<PAGE>


     MEDY management  believes that profit from these activities will improve as
MEDY's  general and  administrative  expenses  are spread  over an  increasingly
larger revenue base.  There can be no assurance these positive changes will ever
result in an  increase  in cash flow from  MEDY's  operations  or net income (as
compared to MEDY's historical net losses).


Please refer to the schedule below for a summary of revenues and gross profit.
<TABLE>
<CAPTION>

                                                                   For The Years Ended September 30,
                                                   1998                                   1997
                                                  Amount                 %               Amount              %
                                               -----------             -----          -----------         ------
<S>                                            <C>                     <C>            <C>                  <C>   
Medical Sales                                  $   271,800             100.0%         $   297,900          100.0%
COGS - Medical Sales                               246,300              90.6%             715,300          240.1%
Gross Profit - Medical Sales                        25,500               9.4%            (417,400)        (140.1)%

Dental Equipment Sales                           2,836,700             100.0%             684,900          100.0%
COGS - Dental                                    2,542,100              89.6%             580,200           84.7%
Gross Profit -  Dental                             294,600              10.4%             104,700           15.3%

Software, Training & Installation                2,906,900             100.0%                --              N/A
COGS - S, T & I                                    687,200              23.6%                --              N/A
Gross Profit - S, T & I                          2,219,700              76.4%                --              N/A

Software Support Sales                           1,831,300             100.0%                --              N/A
COGS - Software Support                            583,200              31.8%                --              N/A
Gross Profit - Software Support                  1,248,100              68.2%                --              N/A

Total Sales                                    $ 7,846,700             100.0%         $   982,800          100.0%
Total COGS                                       4,058,800              51.7%           1,295,500          131.1%
Total Gross Profit                               3,787,900              48.3%            (312,700)         (31.8)%
</TABLE>


Cost of Sales.  Cost of sales for medical  products  for the fiscal  years ended
September  30, 1998 and 1997 as a percent of gross  medical sales were 90.6% and
240.1%  respectively.  The  decrease  in the  cost of  sales  percentage  is due
primarily  to an obsolete  inventory  reserve  adjustment  of  $346,800  and the
application  of under  applied  overhead  of  $290,800  in the fiscal year ended
September 30, 1997, as opposed to an obsolete  inventory  reserve  adjustment of
$50,100 and the  application of under applied  overhead of $37,800 in the fiscal
year ended September 30, 1998.

                                       21

<PAGE>


     Cost of sales for dental  equipment  for the year ended  September 30, 1998
and 1997, as a percent of gross dental sales were 89.6% and 84.7%  respectively.
The 4.9%  increase in cost of sales is  attributable  to an increase in warranty
reserve  expense of $20,000 and a  different  dental  equipment  product mix for
fiscal 1998.

     Cost of sales for Software,  Training and  Installation  for the year ended
September 30, 1998, as a percent of gross  Software,  Training and  Installation
sales were 23.9%, resulting in a gross margin percentage of 76.1%. There were no
Software,  Training and  Installation  sales in the comparable  fiscal period in
1997.

     Cost of sales for Software  Support for the fiscal year ended September 30,
1998, as a percent of gross  Software  Support sales were 31.4%,  resulting in a
gross margin  percentage  of 68.6%.  The major  components  of Cost of Sales for
software  support consist of software support wages of $278,200 and amortization
of technical support contracts of $305,000. There were no software support sales
in the comparable fiscal period in 1997.

Selling & Marketing.  Selling and marketing  expenses for the fiscal years ended
September 30, 1998 and 1997 were  $2,078,900 and $144,600  respectively,  for an
increase of $1,934,900 or 1,337.7%.  The  acquisitions  of CADI, IPS and Command
and their  related  selling and marketing  costs account for  $1,974,600 of this
increase while MEDY's selling and marketing  costs  decreased  $(39,700) for the
same period.

General & Administrative  Expenses (G & A). General and administrative  expenses
for the fiscal  years  ended  1998 and 1997 were  approximately  $3,932,800  and
$846,500 respectively, for an increase of $3,086,300 or 364.6%. The acquisitions
of CADI,  IPS and Command and their related  expense  streams,  as well as their
depreciation  and  amortization,  account  for  $3,264,400  of the  total  G & A
expenses,  while MEDY's G & A expenses decreased $(178,100) for the same period.
The major  components of G & A expenses for the fiscal year ended  September 30,
1998  are  employee   wages  and  benefits  of   $2,541,700   or  56.7%,   rent-
building/storage of $398,400 or 8.9%, and telephone expense of $352,200 or 7.9%.

Stock-based Compensation. Stock-based compensation for the fiscal years 1998 and
1997 were  $33,900  and  $109,400,  respectively,  for a decrease  of $75,500 or
69.0%. The decrease is due to a decrease in stock options granted to consultants
in fiscal 1998 as compared with the vesting of stock  options  granted in fiscal
1997.

                                       22

<PAGE>

Research &  Development  Costs (R & D). For the fiscal year ended  September 30,
1998 and  1997,  R & D costs  were  $46,700  and  $200,300  respectively,  for a
decrease of $153,600 or 76.7%. The decrease from fiscal 1997 to fiscal 1998 is a
result of the R&D and  modifications  to the  design of the  intra  oral  camera
having been  substantially  completed in fiscal 1997. The Company's policy is to
fund  research and  development  as it deems  appropriate  to maintain or gain a
competitive advantage. Note that all software development costs are not included
in R & D costs.  Qualifying  software  development  costs are  capitalized  then
amortized  to costs of sales.  Capitalized  software  development  costs for the
fiscal year ended September 30, 1998 were $268,200.

Loss on  Impairment  of  Demonstration  Equipment.  For the  fiscal  year  ended
September 30, 1998, no impairment  was recognized  for  demonstration  equipment
compared  to fiscal 1997 when a charge of $70,600 was  recognized  for  impaired
medical products.

Other  Income:  Other income for the fiscal years ended  September  30, 1998 and
1997 was  approximately  $51,200  and  $81,300  respectively,  for a decrease of
$30,100  or 37.0%.  The  majority  of the  decrease  is due to a drop in product
service  revenue (  billable  product  repair)  and other  income  derived  from
outsourcing engineering services.

Interest  Income and  Expense.  Interest  income is a function  of current  cash
invested for the period. Interest income for the fiscal year ended September 30,
1998 and 1997 was $37,400 and $55,000  respectively.  The  reduction in interest
income in fiscal 1998 was due to lower interest rates and less funds invested.

     Interest  expense for the fiscal  year ended  September  30,  1998  totaled
$305,700 as compared to $200 for fiscal  1997.  Interest  expense  increased  in
fiscal  1998  due to  $2,200,000  in  borrowings  from  convertible  debentures,
$933,200 of debt incurred in business acquisitions and a capital lease financing
for  $87,600.  Interest  was  imputed  at an  effective  rate  of  15%  for  the
acquisition debt. Interest expense includes non-cash charges for amortization of
debt discounts and issue costs of $166,000,  and accrued  interest  converted to
common stock for $35,800.

Year  2000  Compliance.  Although  there  can be no  assurance,  MEDY  does  not
anticipate that it will suffer any adverse impact as a result of Year 2000 (Y2k)
computer software issues either as a result of third party  non-compliance or as
a result  of  internal  matters.  None of the  information  technology  or other
software and hardware systems utilized by MEDY and its subsidiaries incorporates
technology  that is incapable  of  recognizing  dates beyond  December 31, 1999.
CADI,  through its internal staff, has developed its dental practice  management
software for the Windows platform and,  consequently,  such software  recognizes
dates beyond  December 31, 1999.  While CADI is still  supporting  some software
which is DOS-based or otherwise may not be Y2k  compliant,  the customers  using
this software  have been advised of their need to upgrade their office  software
in  anticipation  of Y2k.  Even if MEDY or CADI were to  provide  the  necessary
software  upgrade to these  customers  at no cost  (which  CADI does not have an
obligation  to do), the total loss to MEDY would be less than $60,000 and is not
considered to be material. Because CADI's dental practice management software is
believed  to be Y2k  compliant,  CADI and MEDY  believe  that this offers them a
marketing  opportunity  in that much of their  competitors'  software  currently
being  utilized  by  dental  offices  is not Y2k  compliant  and will need to be
replaced by those offices before  December 31, 1999.  There can be no assurance,
however, that these offices will all purchase dental practice management systems
from CADI.

                                       23

<PAGE>


     In making the foregoing determination, MEDY and CADI have assessed embedded
systems   contained   in  their   office   buildings,   equipment,   and   other
infrastructures.  As a result,  MEDY and CADI have not established a contingency
plan to come into effect in the event of a Y2k  catastrophe  and management does
not believe  that such a plan is  necessary.  Of course,  MEDY and CADI are both
dependant on  facilities  outside of their  control,  such as  electrical  power
supplies,  banking facilities,  transportation facilities (such as airlines) and
communication  facilities.  While MEDY and CADI believe, based on public reports
and some  notifications  it has received,  that these outside  facilities are or
will be Y2k compliant,  neither MEDY or CADI has any other basis for determining
their  compliance.  The operations of MEDY and CADI would be  significantly  and
adversely  affected if any of these outside facilities are adversely affected by
the millenium and other issues related to Y2k.

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 (Page F-2)

    Consolidated Balance Sheet - September 30, 1998 (Page F3)

    Consolidated  Statements of Operations - Years ended  September 30, 1998 and
    1997 (Page F4)

    Consolidated  Statements of Stockholders' Equity - Years ended September 30,
    1998 and 1997 (Page F5)

    Consolidated  Statements of Cash Flows - Years ended  September 30, 1998 and
    1997 (Page F7)

    Notes to Consolidated Financial Statements (Page F8)

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

Not Applicable.

                                       24

<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:
<TABLE>
<CAPTION>

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

<S>                                  <C>        <C>                                                   
Edwin L. Adair, M.D. (1)             68         Chairman of the Board and Treasurer of MEDY

Van A. Horsley (2)                   46         Director,   President,   Chief  Financial  Officer  and
                                                Chief  Executive  Officer  of MEDY;  Director  and Vice
                                                President of CADI

Daniel L. Richmond                   37         Director  of  MEDY;   Director   and  Chief   Executive
                                                Officer of CADI

Chae U. Kim                          37         Director of MEDY; Director and President of CADI

Edward L. Boggs                      43         Controller of MEDY, CADI

Pat Horsley Adair (1)                70         Director and Secretary of MEDY

I. Dean Bayne, M.D. (2)              71         Director and Assistant Secretary of MEDY

Leroy Bilanich (2)                   48         Director of MEDY

R. Scott McLaughlin                  52         Vice President, National Sales Manager, CADI

Don C. Jackson                       50         Vice President, Hardware Product Development
                                                and Technical Services, CADI
</TABLE>

(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.  All directors  were  reelected by the
shareholders at a meeting held in June, 1998.

                                       25

<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.

Van A. Horsley has been a director,  President  and Chief  Executive  Officer of
MEDY since July 13, 1990.  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.

Edward L. Boggs has been  Controller  since August 1997.  Mr. Boggs holds a B.S.
degree in accounting conferred from Rollins College,  Winter Park, Florida. From
1982 to 1987 Mr. Boggs held the position of  Supervisor  Financial  Planning and
Analysis for  Presbyterian/St.  Luke's Hospitals and most recently as Controller
for Specialty Healthcare Management until its sale to Horizon Mental Healthcare,
Inc.  Mr.  Boggs  has  been in the  Healthcare  Industry  in  various  financial
capacities  since his internship at Orange County  Memorial  hospital during his
senior year of college.

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.

                                       26

<PAGE>


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.

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.

R. Scott McLaughlin has been an officer since February, 1998. Since 1990, and up
until  its  acquisition  by  CADI,  Mr.  McLaughlin  has been a  shareholder  in
Information  Presentation Services,  Inc. Prior to that, Mr. McLaughlin was with
Unisys  Corporation and its  predecessor  company,  the Oakleaf  Corporation for
eleven years in sales management,  and previously General Motors Corporation for
eleven years in financial  analysis.  Mr. McLaughlin  attended the University of
South Florida in 1966 through 1967.

Don C.  Jackson  has been an  officer  since  February,  1998 and was the  other
shareholder of Information  Presentation Systems, Inc. since its inception.  Mr.
Jackson was  Southeast  Vice  President  of the auto  division of Unisys and its
predecessor,  Oakleaf,  for  approximately  twelve years  before 1990.  While at
Oakleaf,  before its  purchase by Unisys,  Mr.  Jackson was the  Executive  Vice
President  of  Oakleaf  at a  time  when  that  corporation  grew  from  six  to
approximately  400 employees.  Mr. Jackson obtained a Bachelor of Science degree
in Electrical Engineering from Wayne State University in 1972.

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

                                       27

<PAGE>


     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.

     (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, 1997 through December 1, 1998 all filing  requirements  applicable to
its officers,  directors and greater than ten-percent shareholders were complied
with.

                                       28
<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 ending  September  30,
1998 and to the other  executive  officers  whose  salary  exceeded  $100,000 in
fiscal 1998.  Messrs.  Kim and  Richmond,  included in the  following  table for
fiscal 1998, were not employees of MEDY during the previous two fiscal years.
<TABLE>
<CAPTION>

                                       Annual Compensation ($$)                          Long Term Compensation
                                       ------------------------                          ----------------------
                                                                                   Awards                     Payouts
                                                                                   ------                     -------
             (a)                (b)       (c)         (d)        (e)         (f)           (g)         (h)           (i)
Name and Position                                                       
-----------------                                                         Restricted
                                                                            Stock        Options       LTIP         Other
                                        Salary      Bonus      Other       Awards        & SARs     Payouts     Compensation
                                        ------      -----      -----       ------        ------     -------     ------------
                                Year     ($$)       ($$)       ($$)         ($$)          ($$)        ($$)          ($$)
                                ----
<S>                             <C>     <C>            <C>      <C>           <C>           <C>         <C>          <C>
Van A. Horsley, President &     1998    123,333        0        5,465         0             0*          0            306
Chief Executive Officer
                                1997    110,000        0          0           0             0*          0            272
                                1996    105,000        0         925          0          237,174*       0            260

Chae U. Kim, Director and       1998    105,000        0       $6,000         0         600,000**       0           1,393
President of CADI

Dan L. Richmond, Director       1998    105,000        0       $6,000         0         600,000**       0           1,400
and CEO of CADI
</TABLE>


* 100,000 options vested in 1998 were originally  granted to Mr. Horsley in 1996
and,  therefore are not included in the foregoing table..  These include options
to acquire 50,000 shares  exercisable at $2.75 and 50,000 shares  exercisable at
$3.00. Does not include options to acquire 50,000 shares  exercisable at a price
of $3.75 per share which vest based upon defined performance goals.

**  600,000  options  to  purchase  common  stock  were  granted in 1998 and are
exercisable  at $3.25.  150,000  of the  options  vested in fiscal  1998 and are
currently exercisable.  450,000 shares,  exercisable at $3.25, vest upon defined
performance goals.

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, 1998, MEDY's
matching  contributions  to the plan for the  accounts  of Van  Horsley  totaled
approximately $306 and the matching contribution under the plan for the accounts
of all executive officers as a group totaled $420. These amounts are included in
column (i) of the Summary Compensation Table.

                                       29

<PAGE>


     When acquired, CADI had a Salary Reduction Simplified Employee Pension Plan
(SARSEP) in place whereby CADI  employees were able to defer  compensation  into
the Plan and CADI would match 20% of the employee's contributions.  At September
30, 1998,  CADI's matching  contributions  to the Plan for the accounts Chae Kim
and Dan Richmond  totaled  approximately  $2,793.  These amounts are included in
column (I) of the Summary  Compensation  Table.  Effective December 1, 1998 CADI
canceled the SARSEP plan and is in the process of adopting a 401-K plan.

Employment  Agreements.  Effective October 1, 1997 CADI, in conjunction with its
purchase by MEDY, 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. Compensation and benefits
may be increased over and above  contractual  terms upon the approval of the CEO
of MEDY.  Effective  February 1, 1998,  CADI, in conjunction  with CADI's merger
with IPS, entered into employment  agreements with Scott McLaughlin (VP of CADI)
and Don Jackson (VP of CADI). The term of the agreements are five years and call
for annual base salaries of $75,000,  use of company  leased  automobiles  until
lease  expiration  then car  allowances  of $500 per month  and  other  benefits
customarily  extended to other CADI employees.  In addition to base salary,  Mr.
McLaughlin is entitled to commissions on sales of CADI products equal to .75% up
to certain  quarterly  limits and .5% over those limits.  The benchmarks for the
quarters in which Mr.  McLaughlin was employed are $1,400,000  through March 31,
$1,600,000  through June 30, and  $1,300,000  through  September  30,  1998.  In
addition to base salary Mr. Jackson was entitled to commissions on sales of CADI
hardware only products  equal to 1%. In both Mr.  McLaughlin  and Mr.  Jackson's
case,  the terms of their  commissions  are to be reset  each  October 1 for the
following year.

     (b) Stock Option Plans.

Options and Option Plans.  On April 10, 1988 the Board of Directors  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.  The 1988 Plan has expired by its
terms.

     On September  15, 1997 the Board of Directors  in  conjunction  with MEDY's
purchase of Computer  Age Dentist,  Inc,  approved the CADI Stock Option Plan as
called for by the merger agreement. 250,000 shares of the Company's common stock
were  reserved  for  issuance  upon  exercise  of  options  which may be granted
pursuant to the  Employee  Stock Option  Plan.  As of December 9, 1998,  232,000
options have been issued to  employees  of CADI who are not  officers  under the
plan.

     On June 11, 1998 the  shareholders  of MEDY  approved  the  adoption of the
Medical Dynamics, Inc. 1998 Stock Option Plan. Under the plan as approved by the
Board of  Directors  and the  shareholders,  1,500,000  shares are  reserved for
issuance to employees,  officers,  directors and consultants of Medical Dynamics
and its subsidiaries.  As of December 9, 1998, no options have been issued under
this plan.

                                       30

<PAGE>


     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 and (or) 1998 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 MEDY's  plans 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.

     The following table sets forth certain information  regarding stock options
granted by MEDY to the Chief Executive Officer and the other executive  officers
that received  total annual salary and bonus in excess of $100,000  during 1998.
No stock appreciation rights were granted.

                                       31


<PAGE>

<TABLE>
<CAPTION>


Option Grants in Fiscal 1998
----------------------------
          (a)                     (b)                    (c)                    (d)                     (e)
                               Number of         % of Total Options
                               Securities       Granted to Employees        Exercise or
                               underlying                in                  Base Price             Expiration
Name                            Options              Fiscal Year               ($/sh)                  Date
                              Granted (#)
---------------               -----------       ---------------------       -----------             -----------
<S>                             <C>                     <C>                    <C>                  <C> 
Dan L. Richmond                 150,000                 5.6%                   $3.25                 Oct. 2004
Dan L. Richmond                 450,000                 16.9%                  $3.25                 Oct. 2004
Chae U. Kim                     150,000                 5.6%                   $3.25                 Oct. 2004
Chae U. Kim                     450,000                 16.9%                  $3.25                 Oct. 2004
</TABLE>


Options for 450,000  shares for Dan L.  Richmond  and Chae U. Kim will vest when
certain revenue and cash flow performance targets are met.

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 1998 fiscal  year as well as the  year-end  value of options  held by
such  persons on  September  30, 1998:  No Stock  Appreciation  Rights have been
granted, or are held by, any such person:
<TABLE>
<CAPTION>

            (a)                      (b)                 (c)                   (d)                      (e)
                                                                      Number of Unexercised
                                                                        Options at FY End            Value of
                                                                          (Exercisable/        In-the-Money Options
                                   Shares                                Unexercisable)          at FY End @$2.31
                                 Acquired on            Value                                      (Exercisable/
Name                               Exercise           Realized                                    Unexercisable)
----                             -----------          --------                                    --------------
<S>                                   <C>                <C>            <C>                       <C>        
Van A. Horsley                        0                  $ 0            370,680 / 50,000           $ 142,637 / 0
Edwin L. Adair                        0                  $ 0               295,000/ 0              $ 157,200 / 0
Pat H. Adair                          0                  $ 0                  0 / 0                   $ 0 / 0
Edward L. Boggs                       0                  $ 0             14,800 / 30,000              $ 0 / 0
I. Dean Bayne                         0                  $ 0             20,000 / 20,000              $ 0 / 0
Leroy Bilanich                        0                  $ 0             20,000 / 20,000         $ 16,200 / $6,200
Chae U. Kim                           0                  $ 0            150,000 / 450,000             $ 0 / 0
Dan L. Richmond                       0                  $ 0            150,000 / 450,000             $ 0 / 0
Don C. Jackson                        0                  $ 0               0 / 340,000                $ 0 / 0
R. Scott McLaughlin                   0                  $ 0               0 / 340,000                $ 0 / 0
</TABLE>

     (c) MEDY has no long term incentive compensation plans.

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

                                       32

<PAGE>


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

     The Company  has adopted a medical  insurance  plan for its  employees  and
provides access to other types of coverage such as life,  disability,  and other
insurance plans for the benefit of its employees, but at the employees expense.

     (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 June 1993,  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 1998 to board members other than as
disclosed above regarding options issued to Dan Richmond and Chae Kim.

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 and $0 has been  accrued to Dr.  Adair
through the end of fiscal 1998.  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.

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

     (f) Employee Contracts and Change of Control Provisions

     MEDY has employment contracts with four executive officers as was described
in Item 10, Executive Compensation.  MEDY has no compensatory  arrangement which
may  result  from a  change-of-control  of MEDY  or a  change  in any  executive
officers responsibilities.  However, the contracts for both Mr. Richmond and Mr.
Kim are terminable for cause by either if they are not reelected to CADI's Board
of  Directors  or if CADI's  Board is incresed in number other than by a vote of
the Directors.

                                       33

<PAGE>


     (g) Repricing of Options

     No options were repriced during the fiscal year.



                                       34


<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,  1998,  MEDY had only one  class of  outstanding  voting
securities,  its common stock. The following table sets forth  information as of
December 15, 1998 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.

<TABLE>
<CAPTION>


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

Edwin L. Adair, M.D. and
<S>                                      <C>                           <C>  
Pat Horsley Adair                        1,239,298 (2)                     11.7%
317 Paragon Way
Castle Pines Village
Colorado, 80104

Daniel L. Richmond                         797,760 (4)                      7.7%
17052 Oak View Drive
Encino, CA. 91436

Chae U. Kim                                797,760 (4)                      7.7%
3231 Cheviot Vista Place
Los Angeles, CA. 90034

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

Van A. Horsley                             405,586 (3)                      3.8%

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

All officers and directors as a
 group (10 persons)                      3,625,204 (5)                     33.2%

</TABLE>

* Percent  of class  based upon  shares  outstanding  on  December  15,  1998 of
10,317,573.

(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 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.

                                       35

<PAGE>


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

(3) Includes 320,680 shares under presently  exercisable stock options. Does not
include  options to acquire  50,000 shares  exercisable  at a price of $3.75 per
share which vest based upon defined performance goals.

(4) Does not include  options to acquire  450,000  shares  exercisable  at $3.25
 which vest upon defined performance goals.

(5) Includes shares  referenced in notes (2) through (5) and 320,000 shares held
by two  officers  and  14,800  options  held by one  officer,  all of which  are
presently  exercisable,  who are not  directors.  Does not  include  options  to
acquire 340,000 shares  exercisable at strike prices ranging from $3.00 to $5.00
per share which vest upon defined performance goals held by two officers who are
not directors.

     (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 MEDY as
could have been obtained from an independent  person,  and the  transaction  was
approved  by the  disinterested  directors.  MEDY will  continue  to follow this
procedure  in  approving  any  transactions  with  affiliated  persons.  No such
transactions are contemplated at this time.

Acquisition  of Computer  Age  Dentist,  Inc.  Effective  October 1, 1997,  MEDY
purchased all of the  outstanding  stock of Computer Age Dentist,  Inc. of which
Dan Richmond and Chae Kim were the majority  owners.  It was as a result of that
transaction that Mr. Richmond and Mr. Kim became  Directors of the Company.  The
business of CADI is further described in Item 1.

     The acquisition was accomplished pursuant to a reverse triangular merger by
which MEDY paid the two former  shareholders  of CADI:  1,295,520  shares of its
restricted common stock,  promissory notes aggregating $300,000, and $254,697 in
cash.  In  addition,  MEDY  assumed  certain  obligations  of CADI  to a  former
shareholder  and satisfied  such  obligations  by paying the former  shareholder
304,480  shares of  restricted  common  stock,  $45,303 in cash, and a  $100,000
promissory note.

                                       36

<PAGE>


     The promissory  notes were  originally  due, in full, no later than October
23, 1998. Subsequent to fiscal year end 1998, the note to the former shareholder
has been  paid in full.  The note to Mr.  Richmond  in the  original  amount  of
$150,000,  was  extended  to include  interest  owing of $12,000  for a total of
$162,000 until July 1, 1999 at an interest rate of 12%.  Payments on the note of
$87,000 were due November 15, 1998 and $12,500 plus accrued  interest  beginning
February 1, 1999 and monthly  thereafter  until paid. The payment of $87,000 due
November 15, 1998 has been made.  The note to Mr. Kim in the original  amount of
$150,000,  was  extended  to include  interest  owing of $12,000  for a total of
$162,000  until August 1, 1999 at an interest rate of 12%.  Payments on the note
of $12,000  were due on November 15,  1998,  $75,000  plus  accrued  interest on
February 1, 1999 with the balance of principal and interest due at maturity. The
payment of $12,000 due November 15, 1998 has been made.

     There  was no  prior  relationship  between  MEDY  and  either  CADI or its
shareholders.  As a result of the acquisition, the two former CADI shareholders,
Dan Richmond and Chae Kim, were named to the Board of Directors of MEDY.  MEDY's
president and Chief Executive Officer,  Van Horsley,  became a Director and Vice
President of CADI.

     In acquiring CADI, MEDY also acquired cash, trade receivables, inventories,
and  personal  property  and  equipment  owned  by  CADI.  At  the  time  of the
acquisition,  CADI employed  approximately  40 people including the priincipals,
Dan Richmond and Chae Kim. In the opinion of MEDY's management,  the fundamental
source of value obtained was CADI's  software  technology  which includes source
code,  development  costs  and the  potential  for  future  sales of the  dental
practice  management  software,  as well as  CADI's  current  technical  support
contracts with its customers.  At the time of purchase,  CADI had a base of more
than 2,200  customer  installations  throughout  the United  States,  serving in
excess of 3,500 dental professionals.

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
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").

                                       37

<PAGE>


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 at a discount to the list price it has already  sold to third
parties. The distribution agreement is attached as exhibit 10.16(*).

     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, 1998,  MEDY
purchased no products from MMD, and MMD has not needed any leased space.

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

     In October 1987, I. Dean Bayne,  M.D., a director,  assigned his rights and
interest in a then pending patent application related to the Bayne Pap Brush(TM)
described in "Item 1 - Business -Patents, Trademarks and Licenses." To reimburse
him for his  expenses in  developing  that product and as  compensation  for the
assignment,  MEDY paid Dr. Bayne 10,000  shares of  restricted  common stock and
will pay him a royalty for the  duration  of the patent  equal to two percent of
the net sales of the Bayne Pap Brush(TM), less certain expenses. As of September
30,  1998,  no royalties  have been accrued or paid since the  inception of this
arrangement  and the  Bayne Pap  Brush  has been  discontinued  and has not been
marketed by the Company since 1992.

     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 $135,000.  The two
sons of Dr. Adair,  Jeff and Randy Adair operate as the Head of Engineering  and
Head of Regulatory Affairs and Quality Assurance,  respectively.  The son of Pat
Horsley  Adair,  Van  Horsley is the  Company's  president  and Chief  Executive
Officer  and a Director.  During the most  recently  completed  fiscal year Jeff
Adair vested 50,000 of previously issued options at exercise prices ranging from
$2.75 to $3.00 and Randy Adair vested  50,000 of  previously  issued  options at
exercise  prices  ranging from $2.75 to $3.00.  Van Horsley's  compensation  and
option issuance is described in detail in Item 10. Executive Compensation.

     Except as otherwise stated above,  since October 1, 1997, 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.

                                       38

<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

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

                                       39

<PAGE>


10.15(n)      401(k) Plan

10.16(*)      Micro Medical Distribution Agreement

10.17(*)      Employment Agreement with Dan Richmond

10.18(*)      Employment Agreement with Chae Kim

10.19(*)      Merchant Capital Agreement

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

23.1  *       Consent of Hein & Associates, LLP

27    *       Financial Data Schedule

*             Filed herewith.

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

(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.

                                       40

<PAGE>


(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.

 (b)  Reports on Form 8-K

     During  the period  covered  by this  Report up to  December  9, 1998,  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. December 31, 1997,  reporting an event under Item 5
         - other Events January 5, 1998, reporting an event under Item 5 - Other
         Events February 6, 1998,  reporting an event under Item 2 - Acquisition
         or Disposition of Assets April 9, 1998,  reporting and event under Item
         2 - Acquisition or  Disposition of Assets July 31, 1998,  reporting and
         event under Item 5 - Other Events  October 9, 1998,  reporting an event
         under Item 5 - Other Events


                                   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 29, 1998

     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.

                                       41

<PAGE>






January 12, 1999              /s/ Van A. Horsley
                              ----------------------------------
                              Van A. Horsley, Principal Executive Officer,
                              Principal Financial Officer, and Director

January 12, 1999              /s/ Edwin L. Adair
                              ----------------------------------
                              Edwin L. Adair, M.D., Chairman
                              of the Board and Director

January 12, 1999              /s/ Daniel L. Richmond
                              ----------------------------------
                              Daniel L. Richmond, Director

January 12, 1999              /s/ Chae U. Kim
                              ----------------------------------
                              Chae U. Kim, Director

January 12, 1999              /s/ I. Dean Bayne
                              ----------------------------------
                              I. Dean Bayne, M.D., Director

January 12, 1999              /s/ Pat Horsley Adair
                              ----------------------------------
                              Pat Horsley Adair, Director

January 12, 1999              /s/ Leroy Bilanich
                              ----------------------------------
                              Leroy Bilanich, Director

January 12, 1999              /s/ Edward Boggs
                              ----------------------------------
                              Edward Boggs, Controller and Principal Accounting
                              Officer

                                       42

<PAGE>



                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



                                                                          PAGE
                                                                          ----

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

Consolidated Balance Sheet - September 30, 1998............................F-3

Consolidated Statements of Operations - For the Years
      Ended September 30, 1998 and 1997....................................F-4

Consolidated Statements of Stockholders' Equity - For the Years
      Ended September 30, 1998 and 1997....................................F-5

Consolidated Statements of Cash Flows - For the Years
      Ended September 30, 1998 and 1997....................................F-6

Notes to Consolidated Financial Statements.................................F-8




                                       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 subsidiaries  (the "Company") as of September 30, 1998, and the related
consolidated statements of operations,  stockholders' equity, and cash flows for
the years ended September 30, 1998 and 1997. 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  subsidiaries  as of  September  30,  1998,  and the  results of their
operations and their cash flows for the years ended September 30, 1998 and 1997,
in conformity with generally accepted accounting principles.

The accompanying  consolidated  financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
financial  statements,  the Company has suffered  recurring  losses and negative
cash flows from operations.  This raises  substantial  doubt about the Company's
ability to continue as a going  concern.  Management's  plans in regard to these
matters are also  described in Note 2. The  financial  statements do not include
any adjustments that might result from the outcome of this uncertainty.



HEIN + ASSOCIATES LLP

Denver, Colorado
December 29, 1998



                                       F-2

<PAGE>
<TABLE>
<CAPTION>
                                         MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                                               CONSOLIDATED BALANCE SHEET
                                                   SEPTEMBER 30, 1998

                                                         ASSETS
                                                         ------
<S>                                                                                         <C>    
CURRENT ASSETS:
    Cash and equivalents                                                                    $    553,100
    Restricted cash                                                                               50,000
    Trade receivables, less allowance for doubtful accounts of $108,400                          879,400
    Inventories                                                                                  879,600
    Prepaid expenses and other                                                                    24,800
                                                                                            ------------
             Total current assets                                                              2,386,900

SOFTWARE DEVELOPMENT AND SUPPORT:
    Software development costs, net of accumulated amortization of $417,800                    2,619,800
    Technical support contracts, net of accumulated amortization of $305,000                   1,303,100
                                                                                            ------------
             Total software development and support                                            3,922,900

PROPERTY AND EQUIPMENT:
    Demonstration equipment                                                                      420,900
    Machinery and equipment                                                                      553,800
    Furniture and fixtures                                                                       355,200
    Leasehold improvements                                                                       127,000
                                                                                            ------------
                                                                                               1,456,900
    Less accumulated depreciation and amortization                                              (799,400)
                                                                                            ------------
         Property and equipment, net                                                             657,500

OTHER ASSETS:
    Goodwill, net of accumulated amortization of $120,800                                      1,892,300
    Non-compete agreements, net of accumulated amortization of $80,000                           119,200
    Debt issuance costs, net of accumulated amortization of $85,400                              125,400
    Patents and trademarks, net of accumulated amortization of $766,200                           29,200
    Deposits and other                                                                            37,000
                                                                                            ------------
             Total other assets                                                                2,203,100
                                                                                            ------------       
TOTAL ASSETS                                                                                $  9,170,400
                                                                                            ============

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

CURRENT LIABILITIES:
    Current maturities of notes payable                                                     $    546,100
    Current maturities of obligations under capital lease                                         40,000
    Accounts payable                                                                             565,800
    Accrued expenses                                                                             416,000
    Unearned revenue                                                                             370,100
                                                                                            ------------
             Total current liabilities                                                         1,938,000

NOTES PAYABLE, net                                                                               321,900

OBLIGATIONS UNDER CAPITAL LEASE, net                                                              39,400

CONVERTIBLE DEBENTURES, net                                                                    1,407,200

COMMITMENTS AND CONTINGENCIES (Notes 2, 5, and 8)

STOCKHOLDERS' EQUITY:
    Preferred stock, $.001 par value;  authorized  5,000,000 shares; none issued
    Common stock, $.001 par value; authorized 30,000,000 shares, issued and
         outstanding 10,034,500 shares                                                            10,000
    Additional paid-in capital                                                                25,246,900
    Accumulated deficit                                                                      (19,793,000)
                                                                                            ------------
             Total stockholders' equity                                                        5,463,900
                                                                                            ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                                  $  9,170,400
                                                                                            ============

                           See accompanying notes to these consolidated financial statements.

                                                           F-3
</TABLE>

<PAGE>
<TABLE>
<CAPTION>
                                   MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                                   CONSOLIDATED STATEMENTS OF OPERATIONS



                                                                      FOR THE YEARS ENDED
                                                                          SEPTEMBER 30,
                                                             -------------------------------------
                                                                 1998                      1997
                                                             -----------               -----------
<S>                                                          <C>                       <C>  
NET SALES:
    Dental products:
         Software, training, and installation                $ 2,906,900               $      --
         Equipment                                             2,836,700                   684,900
         Support services                                      1,831,300                      --
    Medical products                                             271,800                   297,900
                                                             -----------               -----------
                                                               7,846,700                   982,800
                                                             -----------               -----------
COST OF SALES:
    Dental products:
         Software, training, and installation                    687,200                      --
         Equipment                                             2,542,100                   580,200
         Support services                                        583,200                      --
    Medical products                                             246,300                   715,300
                                                             -----------               -----------
                                                               4,058,800                 1,295,500
                                                             -----------               -----------

GROSS PROFIT (LOSS)                                            3,787,900                  (312,700)
                                                             -----------               -----------

OPERATING EXPENSES:
    Selling and marketing                                      2,078,900                   144,600
    General and administrative                                 3,932,800                   846,500
    Stock-based compensation                                      33,900                   109,400
    Research and development                                      46,700                   200,300
    Loss on impairment of demonstration equipment                   --                      70,600
                                                             -----------               -----------
         Total operating expenses                              6,092,300                 1,371,400
                                                             -----------               -----------

OPERATING LOSS                                                (2,304,400)               (1,684,100)

OTHER INCOME (EXPENSE):
    Other income                                                  51,200                    81,300
    Interest income                                               37,400                    55,000
    Interest expense                                            (305,700)                     (200)
                                                             -----------               -----------

NET LOSS                                                     $(2,521,500)              $(1,548,000)
                                                             ===========               ===========

NET LOSS PER COMMON SHARE                                    $      (.27)              $      (.21)
                                                             ===========               ===========

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING                  9,512,200                 7,523,200
                                                             ===========               ===========


                  See accompanying notes to these consolidated financial statements.

                                                 F-4
</TABLE>

<PAGE>
<TABLE>
<CAPTION>
 
                                            MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                                        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                        FOR THE YEARS ENDED SEPTEMBER 30, 1998 AND 1997

                                                                              
                                            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, 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

    Issuance of common stock
     for acquisition of:
      Computer Age Dentist, Inc.       1,600,000        1,600      4,478,400            --         --          --         4,480,000
      Information Presentation Systems   320,000          300        687,900            --         --          --           688,200
      DOM, Inc.                          141,700          200        339,800            --         --          --           340,000
    Conversion of debentures to
     common stock:
      Principal, net of discount         315,700          300        602,600            --         --          --           602,900
      Accrued interest                    17,300         --           35,800            --         --          --            35,800
    Fair value of warrants issued
     for debt of discount                   --           --          223,000            --         --          --           223,000
    Proceeds from exercise of
     stock options                        12,500         --           34,400            --         --          --            34,400
    Attriution of compensation
     expense under stock options
     and warrants:
      Employees                             --           --            8,900            --         --          --             8,900
      Non-employees                         --           --           25,000            --         --          --            25,000
    Net loss                                --           --             --        (2,521,500)      --          --        (2,521,500)
                                      ----------    ---------   ------------    ------------    -------    --------    ------------

BALANCE, September 30, 1998           10,034,500    $  10,000   $ 25,246,900    $(19,793,000)      --      $   --      $  5,463,900
                                      ==========    =========   ============    ============    =======    ========    ============

                              See accompanying notes to these consolidated financial statements.

                                                              F-5
</TABLE>

<PAGE>
<TABLE>
<CAPTION>
                                         MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                                          CONSOLIDATED STATEMENTS OF CASH FLOWS

                                                                                       FOR THE YEARS ENDED
                                                                                          SEPTEMBER 30,
                                                                              ----------------------------------
                                                                                  1998                   1997
                                                                              -----------            -----------
<S>                                                                           <C>                    <C>  
CASH FLOWS FROM OPERATING ACTIVITIES:
    Net loss                                                                  $(2,521,500)           $(1,548,000)
    Adjustments to reconcile net loss to net cash used in
        operating activities:
            Common stock options granted for compensation                          33,900                109,400
              and other services
            Depreciation expense                                                   71,400                113,800
            Amortization of intangible assets                                     955,500                 59,500
            Amortization of debt discount and issuance costs                      166,000                   --
            Conversion of accrued interest on debentures to
                  common stock                                                     35,800                   --
            Bad debt expense                                                         --                   35,700
            Loss on impairment of demonstration equipment                            --                   70,600
            Provision for obsolete and slow-moving inventories                     50,100                346,800
            Changes in operating assets and liabilities, net of
                  effects of acquisitions:
                    Decrease (increase) in:
                     Trade receivables                                           (295,000)                18,400
                     Inventories                                                  (51,200)              (369,900)
                     Prepaid expenses and other                                    37,200                 (6,300)
                    Increase (decrease) in:
                     Accounts payable                                               9,800                 79,700
                     Accrued expenses                                             263,600                (20,400)
                     Unearned revenue                                               5,400                   --
                                                                              -----------            -----------
            Net cash used in operating activities                              (1,239,000)            (1,110,700)
                                                                              -----------            -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
    Increase in restricted cash                                                      --                  (40,000)
    Payments for acquisition of businesses, net of cash acquired                 (599,200)                  --
    Software development costs                                                   (238,100)
    Proceeds from sale of property and equipment                                   12,400                   --
    Purchase of property and equipment                                           (266,600)               (22,000)
    Other                                                                         (11,500)               (43,600)
                                                                              -----------            -----------
            Net cash used in investing activities                              (1,103,000)              (105,600)
                                                                              -----------            -----------



                        See accompanying notes to these consolidated financial statements.


                                                         F-6
<PAGE>

                             MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                              CONSOLIDATED STATEMENTS OF CASH FLOWS
                                           (continued)

                                                                                  FOR THE YEARS ENDED
                                                                                      SEPTEMBER 30,
                                                                            ----------------------------------
                                                                                1998                   1997
                                                                            ------------           -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
    Principal payments on:
        Notes payable                                                           (44,400)                  --
        Capital lease obligations                                                (8,200)                  --
    Proceeds from exercise of common stock options                               34,400              1,059,500
    Proceeds from issuance of convertible debentures                          1,989,300                   --
    Proceeds from capital lease financing                                        87,600                   --
                                                                            -----------            -----------
            Net cash provided by financing activities                         2,058,700              1,059,500
                                                                            -----------            -----------

NET DECREASE IN CASH AND EQUIVALENTS                                           (283,300)              (156,800)

CASH AND EQUIVALENTS, beginning of year                                         836,400                993,200
                                                                            -----------            -----------

CASH AND EQUIVALENTS, end of year                                           $   553,100            $   836,400
                                                                            ===========            ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION -
    Cash paid for interest                                                  $    13,300            $       200
                                                                            ===========            ===========

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
  FINANCING ACTIVITIES:
    Issuance of common stock for acquisition of business                    $ 5,508,200            $      --
                                                                            ===========            ===========

    Notes payable incurred for acquisition of businesses,
         net of discounts                                                   $   865,300            $      --
                                                                            ===========            ===========

    Conversion of debentures to common stock, net of discount               $   602,900            $      --
                                                                            ===========            ===========

    Fair value of warrants issued for debt discount                         $   223,000            $      --
                                                                            ===========            ===========

    Debt issuance costs incurred for convertible debentures                 $   210,800            $      --
                                                                            ===========            ===========

    Debt assumed in business acquisitions                                   $    67,900            $      --
                                                                            ===========            ===========

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

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

                             See accompanying notes to these consolidated financial statements.

                                                           F-7
</TABLE>

<PAGE>

                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   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.

     As a result of the October 1997 acquisition of Computer Age Dentist,  Inc.,
     the Company is engaged in the sale of dental practice  management  software
     and equipment.  The Company also provides related software  maintenance and
     support services.

     Principles of Consolidation - The consolidated financial statements include
     the accounts of the Company and its wholly-owned  subsidiaries,  MedPacific
     Corporation  and Computer Age Dentist,  Inc. All  significant  intercompany
     accounts  and  transactions   have  been  eliminated  in  the  accompanying
     consolidated financial statements.

     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  intangible  assets and property  and  equipment,  realization  of
     long-lived assets, and assumptions  affecting the valuation of common stock
     issued in business combinations,  and stock options and warrants 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, 1998, 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.


                                       F-8

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     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.

     Software  Development  Costs - The Company  capitalizes  costs of producing
     software to be sold, leased, or otherwise marketed,  incurred subsequent to
     establishing  technological  feasibility  in accordance  with  Statement of
     Financial Accounting Standards No. 86.

     Amortization  of capitalized  software  development  costs is computed on a
     product-by-product  basis.  The annual  amortization  is the greater of the
     amount  computed  using the ratio of current gross revenue for a product to
     the total of current and anticipated  future gross revenue for that product
     or the straight-line method, not to exceed 7 years. In addition, management
     periodically compares the unamortized capitalized costs for each product to
     the net realizable  value of that product.  If the unamortized  capitalized
     costs  exceed  the net  realizable  value,  the  excess  will be charged to
     operations.

     The total amount  charged to expense in the  statements of  operations  for
     amortization  of  capitalized  software costs was $417,800 and $-0- for the
     years ended September 30, 1998 and 1997,  respectively,  and is included in
     cost of sales.

     Costs incurred in  researching,  designing and planning for the development
     of new software are classified as research and development expenses and are
     charged to operations as incurred.

     Other Intangible  Assets - Other  intangible  assets are stated at cost and
     are  amortized  utilizing  the  straight-line  method  over  the  following
     estimated useful lives:


                                                             Years
                                                            --------
                  Technical support contracts                   5
                  Goodwill                                     15
                  Non-compete agreements                       2.5
                  Patents and trademarks                     3 - 10


     Debt Issuance Costs - Debt issuance costs are amortized  using the interest
     method over the term of the related debt.


                                       F-9

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     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 accrued  expenses in the  accompanying
     balance sheet.

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

     Advertising   -   Advertising   costs  are  expensed  the  first  time  the
     advertisement  is  run.  Total  advertising  costs  charged  to  operations
     amounted to $456,300 and $16,200 for the years ended September 30, 1998 and
     1997, respectively.

     Earnings Per Share - Net loss per common  share is presented in  accordance
     with the provisions of Statement of Financial Accounting Standards No. 128,
     Earnings Per Share (FAS 128). FAS 128 replaces the  presentation of primary
     and fully diluted  earnings per share (EPS),  with a presentation  of basic
     EPS and  diluted  EPS.  Under FAS 128,  basic  EPS  excludes  dilution  for
     potential  common  shares and is computed  by dividing  the net loss by the
     weighted average number of common shares  outstanding for the year. Diluted
     EPS reflects the potential dilution that could occur if securities or other
     contracts  to issue common  stock were  exercised or converted  into common
     stock and resulted in the issuance of common  stock.  Basic and diluted EPS
     are  the  same  in  1998  and  1997 as all  potential  common  shares  were
     antidilutive.

     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.  Revenue from the sale of the Company's  proprietary
     software is  recognized  when the software is delivered and the Company has
     substantially  performed  all  material  obligations  relating  to the sale
     agreement and collectibility is deemed probable by management. Revenue from
     software services is recognized  ratably over the contractual  period or as
     the services are performed.

     Unearned  revenue  primarily   represents  payments  received  on  deferred
     maintenance  contracts that has not been earned.  The amounts are amortized
     into  revenue on a monthly  basis using the  straight-line  method over the
     life of the contracts.

                                      F-10

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     Costs for maintenance and customer  support are charged to expense when the
     related  revenue is recognized or when those costs are incurred,  whichever
     occurs first.

     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). FAS 123
     requires that options,  warrants, and similar instruments which are granted
     to  non-employees  for goods and  services be recorded at fair value on the
     grant date.  Fair value is  generally  determined  under an option  pricing
     model using the  criteria  set forth in FAS 123.  The Company did not adopt
     FAS 123 to  account  for  stock-based  compensation  for  employees  but is
     subject to the pro forma disclosure requirements.

     Segment  Disclosures - Operating segments are components of a company about
     which  separate  financial  information  is  available  that  is  evaluated
     regularly by the chief operating  decisionmaker in deciding how to allocate
     resources and in assessing performance.  The only material segment that the
     Company  is  currently   engaged  in  is  the  dental   products   segment.
     Accordingly,   the  accompanying   financial   statements  do  not  include
     disclosures for the immaterial medical products segment.

     Reclassifications  - Certain amounts in the 1997 financial  statements have
     been   reclassified   to  conform   with  the  1998   presentation.   These
     reclassifications had no effect on the 1997 net loss.


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

     Through September 30, 1998, the Company has incurred 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.  As  discussed  in Note 4, the
     Company  completed  three  business  acquisitions  during  the  year  ended
     September 30, 1998. As a result of these  activities,  the Company realized
     an increase in sales in fiscal 1998 of approximately $6.9 million. However,
     despite  the  positive  impact of  increases  in  sales,  the  Company  has
     struggled to generate  adequate working capital to finance this growth.  At
     September  30,  1998,  the  Company had working  capital of  $448,900,  and
     management has devoted  substantial efforts to obtain additional capital to
     finance planned activities for fiscal 1999.

     As  discussed  further in Note 5, the Company was  successful  in obtaining
     additional  debt  financing of $800,000 in October  1998 and payment  terms
     were  extended  on  certain  notes  payable to  related  parties.  However,
     management believes additional capital is necessary to fund working capital
    

                                      F-11

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     requirements related to additional increases in sales which are expected in
     the forthcoming  year. The Company's ability to continue as a going concern
     is  dependent  on raising  additional  capital  and to  ultimately  achieve
     profitable operations and positive cash flows from operating activities.


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

     Inventories consist of the following at September 30, 1998:


     Raw materials and replacement parts                   $   313,900
     Finished goods                                            787,000
                                                           -----------
         Total inventory                                     1,100,900

     Less provision for obsolete and slow-moving
       inventory                                              (221,300)
                                                           -----------

         Net inventories                                   $   879,600
                                                           ===========


     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.


4. BUSINESS COMBINATIONS:
   ---------------------

     During the year ended  September  30,  1998,  the Company  completed  three
     acquisitions  of businesses  engaged in various  aspects of the development
     and sale of  practice  management  systems  for the dental  profession.  In
     October 1997, the Company acquired 100% of the outstanding  common stock of
     Computer Age Dentist,  Inc. (CADI).  CADI, which is located in Los Angeles,
     California,  is engaged  in the  design,  sale,  and  support  of  practice
     management  software  for the dental  profession.  The  Company  paid total
     consideration of $5,183,600 to acquire CADI, consisting of $334,300 in cash
     payments, $369,300 (net of discount) in notes payable, and 1,600,000 shares
     of the Company's common stock with an estimated fair value of $4,480,000.

     In February  1998,  the Company  completed the  acquisition  of 100% of the
     outstanding common stock of Information  Presentation  Systems, Inc. (IPS).
     IPS is  located  in  Marietta,  Georgia,  and is  engaged  in the  sale  of
     customized  multimedia  systems  for use in a variety  of dental  operatory
     applications.  The Company paid total  consideration of $888,200 to acquire
     IPS,  consisting of $200,000 in cash  payments,  and 320,000  shares of the
     Company's common stock with an estimated fair value of $688,200.

     In  April  1998,  the  Company  completed  the  acquisition  of 100% of the
     outstanding  common  stock  of DOM,  Inc.,  d/b/a  Command  Dental  Systems
     (Command). Command is located in Farmington Hills, Michigan, and is engaged
     in the development and sale of computer  software and hardware  systems for
     the management of dental practices. The Company paid total consideration of
     $719,600 to acquire  Command,  consisting of notes payable of $379,600 (net
     of  discount)  and 141,700  shares of the  Company's  common  stock with an
     estimated fair value of $340,000.


                                      F-12

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                     
     The acquisitions were accounted for using the purchase method of accounting
     for business combinations and, accordingly,  the accompanying  consolidated
     financial  statements  include the results of  operations  of the  acquired
     businesses since the respective dates of acquisition.  The Company recorded
     goodwill of approximately $1,024,500, $731,000, and $257,600 related to the
     acquisitions  of CADI, IPS, and Command,  respectively.  In connection with
     the  acquisitions,  IPS and Command  were merged into CADI.  The  following
     unaudited pro forma information  assumes that the acquisitions had occurred
     on October 1, 1996:

                                                 Years Ended September 30,
                                              -------------------------------
                                                 1998                1997
                                              -----------         -----------
           Revenue                            $ 9,327,000         $ 7,548,000
           Net loss                           $(2,478,000)        $(2,022,000)
           Net loss per share                 $      (.26)        $      (.21)


5. LONG-TERM LIABILITIES:
   ---------------------

     Convertible  Debentures - In October 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. 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.  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.  The  Company  received  net  proceeds of
     $986,000  from the  debentures,  after  paying  all  costs  related  to the
     issuance.  Through September 30, 1998, the holder had converted $660,000 of
     debentures to 315,700  shares of common stock.  In October 1998, the holder
     converted the remaining  $440,000 of debentures to 234,667 shares of common
     stock.

     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. The estimated fair value of
     this warrant of $120,000 was accounted for as a discount on the convertible
     debentures.

     In July 1998, the Company issued additional 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.  The principal  balance is due July 2003 and
     the holder of the debentures has the option to convert the debentures  into
     shares of the  Company's  common  stock  beginning in November  1998,  when
     

                                      F-13

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     one-third  of the  principal  balance may be  converted,  January 1999 when
     two-thirds may be converted,  and March 1999 when the entire balance may be
     converted.  Any unpaid  principal  and  interest  as of July 31,  2003 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.  The Company  received net
     proceeds of $1,003,000 from the debentures,  after paying all costs related
     to the issuance.

     The Company also granted the Debenture holder a warrant to purchase 110,000
     shares of the Company's common stock. The warrant is exercisable until July
     31, 2003 at an exercise  price of $2.58.  The estimated  fair value of this
     warrant of $100,000  was  accounted  for as a discount  on the  convertible
     debentures.

     At September 30, 1998, convertible debentures consist of the following:


      Interest at 8%, due October 2000, unsecured                   $  440,000
      Discount for fair value of warrant, net of accumulated           
        amortization of $14,700                                        (33,300)
                                                                    ----------
           Net                                                         406,700
                                                                    ----------
      Interest at 8%, due July 2003, unsecured                       1,100,000
      Discount for fair value of warrant, net of accumulated          
        amortization of $3,400                                         (99,500)
                                                                    ----------
           Net                                                       1,000,500
                                                                    ----------
            Convertible debentures                                  $1,407,200
                                                                    ==========

     In November 1998, the Company issued an additional  $400,000 of convertible
     debentures  with terms similar to the July 1998 issuance  described  above,
     except for a 3-month delay for the  principal  conversion  privileges.  The
     Company  also  agreed to issue an  additional  warrant  for  40,000  shares
     exercisable until November 2003 at an exercise price of $2.58 per share.

     Notes  Payable - At September  30,  1998,  long-term  debt  consists of the
     following:


      Notes payable to former shareholders of CADI:
       Interest at 8%, due October 1998, unsecured                 $   400,000
       Discount for below-market interest, net of accumulated             
        amortization of $28,000                                         (2,700)
                                                                   -----------
            Net                                                        397,300
                                                                   -----------
      Notes payable to former owners of Command:
       Interest at 6%, due April 2003, unsecured                       500,000
       Discount for below-market interest, net of accumulated            
        amortization of $17,900                                        (92,600)
                                                                   -----------
            Net                                                        407,400
                                                                   -----------
       Interest at 8.5%, due April 1999, unsecured                      40,600
       Discount for below-market interest, net of accumulated             
        amortization of $1,300                                            (900)
                                                                   -----------
            Net                                                         39,700
                                                                   -----------

                                      F-14

<PAGE>

                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



      Other                                                            23,600
                                                                    ---------
         Total notes payable                                          868,000

         Less current maturities                                     (546,100)
                                                                    ---------

         Notes payable, less current maturities                     $ 321,900
                                                                    =========

     The effective interest rate on the debt incurred under the notes payable to
     the former owners of CADI and Command was 15% to 16%.

     In October  1998,  the notes  payable to former  shareholders  of CADI were
     amended.  The interest rate was increased to 12% and the principal payments
     were deferred to November 1998 for $99,000,  February 1999 for $87,500, and
     the remaining balance is due by August 1999.

     Aggregate  Maturities - As of September 30, 1998,  aggregate  maturities of
     notes payable and convertible debentures are as follows:


     Year Ending September 30,         Principal       Discount         Net
     -------------------------         ---------       --------     ----------

             1999                    $  614,100       $ (68,000)    $  546,100
             2000                        75,000         (60,500)        14,500
             2001                       515,000         (41,300)       473,700
             2002                        75,000         (35,000)        40,000
             2003                     1,225,100         (24,200)     1,200,900
                                     ----------        --------     ----------

             Total                   $2,504,200       $(229,000)    $2,275,200
                                     ==========       =========     ==========


     Obligations  Under Capital Lease - In June 1998, the Company entered into a
     lease for computer  equipment  under an agreement  classified  as a capital
     lease. This equipment with a cost of $93,000, had accumulated  amortization
     of $9,300 as of September  30, 1998.  The following is a schedule of future
     minimum lease payments under this lease at September 30, 1998:


      Future minimum lease payments                                $  104,500
      Less amount representing interest                               (25,100)
                                                                   ----------
        Present value of net minimum lease payments                    79,400

      Less current maturities                                         (40,000)
                                                                   ----------

      Obligations  under capital  leases,  net of current
       maturities                                                  $   39,400
                                                                   ==========

                                      F-15

<PAGE>

                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     Future minimum lease payments under this lease are as follows:


      Year Ending September 30,      Principal        Interest          Total
      -------------------------      ---------        --------         --------

             1999                    $ 40,000         $ 19,700         $ 59,700
             2000                      39,400            5,400           44,800
                                     --------         --------         --------

             Total                   $ 79,400         $ 25,100         $104,500
                                     -=======         -=======         ========

     Line-of-Credit - In October 1998, the Company entered into a line-of-credit
     agreement with a commercial bank. The  line-of-credit  provides for maximum
     borrowings  of $1.0  million  with an initial  borrowing  base of $400,000.
     Borrowings are  collateralized by substantially all of the Company's assets
     and the  maturity  date is  October  2001.  The credit  agreement  contains
     various  covenants which limit or prohibit the Company from incurring debt,
     paying dividends,  and selling certain assets. The Company is also required
     to meet certain  minimum  financial  ratios  which the Company  violated in
     fiscal 1999.


6. STOCK-BASED COMPENSATION:
   ------------------------

     Stock  Option  Plan - The Company  has two stock  option  plans 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.  Under the first plan which was approved by
     shareholders  in October  1988,  an  aggregate  of  1,000,000  shares  were
     reserved for issuance  pursuant to the terms of the plan.  Under the second
     plan which was  approved by  shareholders  in June 1998,  an  aggregate  of
     1,500,000  shares were  reserved for issuance  pursuant to the terms of the
     plan. The maximum term is 10 years for options granted under both plans. No
     options have been granted  under the 1998 plan.  Activity in the 1988 stock
     option plan for the years ended September 30, 1998 and 1997 is as follows:

                                                      1988 Plan
                                              -----------------------------
                                                                Weighted
                                                                 Average
                                              Number of       Exercise Price
                                               Shares           Per Share
                                              ---------       --------------
      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
          Granted                                5,000              2.63
          Exercised                             (7,500)             2.75
          Canceled                              (2,000)             3.00
                                              --------
      Outstanding, September 30, 1998           57,200              1.74
                                              ========

                                      F-16

<PAGE>


     Options  available for future grant at September 30, 1998 totaled 1,500,000
     shares  under the 1998 plan.  No shares were  available  for future  grants
     under the 1988 plan.

     All options  outstanding  under the 1988 plan are vested at  September  30,
     1998. If not  previously  exercised,  options  outstanding at September 30,
     1998, will expire as follows:


                                                Number of        Exercise
      Year Ending September 30,                  Shares            Price
      -------------------------                 ---------        --------
            2001                                 37,200            $1.38
            2002                                 15,000             2.33
            2003                                  5,000             2.63
                                                 ------            -----

                                                 57,200             1.74
                                                 ======            =====


     Non-Qualified  Stock  Options and  Warrants - The Company has also  granted
     non-qualified stock options and warrants to officers, directors, employees,
     consultants, and lenders. The following is a summary of activity during the
     years ended September 30, 1998 and 1997:

                                                                     Weighted
                                                                      Average
                                                   Number of      Exercise Price
                                                    Shares           Per Share
                                                ------------      --------------
      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
          Granted to:
                 Employees                         2,358,200           3.48
                 Consultants                         300,000           4.42
                 Convertible debenture holders       194,600           2.93
          Canceled                                  (205,200)          3.22
          Exercised                                   (5,000)          2.75
                                                ------------

      Outstanding, September 30, 1998              4,236,500           3.28
                                                ============



                                      F-17

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     If not previously  exercised,  non-qualified options and warrants expire as
     follows:


                                                                   Weighted
                                                                    Average
                                             Number of             Exercise
      Year Ending September 30:               Shares                 Price
      -------------------------              ---------             ---------
               1999                             50,000               $1.13
               2000                            175,800                1.16
               2000                            300,000                4.42
               2001                            115,000                2.00
               2001                            400,000                2.87
               2001                            190,000                3.75
               2002                             42,000                3.71
               2003                             70,000                1.50
               2003                            553,900                2.84
               2003                            989,800                4.04
               2005                          1,350,000                3.25
                                            ----------

                                             4,236,500                3.28
                                            ==========


     At September 30, 1998, a total of 1,666,500 non-qualified stock options and
     warrants are vested. Unvested employee performance options were outstanding
     for 115,000 shares, and unvested  non-employee options were outstanding for
     150,000  shares.  These  options  vest when the  Company  achieves  various
     revenue levels.  The Company also has 2,305,000  options  outstanding  that
     vest  at  future  dates.  Vesting  under  most  of  these  options  can  be
     accelerated if various performance targets are achieved.

     During the years ended September 30, 1998 and 1997, the Company  recognized
     compensation  expense  of $8,900  and  $28,900,  respectively,  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 fair value of options  granted  to  non-employees  in 1998 and 1997 was
     estimated on the date of grant using the Black-Scholes option-pricing model
     with the following weighted average assumptions:


                                                  Years Ended September 30,
                                                  -------------------------
                                                    1998             1997
                                                  --------         --------
        Expected volatility                           70%             87%
        Risk-free interest rate                      5.7%            6.2%
        Expected dividends                             0%              0%
        Expected terms (in years)                     1.5             3.0


                                      F-18

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     For the years  ended  September  30,  1998 and  1997,  options  granted  to
     non-employees  resulted in the  recognition  of  approximately  $25,000 and
     $20,000, respectively, of compensation expense.

     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,
                                                ------------------------------
                                                    1998              1997
                                                -----------       -----------
        Net loss:
             As reported                        $(2,521,500)      $(1,548,000)
             Pro forma                           (4,838,700)       (1,749,900)
        Net loss per common share:
             As reported                        $      (.27)      $      (.21)
             Pro forma                                 (.51)             (.23)

     For  purposes of the above pro forma  amounts,  the  weighted  average fair
     value of options  granted to employees  for the years ended  September  30,
     1998 and 1997 was $1.67 and  $1.41,  respectively.  The fair  value of each
     employee option granted in 1998 and 1997 was estimated on the date of grant
     using the Black-Scholes  option-pricing  model with the following  weighted
     average assumptions:


                                                   Years Ended September 30,
                                                   -------------------------
                                                     1998             1997
                                                   -------           -------
        Expected volatility                          70%               87%
        Risk-free interest rate                      5.7%             6.1%
        Expected dividends                            0%               0%
        Expected terms (in years)                    4.0              3.2



                                      F-19

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



7. INCOME TAXES:
   ------------

     The amounts  which give rise to the net deferred tax asset at September 30,
     1998, are as follows:


       Current Assets:
           Allowance for doubtful accounts                          $   40,400
           Provision for obsolete and slow-moving inventories           82,600
           Accrued expenses                                             31,600
                                                                    ----------
                  Total current assets                                 154,600
                                                                    ----------
       Long-term Assets:
           Property and equipment                                       29,700
           Patents, patents pending, and trademarks                     15,600
           Compensation expense related to stock options               177,400
           Net operating loss carryforwards                          7,161,600
           Research and development tax credit carryforwards            35,000
                                                                    ----------
                  Total long-term assets                             7,419,300
                                                                    ----------
       Total Deferred Tax Assets                                     7,573,900

       Valuation Allowance                                          (7,573,900)
                                                                    ----------
                                                                    $     --
                                                                    ==========

     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
     $397,000 and $625,000  during the years ended  September 30, 1998 and 1997,
     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, 1998,  the Company has  approximately  $19,200,000  of net
     operating loss  carryforwards,  and  approximately  $35,000 of research and
     development  tax  credit  carryforwards,  both of which  expire in  varying
     amounts from 1999 through 2018.


8. COMMITMENTS AND CONTINGENCIES:
   -----------------------------

     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
     greater  of 2% of sales of  products  which  relate to this  technology  or
     minimum annual royalties of $120,000.

                                      F-20

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



     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 years ended
     September 30, 1998 and 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 - 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, 1998.

     Regulatory  Matters - The Company's  medical  products are 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.

     Operating  Leases  -  The  Company  conducts  its  operations  from  leased
     facilities and leases certain equipment. The terms of the facilities leases
     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,

                   1999                                   $  286,900
                   2000                                      208,700
                   2001                                      177,600
                   2002                                       78,600
                   2003                                       34,800
                                                          ----------
                                                          $  786,600
                                                          ==========

     Total rent expense was $421,900 and $177,100 for the years ended  September
     30, 1998 and 1997, respectively.

     Letter-of-Credit  - At  September  30,  1998,  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

                                      F-21

<PAGE>


                     MEDICAL DYNAMICS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     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, 1998.

     Employment   Agreements  -  During  1998,  the  Company  has  entered  into
     employment  agreements with four  individuals who are officers or directors
     of the Company or CADI.  The  agreements are effective for a period of five
     years and provide for aggregate annual compensation of $360,000.

     Contingencies  - The  Company  may from time to time be involved in various
     claims,   lawsuits,   disputes  with  third  parties,   actions   involving
     allegations  of  discrimination,  or breach of contract  incidental  to the
     operations  of its business.  The Company is not currently  involved in any
     such  incidental  litigation  which it  believes  could  have a  materially
     adverse effect on its financial condition or results of operations.


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

     During the year ended September 30, 1997, the Company had sales to a single
     customer which  accounted for 61% of net sales.  At September 30, 1998, the
     Company had accounts receivable from a single customer of $250,400.

     At September  30, 1998,  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 $450,300 at September 30, 1998.

     During the year ended  September 30, 1998,  the Company issued $2.2 million
     of convertible  debentures to a single lender. In October 1998, the Company
     issued an additional $400,000 of convertible debentures to this lender.





                                      F-22