<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549
                          ___________________________

                                  FORM 10 - K
 (Mark One)
   [  X  ]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
            OF THE SECURITIES EXCHANGE ACT OF 1934
                      (Fee Required)

                  For the fiscal year ended December 31, 1996

                                       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 0-19897
                                                -------

                             SMT HEALTH SERVICES INC.
            ------------------------------------------------------
               (Exact name of registrant as specified in charter)

                  Delaware                                 25-1672183
  ---------------------------------------------            ---------- 
  (State or other jurisdiction of incorporation         (I.R.S. Employer
              Identification No.)                       or organization)

             10521 Perry Highway
            Wexford, Pennsylvania                            15090
  ---------------------------------------------           ------------
     (Address of principal executive offices)              (Zip Code)

Registrant's telephone number, including area code:  412-933-3300
                                                     ------------

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

Securities registered pursuant to Section 12(g) of the Act:

 
     Common Stock, Par     Warrants to Purchase  Preferred Stock
    Value $.01 Per Share      Common Shares      Purchase Rights
    --------------------- ---------------------  ---------------

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.   Yes   X     No ____
                                         -----          

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

The aggregate market value of the Common Stock held by non-affiliates of the
Registrant was approximately $41.0 million based upon the closing trading price
of the Common Stock on the National Association of Securities Dealers, Inc.
Automated Quotations System on March 19, 1997.

As of March 19, 1997, the Registrant had 5,685,080 shares of Common Stock
outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

    Parts II and III incorporate information by reference from the Registrant's
    definitive Proxy Statement filed with the Commission within 120 days after
    the close of the Registrant's fiscal year.
<PAGE>
 
                                    PART I

    ITEM 1. BUSINESS
            --------

    General

    SMT Health Services Inc. ("SMT"), a Delaware Corporation formed in 1991, and
    its subsidiaries (collectively, the "Company") are primarily engaged in the
    business of operating mobile Magnetic Resonance Imaging (MRI) units ("Mobile
    Units").  The Company, through its subsidiaries, currently operates eighteen
    Mobile Units, including a unit purchased in February 1996, two new units
    purchased from another mobile provider in March 1996 and the addition of
    four new units late in the third quarter and early in the fourth quarter of
    1996.  The Company's mobile MRI fleet currently services healthcare
    providers located in Pennsylvania, North Carolina, West Virginia, Kentucky,
    Virginia, South Carolina and Ohio.  The Company announced in February 1997
    that it intends to purchase and begin operation of its nineteenth mobile
    unit during April 1997.  The MRI equipment is transported in specially
    designed vans that are driven to the healthcare provider's facility where
    the imaging occurs.  The Company typically charges fees on a fee-per-scan
    basis.  For financial information regarding the Company, please see Item 6
    "Selected Financial Data" and the Consolidated Financial Statements included
    in Item 8, which information is incorporated herein by reference.

    Current Operations

    The Company's mobile MRI operations continue to grow.  In 1994, healthcare
    costs came under great scrutiny and healthcare market forces began their own
    healthcare reform.  This reform continues, and mobile diagnostic imaging has
    benefitted from such market reform of the healthcare system as shared
    equipment is a key to containing healthcare costs while still delivering
    advanced and cost effective medical technology.  As hospitals continue to
    look for ways to reduce capital expenditures and contain costs, SMT and
    shared mobile diagnostic imaging units/systems allow hospitals to add or
    increase the range of quality, state-of-the-art diagnostic services with no
    capital expenditure by providing an outsourcing alternative.  Further, many
    states, including those in which the Company operates, have strengthened
    their Certificate of Need ("CON") review systems, whereby healthcare
    providers must justify a need in a community before the state will permit
    capital expenditures for medical equipment.  As a result of CON review
    systems, hospitals and other healthcare providers are less able to install
    fixed site facilities thus providing an opportunity for mobile suppliers
    whose equipment will be shared among many hospitals (see Government
    Regulation).

    Unit Purchases and Upgrades

    The Company upgraded one of its .5 Tesla Signas to a 1.0 Tesla Horizon unit.
    The new unit was financed at a net total cost of approximately $2.0 million
    and was delivered in late February 1996. The Company financed the purchase
    of this new unit with a 60 month dollar-out lease (bargain purchase option
    of one dollar) requiring monthly payments of approximately $44,000.

                                      -2-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    The Company contracted with several new hospital clients and purchased a new
    Siemens 1.0 Tesla Impact unit which began service in mid-February 1996.  The
    cost of this new unit approximated $1.9 million which was financed with a 60
    month loan requiring monthly payments of approximately $41,000.

    In April 1996, the Company upgraded one of the units purchased from another
    mobile provider (See Note 16 of the Company's Consolidated Financial
    Statements incorporated herein by reference) to a Siemens 1.0 Tesla Impact
    unit.  The new unit was financed at a net total cost of approximately $1.9
    million.  The Company financed this new unit with a 60 month loan requiring
    monthly payments of approximately $43,000.

    In June 1996, the Company upgraded one of its .5 Tesla Signas to a Siemens
    1.0 Tesla Impact unit. The new unit was financed at a net total cost of
    approximately $2.0 million with a 60 month dollar-out lease requiring
    monthly payments of approximately $43,000.

    The Company in May 1996 signed an agreement with Siemens Medical Systems to
    upgrade the second unit purchased from another mobile provider (see Note 16
    of the Company's Consolidated Financial Statements incorporated herein by
    reference) and to purchase a new unit during the fourth quarter of 1996.
    Delivery of the upgraded unit occurred in July 1996 and the new unit was
    delivered and began operation on October 1, 1996.  The upgrade's net cost
    approximated $1.9 million and the Company financed approximately $1.7
    million with a 60 month finance agreement requiring monthly payments of
    approximately $36,000.  The Company's new unit cost approximately $1.9
    million and the Company financed approximately $1.7 million requiring a
    monthly payment of approximately $37,000.

    During September 1996, the Company upgraded an older unit to a new Siemens
    1.0 Tesla Impact. The cost of this new unit approximated $1.9 million which
    was financed with a 60 month loan requiring monthly payments of
    approximately $39,000.

    The Company purchased and took delivery of two new GE 1.0 Tesla Horizon
    units in late September 1996.  These units were purchased at a cost of
    approximately $1.8 million each and the Company financed approximately $1.6
    million and $1.5 million with 60 month finance agreements requiring monthly
    payments of approximately $34,000 and $32,000, respectively.

    The Company completed a previously negotiated upgrade of a .5 Tesla Signa to
    a 1.0 Tesla Horizon on November 2, 1996.  The new unit was financed at a net
    cost of approximately $1.5 million with a 60 month finance agreement
    requiring monthly payments of approximately $32,000.

    On November 1, 1996, the Company purchased a mobile MRI unit from Palmetto
    Community Health Network (the "Network") for approximately $390,000 and
    signed new service contracts with six South Carolina hospitals which are
    members of the Network.  This new unit represents the Company's eighteenth
    mobile MRI unit and the seventh new unit acquired during 1996.

                                      -3-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    In December 1996, the Company upgraded the mobile MRI unit purchased from
    the Network to a new 1.0T Horizon.  The new unit was financed at a net cost
    of approximately $1.4 million with a 60 month finance agreement requiring
    monthly payments of approximately $30,000.

    Lease Refinancing

    During July 1996, the Company refinanced two of its Mobile MRI Units to more
    favorable lease terms.  The refinancing of the two units will reduce the
    Company's annual debt service approximately $200,000.

    Equipment

    All of the Company's mobile MRI equipment is financed through capital leases
    and finance agreements. Generally, the Company orders its equipment from the
    manufacturer while simultaneously contracting with healthcare providers for
    its use, thereby reducing the Company's risk.

    The Company expects that future acquisitions of equipment will be made
    pursuant to capital leases or purchase financing and the Company expects to
    utilize working capital of $200,000 to $400,000 per unit to fund initial
    down payments on the purchases, financing the balance of $1.5 million to
    $1.6 million over typically a 60 month term.

    MRI Equipment.  Magnetic resonance imaging involves the use of high strength
    magnetic fields and radio waves to produce cross-sectional images of the
    anatomy.  MRI and other medical diagnostic imaging systems facilitate the
    diagnosis of disease and disorders at an early stage, often minimizing the
    amount and cost of care needed to stabilize or cure the patient and
    frequently obviating the need for invasive diagnostic procedures, such as
    exploratory surgery.  Diagnostic imaging systems are based on the ability of
    energy waves to penetrate human tissue and generate images of the body which
    can be displayed either on film or on a video monitor.

    The major components of an MRI system are a large magnet, radio wave
    equipment, and a computer for data storage and image processing.  During an
    MRI study, a patient lies on a table which is then placed into the magnet.
    The patient spends approximately 15 to 45 minutes inside the magnet,
    depending upon the type of diagnostic study, during which time images of
    multiple planes are acquired.  Images obtained from an MRI examination are
    displayed on a computer screen in the form of a cross-section of the organ
    or tissue.  This information can be stored on magnetic media for future
    access or printed on film for interpretation by a physician and retention in
    the patient's files.

    Other diagnostic imaging techniques include CAT scans, nuclear medicine,
    radiography/fluoroscopy, ultrasound, mammography and conventional x-ray.
    Available evidence suggests that MRI has advantages over other diagnostic
    imaging methods, leading to its increased use.  Except for ultrasound, these
    other methods use ionizing radiation.  MRI does not use ionizing radiation
    and is thought to be risk-free for most patients.  In addition, MRI provides
    superior soft-tissue contrast, without artifacts from bony structures that
    are sometimes apparent with x-ray based imaging techniques.

                                      -4-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    In addition to the absence of ionizing radiation, MRI offers several
    significant advantages to CAT scanning.  MRI has the ability to obtain
    images of equally high resolution in multiple planes without moving the
    patient.  In certain cases, particularly those involving the nervous system,
    MRI provides superior image resolution.  In addition, the presence or amount
    of certain abnormal tissue masses which may be undetected utilizing CAT
    scanning may be detected utilizing MRI.  This factor is important in the
    early diagnosis of cancer, multiple sclerosis and other diseases.

    Research is currently being conducted for additional uses of MRI and the
    Company believes more applications for MRI may be discovered in the future.
    Contrast agents enhance the use of MRI in the detection of neurological
    lesions, including specific types of brain tumors.  Contrast agents also
    enhance images of the post-operative spine, and are under investigation for
    use in the liver and other organ systems.  MRI's role in the evaluation of
    cardiac disease and diseases of the bone marrow and joints is also on the
    increase.  New technological developments are expected to extend the
    clinical uses of this technology and to increase the number of scans
    performed by the Company's customers. In October 1995, Medicare began to
    reimburse MR Angiography (MRA) procedures on a limited basis.  MRA utilizes
    MRI technology to view blood flow of the head and neck.  Prior to October
    1995, MRA procedures were considered experimental and were not reimbursed by
    Medicare.  It is expected that additional MRA procedures will be approved by
    Medicare in the near future.

    The use of advanced imaging technologies has grown significantly in the
    United States during the last several years due to increasing physician
    acceptance of the value of advanced imaging technologies in the early
    diagnosis of disease, the expanding applications of MRI (partially because
    they do not involve ionizing radiation) and the growing patient base
    attributable to an aging population.  Hospitals and other healthcare
    providers are facing competitive pressures to provide these technologies and
    related services despite strict budgetary limitations and are increasingly
    utilizing third parties such as the Company to provide the necessary
    facilities and related services due to the substantial equipment and
    personnel costs.

    Changes in Medicare reimbursement systems have resulted in declining profit
    margins for many hospitals and other healthcare providers, thereby reducing
    capital available to purchase new and expensive equipment.  In addition,
    many medical professionals have become increasingly aware of the risks of
    medical malpractice suits and believe that such risks would be reduced by
    utilizing state-of-the-art medical technology and related services.

    MRI has undergone a significant expansion since it became commercially
    available to healthcare providers in 1983.  Numerous significant
    developments have occurred since that time, and further developments are
    expected primarily in the computer software.  MRI units are in general
    easily upgraded and, therefore, can remain abreast of technological changes
    through software updates.  The Company has user agreements with the MRI
    manufacturers which state, among other things, that such manufacturers will
    provide software updates at no additional charge during the term of such
    agreements.  However, the development of new technologies or refinements of
    existing ones might make the Company's existing equipment technologically or
    economically obsolete or cause a reduction in the value of the Company's
    equipment or reduce the need for its equipment.

                                      -5-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    All of the Company's MRI equipment is located in Mobile Units.  The MRI
    equipment is installed by the manufacturer in a specifically constructed van
    jointly designed by the van's manufacturer and the equipment manufacturer.
    The van is designed to provide medical facilities comparable to those found
    in fixed-site MRI facilities.

    Equipment Maintenance

    Timely, effective service is essential to maintaining high utilization rates
    on the Company's mobile MRI equipment.  Should the Company experience
    greater than anticipated malfunctions of its equipment or should it be
    unable to promptly obtain the service necessary to keep its equipment
    functioning effectively, its business would be adversely affected.  The
    Company's business also might be adversely affected if its suppliers stopped
    providing maintenance service because, although other service providers are
    available, it is uncertain whether or how effectively such other service
    providers could provide equipment maintenance.

    The Company contracts with the MRI equipment manufacturers for comprehensive
    maintenance programs on its equipment to minimize downtime (the period of
    time equipment is unavailable during scheduled use hours because of
    malfunctions).  These maintenance contracts are long-term in nature (greater
    than five years), commencing upon the expiration of the applicable warranty
    period.  The equipment is generally warranted by the equipment manufacturer
    for a specified period of time, usually one year to eighteen months from the
    date of purchase.  During the warranty period and maintenance contract term,
    the Company receives uptime guarantees (a guarantee that the equipment will
    function for a specified percentage of scheduled use hours.)   However,
    these guarantees are not expected to substantially compensate the Company
    for loss of revenue for downtime.

    The Company also carries a business interruption insurance policy, which
    provides for an aggregate $1.0 million of coverage for its diagnostic
    equipment, to help protect itself from unexpected long-term equipment
    failures which would cost the Company more than the deductible amount.

    Healthcare Providers

    Many healthcare providers do not own MRI equipment because of insufficient
    patient volume to justify the costs associated with the acquisition and
    operation of such equipment.  Depending upon type, features and options
    selected, the MRI equipment costs between $1.6 million and $2.2 million.
    Many healthcare providers cannot afford a capital investment of this size or
    cannot utilize the equipment in a cost-effective manner.  Moreover, a
    healthcare provider with sufficient patient volume and resources to purchase
    in-house diagnostic imaging equipment may still contract for the use of the
    Company's services to supplement in-house imaging equipment primarily to
    service patient backlogs or to have access to more state-of-the-art
    equipment.

                                      -6-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    Among the reasons for such use of the Company's equipment are elimination of
    the need to recruit and employ qualified technicians, avoidance of the risk
    of technological obsolescence of the equipment, provision of short-term
    mobile services to allow the customer to learn the technology, establishment
    of a patient base before an in-house unit is installed, provision of
    additional coverage when patient demand exceeds in-house capacity, lack of a
    suitable interior location, reduction of the risks of medical malpractice
    suits by utilizing state-of-the-art medical technology and related services
    and changes in third-party reimbursement systems.

    Marketing

    The Company's executive officers currently spend a portion of their time
    marketing the Company's services.  In addition, the Company's regional vice
    presidents spend a portion of his or her time attempting to attract
    additional business.  The Company currently has four marketing personnel,
    including two hired during 1996, to market the Company's mobile MRI business
    to referring physicians and existing customers.

    A significant marketing resource for the Company has been existing customer
    referrals. Additionally, the Company is the preferred vendor of services for
    Amerinet, which is a nonprofit consortium of approximately 3,000 hospitals
    and other healthcare providers nationwide.

    The Company intends to concentrate much of its marketing efforts in
    Pennsylvania, West Virginia, North Carolina, Virginia, Kentucky, Ohio, South
    Carolina, and certain other southern states.

    Competition

    The healthcare industry in general, and the market for mobile diagnostic
    imaging services in particular, is highly competitive.  In addition to
    direct competition from other diagnostic imaging providers, the Company must
    compete with larger healthcare providers as well as private clinics and
    radiology practices that own diagnostic imaging equipment and with equipment
    manufacturers which sell equipment to healthcare providers for in-house
    installation.

    In addition, existing healthcare providers who are customers of the Company
    may purchase equipment if their volume of patients increases to the point
    that it becomes cost effective to own and operate their own equipment,
    although the Company believes that the large capital expenditure required to
    purchase such equipment and CONs (see Government Regulation) may discourage
    many hospitals from doing so.

    Several competitors operate fixed-site centers and/or Mobile Units in the
    Company's primary service areas.  Moreover, certain of these competitors may
    have substantially greater financial resources than those of the Company,
    which may give them advantages in negotiating equipment acquisitions and
    responding quickly to new demand.  The Company believes that it competes
    effectively against other fixed-site and/or mobile providers based on its
    ability to provide high quality equipment at competitive prices and because
    of its reputation for service and reliability.

                                      -7-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    MRI competes with less expensive imaging devices and procedures which may
    provide similar information to the physician.  Alternative imaging
    technology includes CAT scans, nuclear medicine, radiography/fluoroscopy,
    ultrasound, mammography, and conventional x-ray.  The cost of a particular
    study depends upon the complexity of the procedure, the length of time of
    equipment utilization and whether the procedure requires introduction of
    contrast agents into the body.  The Company believes that MRI's significant
    benefits justify any pricing differential between MRI and other modalities.

    Diagnostic imaging does not require proprietary information, trade secrets
    or similar non-public intellectual property.  Consequently, there are no
    significant barriers to entry other than the costs of the equipment, hiring
    of qualified technicians and management and, where applicable, Certificate
    of Need regulations and other regulatory constraints (see Government
    Regulation).

    The diagnostic imaging industry is highly fragmented.  Consolidation of the
    diagnostic imaging industry has begun and is expected to continue into the
    foreseeable future as companies acquire and merge and as numerous smaller,
    inefficient companies discontinue business.

    Reimbursement

    The Company's revenues are currently derived from payments by hospitals
    pursuant to mobile service contracts between the Company and the hospitals.
    Under existing laws and regulations of certain states, the Company, as an
    outside supplier, is prohibited from directly billing most hospital
    inpatients or outpatients, or their insurers, for the services provided by
    the Company.

    Payments made by the hospitals are generally subject to the various laws,
    regulations and practices of governmental and commercial insurance programs,
    including Medicare, Medicaid and Blue Cross and Blue Shield Plans, because
    the insurers' reimbursement practices indirectly affect the level of fees
    the Company may charge.  However, hospital payment obligations to the
    Company under the service contracts are not directly conditioned upon the
    hospital's receipt or level of reimbursement from the third party payor or
    the patient.

    Payments for Company Services to Hospital Patients.  Medicare, which was
    enacted as part of the Social Security Act of 1965, and frequently amended
    since then, provides for the payment of certain healthcare benefits,
    including inpatient and outpatient hospital services, to persons who are 65
    years of age or older, disabled or who qualify for the End Stage Renal
    Disease program.  Beginning October 1, 1983, Medicare implemented a
    prospective payment system ("PPS") for most inpatient hospital services.
    Under PPS, reimbursement for the operating costs of inpatient services was
    shifted from a reasonable and allowable cost-based system to a system
    providing a fixed payment for each Medicare discharge without regard to the
    actual cost incurred.  Each patient is classified into one of approximately
    490 diagnosis-related groups ("DRG") and payment is made according to the
    DRG. With certain exceptions, the PPS payment is not adjusted for variations
    in length of stay or intensity or utilization of services.  Consequently,
    the DRG reimbursement received by the hospital for inpatient services
    rendered to a Medicare beneficiary may not be adequate to cover its costs of
    providing services.

                                      -8-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    Under PPS, payment for the Company's services furnished to an inpatient is
    included in the DRG payment to the hospital.  The Medicare patient is also
    responsible for reimbursing the hospital for certain co-insurance and
    deductible amounts for the inpatient services furnished.

    Since 1985, only minimal increases in the Medicare PPS rates have been
    authorized by Congress. In addition, payments to hospitals by Medicare have
    been subject to automatic reductions from time to time under the Balanced
    Budget and Emergency Deficit Control Act of 1987 (the "Gramm-Rudman Act").
    The OMNIBUS Budget Reconciliation Act of 1993 ("OBRA 1993") calls for a
    reduction in spending by Medicare of $55.8 billion over a five year period
    beginning October 1, 1993, including payments for inpatient hospital and
    outpatient care.

    Beginning October 1, 1991, Medicare phased in a PPS system to reimburse
    hospitals for a portion of their capital costs incurred in providing
    services to Medicare beneficiaries.  Previously, such capital costs were
    reimbursed on a reasonable cost basis.  This new reimbursement system will
    have varying impacts on hospitals, including those hospitals with which the
    Company has contracted, in terms of their capabilities to acquire MRI and
    other diagnostic equipment and provide services that may compete with those
    of the Company.

    While a PPS system has not been implemented for hospital outpatient
    services, beginning October 1, 1988, payment to hospitals for outpatient
    radiology services, including MRI technical services provided by the
    Company, became subject to certain limitations.  Under the Omnibus Budget
    Reconciliation Act of 1987, Medicare payment is limited to the lesser of (a)
    the lower of the hospital's costs or charges or (b) a "blended amount" of
    50% of the hospital's specific costs and 50% percent of the Medicare fee
    schedule amount applicable to similar services furnished in a physician's
    office.  The Omnibus Budget Reconciliation Act of 1986 prohibited mobile
    vendors, such as the Company, from billing Medicare directly for services to
    Medicare outpatients.  This "rebundling" was designed to provide a basis for
    the future implementation of a PPS system for hospital outpatients.  Such
    changes in the reimbursement system for outpatient services may lead to
    further reductions in payments by Medicare which could adversely affect the
    Company's charge levels.

    During 1995 and 1996, Congress and the President debated a balanced budget
    amendment which called for balancing the federal budget in seven years.  To
    date, such debate has included discussions of reducing the rate of growth of
    Medicare, Medicaid and Social Security.  Such debate continues and the
    Company is not able to predict the outcome of the final budget compromise,
    the effect of the final budget compromise on Medicare and Medicaid
    reimbursements nor the effect of these proposed changes on the Company's
    operations.

    Medicaid is a joint federal and state program, administered primarily by the
    states, which is designed to provide reimbursement for healthcare services
    to certain medically and financially needy individuals.  Medicaid
    reimbursement principles vary among states, although they are generally
    based on Medicare reimbursement principles, including PPS and rebundling of
    services provided by vendors, such as the Company, for payment purposes.
    Medicaid payments to hospitals in many states have been lower than Medicare
    reimbursements and, in recent years, the adequacy of Medicaid payment rates
    has been successfully challenged by providers in various states, including
    Pennsylvania.  However, because of the fiscal difficulties which many states
    are experiencing, there

                                      -9-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    can be no guarantee that the payments made by the states for healthcare
    services will be adequate to cover the costs incurred by providers or will
    not adversely affect the Company's level of charges.

    Blue Cross and Blue Shield Plans and other commercial insurers provide third
    party reimbursement to hospitals for inpatient and outpatient services to
    their subscribers on the basis of various formulas. Renegotiation of such
    formulas and reductions in reimbursement may indirectly affect charge levels
    or payment by the hospitals for the Company's mobile services, although it
    is not possible to predict the effect of such changes at this time.

    Other Reimbursement Matters.  Many insurance companies, employers and other
    payors are increasing their use of managed care plans such as health
    maintenance organizations ("HMOs") and preferred provider organizations
    ("PPOs") as a means of controlling their healthcare costs.

    In addition to contracting with selected healthcare providers to provide
    healthcare services, often at a discount or on a capitation basis, such
    plans engage in strict utilization review activities to more closely control
    the utilization of services by their subscribers.  The Company has begun
    discussions with certain HMOs and PPOs.  However, there can be no certainty
    that the Company will be able to contract with such HMOs or PPOs and there
    can be no assurance that the increased use of managed care plans in the
    Company's service areas will not affect its level of charges or the demand
    for its services.

    Numerous changes have been made in governmental and commercial insurance
    programs in recent years in an effort to reduce the extent to which these
    third-party payors absorb increases in medical costs.  Some third-party
    payors have also experienced difficulties in meeting their payment
    obligations whether  on a timely basis or otherwise.  In addition, a number
    of bills proposing to regulate, control or alter the methods of financing
    and delivering healthcare, including proposals for a national health
    insurance program, have been discussed and introduced in Congress and
    various state legislatures.  The effect of any of these proposals or changes
    by existing insurers in their reimbursement methodologies on the healthcare
    industry and the Company cannot be determined at this time.

    Government Regulation

    General.  The provision of diagnostic imaging services is subject to a
    number of federal, state and local laws, regulations and rules, some of
    which are very complex.  Although the Company believes that it is currently
    in compliance with applicable laws, regulations and rules, some of such laws
    are broadly written and subject to little or no interpretation by courts or
    administrative authorities. Hence, there can be no assurance that a third
    party or governmental agency will not contend that certain aspects of the
    Company's operations or procedures are not in compliance with such laws,
    regulations or rules or that state agencies or courts would interpret such
    laws, regulations and rules in the Company's favor.  The sanctions for
    failure to comply with such laws, regulations or rules could be denial of
    the right to conduct business, significant fines and/or criminal penalties.
    The Federal Health Insurance Portability and Accountability Act, enacted in
    August 1996, expanded the

                                      -10-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    Civil and Criminal sanctions for violations of such laws and provided for
    increased governmental and private enforcement programs.  Additionally, an
    increase in the complexity or substantive requirements of such laws,
    regulations or rules could adversely affect the Company's business.

    Certificate of Need.  In addition, several states in which the Company
    operates have CON laws and regulations that control and regulate the
    establishment of healthcare facilities and services and the acquisition and
    operation by hospitals and other providers of major equipment such as MRI
    units and other diagnostic imaging equipment.  In several states in which
    the Company operates, a hospital or the Company may need a CON before the
    Company can provide its diagnostic imaging services. CON regulations could
    inhibit the expansion of the Company's business.  Pennsylvania's CON law
    expired in December 1996 and a new CON law has not been enacted.  While
    discussions of a new CON law are on-going, it is not known whether the
    Pennsylvania legislature will adopt a new CON law.  However, the
    Pennsylvania Department of Health issued a Policy Statement on December 14,
    1996 addressing its intent to strictly enforce the licensing requirements
    which continue in effect under the Healthcare Facilities Act.

    Practice of Medicine.  The establishment, marketing and operation of the
    diagnostic imaging units are subject to laws prohibiting the practice of
    medicine by non-physicians.  The Company's employees provide only the
    technical services relating to the diagnostic procedures (under the
    supervision of licensed physicians) and the related non-medical
    administrative support services. Professional medical services, such as the
    reading of the diagnostic imaging studies and related diagnosis, are
    separately provided by licensed physicians.  The Company does not employ any
    physicians to provide medical services.  There can be no assurance, however,
    that state authorities or courts will not determine that the Company's
    services and/or relationships with providers constitute the unauthorized
    practice of medicine by the Company.

    Fraud and Abuse Laws.  The Social Security Act and certain provisions of
    state law provide civil and criminal penalties for persons who knowingly and
    willfully solicit, pay, offer or receive any remuneration, directly or
    indirectly, as an inducement to make a referral of a patient for services or
    items for which payment may be made under the Medicare or Medicaid programs.
    Often termed "fraud and abuse" or "anti-kickback" laws, the provisions have
    been broadly interpreted by the courts.

    The Office of Inspector General of the Department of Health and Human
    Services ("HHS") has issued regulations specifying certain business
    arrangements and payment practices involving providers or other entities,
    such as the Company, which will not be considered prohibited activities.
    Commonly termed "safe harbor regulations," the regulations set forth certain
    standards which, if satisfied, will ensure that the arrangement will not be
    subject to criminal prosecution or civil sanctions under the fraud and abuse
    laws.  Failure to satisfy the safe harbors in and of itself does not render
    an arrangement illegal.  The Company believes it is in compliance with the
    safe harbor regulations applicable to its current operations.

                                      -11-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    One principal focus of the fraud and abuse laws has been on arrangements in
    which profit distributions are made by a partnership or other business
    venture for health-related items or services to investors who make or are
    otherwise in a position to influence referrals of Medicare or Medicaid
    patients to the venture.  Where such arrangements exist, a question is
    raised as to whether the profit distributions are illegal payments in
    exchange for referrals.  Certain safe harbors set forth criteria which, if
    met, will insure that investors in business ventures for health-related
    items or services will not be subject to scrutiny under the fraud and abuse
    laws.

    One safe harbor involves investments in publicly traded companies with
    tangible assets of more than $50 million.  At present, the Company does not
    satisfy this safe harbor.

    Another safe harbor covers investment interests in small entities.  The
    conditions for compliance with this safe harbor include requirements that no
    more than 40% of the investment interests of each class of investments in
    the entity may be held by persons who are in a position to make or influence
    referrals (including hospitals and physicians), furnish items or services to
    the entity or otherwise generate business of the entity, so-called "tainted
    investors," and that no more than 40% of the entity's gross revenues may
    come from referrals, items or services furnished or business otherwise
    generated by "tainted investors."  Unless a large percentage of the
    Company's Common Stock is held by "tainted investors," it would appear that
    investments in the Company will fall within the safe harbor for investment
    interests.

    None of the Company's mobile MRI activities are carried out through
    partnerships or other ventures with hospitals, physicians or other third
    parties.  The Company believes that its investments in partnerships which
    operated the cardiac care centers complied with current fraud and abuse
    laws. Such investments were sold in June 1995.

    There can be no assurance that enforcement agencies or courts will determine
    that any existing arrangements comply with all applicable laws and
    regulations.

    Other Patient Referral Restrictions.  Pennsylvania, as well as other states
    in which the Company operates, prohibits the referral of Medicaid patients
    for services or items by a provider in which the referring physician has an
    ownership interest.  Certain states do not restrict patient referrals but do
    require the disclosure to a patient by the referring physician of a
    financial interest in a facility or vendor to which the patient is being
    referred for services or items.

    Stark II.  The Omnibus Budget Reconciliation Act of 1993, enacted new
    federal anti-referral legislation, more commonly know as "Stark II" after
    its prime sponsor, Rep. Fortney "Pete" Stark (D. Calif.).  Effective January
    1, 1995, Stark II bans referrals by physicians of Medicare and Medicaid
    patients to entities for certain designated health services, including MRI
    services, if a physician or immediate family member has a prohibited
    financial relationship with the entity providing the service.  A financial
    relationship is generally defined as an ownership or investment interest in,
    or compensation arrangement with the entity, subject to certain exceptions.
    Penalties include nonpayment for services rendered pursuant to a prohibited
    referral, civil money penalties and fines and possible exclusion from the
    Medicare and Medicaid programs.  The Company believes it is currently in
    compliance with the requirements of Stark II.  However, there can be no
    assurance

                                      -12-
<PAGE>
 
    ITEM 1.  BUSINESS (continued)
             --------            

    that enforcement agencies or courts will determine that existing
    arrangements comply with all applicable laws and regulations.

    Other Requirements Concerning Licensing, Permits and Approvals.  Most states
    do not currently license MRI providers such as the Company.  Hospitals with
    which the Company has contracted are subject to a variety of regulations and
    standards of state licensing and other authorities and accrediting bodies
    such as the Joint Commission for the Accreditation of Healthcare
    Organizations ("JCAHO").  As an outside vendor, the Company may be required
    to comply with such regulations and standards to enable the hospitals with
    which it has contracted to maintain their permits, approvals and
    accreditation.

    During January 1997, the Company received Accreditation with Commendation
    from the Joint Commission for the Accreditation of Healthcare Organizations
    ("JCAHO").

    There can be no assurance that future changes in the laws and regulations
    relating to the delivery of healthcare items and services may require the
    Company or any venture involving the Company to obtain and maintain certain
    governmental approvals for continued operations.  It is not possible to
    predict the effect of such changes in the law on the Company at this time.

    For the most part, the Company's employees need not have special licenses.
    Drivers of trucks must have certain special driving licenses.  MRI
    technicians are not required to have licenses in any of the states in which
    the Company does business.  However, many states are holding discussions to
    require such licensing.  The Company believes that any such licensing
    requirement would not have an adverse impact on the Company.  Beginning in
    1995, MRI technologists were required to meet certain continuing education
    requirements.  The Company and its employees are fully complying with this
    requirement.

    Freestanding Healthcare Centers

    During 1991 and 1992, the Company initiated what it then believed was a
    natural progression into the operation of outpatient full service diagnostic
    imaging centers and freestanding radiation therapy facilities (outpatient
    healthcare centers).  The Company's expansion into these businesses was
    based upon the belief that (i) numerous opportunities existed to develop or
    acquire outpatient healthcare facilities due to new regulatory changes
    enacted (see "Fraud and Abuse Laws" and "Other Patient Referral
    Restrictions"), (ii) once mature, the healthcare facilities it developed or
    acquired could generate substantial incremental earnings and (iii)
    freestanding healthcare facilities would complement the Company's current
    mobile MRI business.  During 1992, the Company acquired one full-service
    freestanding diagnostic imaging center and developed one freestanding
    radiation oncology facility.  However, through December 31, 1993, these
    outpatient healthcare centers operated below expectation and incurred
    substantial losses while the Company's core mobile business sustained an
    increase in revenues and profit.  Further, with continued uncertainty in the
    healthcare industry surrounding the Clinton Administration's efforts to
    reform healthcare, the Company has seen an increase in the demand for its
    mobile MRI services.  Based upon continued growth and profitability of its
    core mobile MRI business, as well as the belief that the Company's capital
    and other resources were insufficient to properly support continued growth
    in its core mobile

                                      -13-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    MRI business and the opening of outpatient healthcare centers, the decision
    was made in December 1993 to sell the freestanding full-service diagnostic
    imaging center and the freestanding radiation oncology center.

    The Company sold substantially all of the assets of the Auburn Regional
    Center for Cancer Care on October 31, 1994.  The sale price of the Auburn
    Regional Center for Cancer Care was approximately $1.3 million comprised of
    $400,000 in cash and the assumption of certain liabilities of the Center.
    The Company remains obligated on approximately $270,000 of capital leases as
    of December 31, 1996.  The buyer has agreed to use its best efforts to have
    the Company released from these leases and has secured its obligations to
    the Company to perform on these leases through a pledge of certain assets in
    favor of the Company (see Note 3 and Note 13 of the Company's Consolidated
    Financial Statements incorporated herein by reference).

    On June 30, 1995, the Company completed the sale of substantially all of the
    assets of its remaining freestanding diagnostic imaging center, Airport
    Regional Imaging Center ("Airport Center"), located in Coraopolis,
    Pennsylvania for a total sale price of approximately $300,000, including
    cash and net trade receivables.  Although the buyer assumed all future
    operating liabilities of the Airport Center, the Company remains obligated
    on approximately $600,000 of capital leases as of December 31, 1996.  The
    buyer has agreed to use its best efforts to have the Company released from
    these leases and has secured its obligations to the Company to perform on
    these leases through a pledge of stock and certain assets in favor of the
    Company (see Note 3 and Note 13 of the Company's Consolidated Financial
    Statements incorporated herein by reference).

    On June 30, 1995, in conjunction with the sale of the Airport Center, the
    Company sold its majority ownership and general partner rights in four
    cardiac care partnerships for a total sale price of $300,000 comprised of
    $200,000 in cash and a $100,000, thirty-month note.  The Company recognized
    a pre-tax gain on this sale of $48,219.  The partnerships, which constituted
    approximately seven percent of the Company's  revenues, had total assets of
    approximately $1.4 million, comprised primarily of diagnostic equipment and
    accounts receivable, and total liabilities of approximately $1.2 million
    comprised primarily of capital lease obligations associated with the
    diagnostic equipment.

    Tractor Leases

    Prior to July 1, 1995, the Company subleased certain truck cabs from Shared
    Mobile Enterprises ("SME"), which, in turn, leased such truck cabs from an
    independent third party leasing company. Effective July 1, 1995, SME
    released the Company from its obligations under ten long-term subleases in
    exchange for the issuance to SME of 120,000 unregistered Common Shares
    valued at $3 per share, the weighted average closing price for the stock for
    the prior thirty trading days.  The Company received an opinion from an
    independent financial advisor that the transaction was fair to the Company
    and its shareholders.  At the same time, with the concurrence of the third
    party leasing company, the Company assumed SME's obligations under its
    original lease and modified that lease by (1) extending the lease term by
    one additional year and (2) adding one additional truck cab to the schedule
    of leased property with a corresponding increase in base rental payments.
    The $360,000

                                      -14-
<PAGE>
 
    ITEM 1. BUSINESS (continued)
            --------            

    value of the shares represents the present value of the excess of the
    sublease payments over the original lease payments.  The Company has
    capitalized the $360,000 and is amortizing this prepaid rent over a period
    which approximates the lease term.  SME was one hundred percent beneficially
    owned by certain officers/directors and a former director/consultant of the
    Company who own approximately 14% of the Company's outstanding Common
    Shares.

    Insurance

    SMT carries workers' compensation insurance, comprehensive and general
    liability coverage, business interruption insurance, and fire and allied
    perils coverage in amounts deemed adequate by management.

    While the Company's Mobile Units are at a customer's facility, they operate
    only under the direction of licensed physicians on the customer's staff  who
    direct the procedures, supervise the Company's technologists and interpret
    the results of the examinations.  The Company requires that the licensed
    physicians carry malpractice insurance to cover their individual practices.
    Currently, there are no known biological hazards associated with MRI.
    However, there is a risk of harm to a patient who has a ferrous material or
    a cardiac pacemaker within his or her body.  Patients are carefully screened
    to safeguard against this risk.  To protect against possible exposure for
    professional liability, the Company maintains a professional liability
    policy to cover all of its operations.  There is no assurance that the
    insurance coverage maintained by the Company, now or in the future, will be
    adequate.

    Employees

    As of December 31, 1996, the Company had 96 full-time employees, including
    six executive personnel, six accounting, marketing, administrative and
    clerical personnel, seven managers, 59 imaging technologists and eighteen
    drivers.  The Company also employs 21 part-time employees. None of the
    Company's employees are represented by labor organizations and the Company
    is not aware of any activity seeking such representations.  The Company
    considers its relationships with its employees to be excellent.


    ITEM 2. PROPERTIES
            ----------

    The Company owns no real property and leases approximately 5,500 square feet
    of office space in Wexford, Pennsylvania.  The lease for the Company's
    principal facility expires on April 30, 1999.

                                      -15-
<PAGE>
 
    ITEM 3. LEGAL MATTERS
            -------------

    The Company had been named as a defendant along with a hospital which
    contracts for the Company's MRI services, in a claim filed by a woman who
    alleged to have incurred partial paralysis as a result of being mishandled
    during an MRI procedure.  The claim had been filed for $6.0 million in
    damages.  This claim was settled by the Company's insurance company in
    November 1996 with no admission of liability by the Company and no financial
    effect to the Company.


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

    There were no matters submitted to a vote of security holders during the
    three months ended December 31, 1996.

    Executive Officers of the Registrant

    The following persons are the current executive officers of the Company:
<TABLE>
<CAPTION>
Name                                      Age               Position
----------------------------------------  ---  -----------------------------------
<S>                                       <C>  <C>
 
                     Jeff D. Bergman       42  President, Chief Executive Officer,
                                                Chairman of the Board & Director
 
                     Daniel Dickman        50  Executive Vice President, Chief
                                                Operating Officer, Secretary &
                                                Director
 
                     David Spindler        45  Senior Vice President of Clinical
                                                Operations & Marketing
 
                     David A. Zynn         33  Chief Financial Officer, Treasurer
                                                & Assistant Secretary
</TABLE>


    Mr. Bergman has been Chief Executive Officer, Chairman of the Board,
    President and a Director of the Company since its formation in 1991 and held
    the same positions with the Company's predecessor since 1987.  From 1979 to
    1982, he was employed by BOC-AIRCO as a Marketing Representative for the
    Corporate Steel Division.  In 1983, Mr. Bergman joined Mobile Diagnostech,
    Inc. ("MDI"), a provider of mobile CAT scanners and MRI equipment and as a
    developer and manager of fixed-site oncology centers.  Mr. Bergman received
    his B.S.B.A. from Robert Morris College.  In 1987, Mr. Bergman left MDI and
    formed the Company.  Mr. Bergman is also an official in the National
    Football League.  Mr. Bergman officiated Super Bowl XXXI in New Orleans, LA
    in January 1997.

                                      -16-
<PAGE>
 
    ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    (Continued)

    Mr. Dickman has been Executive Vice President, Chief Operating Officer,
    Secretary and a Director of the Company since 1991 and held the same
    positions with the Company's predecessor since 1988. From 1985 to 1987, Mr.
    Dickman was responsible for the management and day-to-day operations of
    Mobile Diagnostech, Inc.'s ("MDI") MRI equipment and CAT scanners.  In 1987,
    Mr. Dickman joined the Company to manage the Company's equipment routes.  He
    has over 12 years' experience in healthcare management consulting and
    systems design, and was formerly employed by Blue Cross of Western
    Pennsylvania as Manager of Hospital Consulting.  Mr. Dickman received his
    B.S.B.A. from Notre Dame University and his M.B.A. from Gannon University.

    Mr. Spindler has been Vice President of Clinical Operations and Marketing
    for the Company since 1991 and held the same positions with the Company's
    predecessor since 1988.  From 1979 to 1984, Mr. Spindler was a Sales
    Representative with BOC-AIRCO (a major supplier of cryogens for MRI
    systems).  In 1984, he joined M.G. Industries where he was an Account
    Representative.  In 1986, Mr. Spindler joined Helium Technologies where he
    was a Division Manager.  Mr. Spindler received his B.S.B.A. from Slippery
    Rock University and his M.B.A. from Robert Morris College.  Mr. Spindler is
    also a Captain in the United States Army Reserves.

    Mr. Zynn has been Chief Financial Officer, Treasurer and Assistant Secretary
    since September 1991. From January 1986 to December 1989 and August 1990 to
    August 1991, Mr. Zynn was employed by KPMG Peat Marwick LLP in several
    capacities, first as a staff accountant and finally as an audit manager and
    a national instructor of auditing and accounting.  From January 1990 to
    August 1990, Mr. Zynn was employed by Black Box Incorporated as the Manager
    of Financial Reporting. Mr. Zynn is a certified public accountant and a
    member of the Healthcare Financial Management Association and American
    Management Association.  Mr. Zynn received his B.S.B.A. from Indiana
    University of Pennsylvania.

                                      -17-
<PAGE>
 
                                    PART II

    ITEM 5.    MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED
               ---------------------------------------------------
               STOCKHOLDER MATTERS
               -------------------

    The following table sets forth the range of high and low prices of the
    Common Stock (SHED) and Warrants (SHEDW) from January 1, 1995 through
    December 31, 1996. On November 3, 1995 and November 16, 1995, respectively,
    the Company's Common Stock and Warrants began to trade on the NASDAQ
    National Market System.  Prior to trading on the NASDAQ National Market
    System, the Company's Common Stock and Warrants traded on the NASDAQ Small
    Cap Market.  For the period through January 1, 1995 through October 31,
    1995, the table sets forth the range of high and low closing bid prices of
    the Common Stock and Warrants.  For the period November 1, 1995 through
    December 31, 1996, the table sets forth the range of high and low trading
    prices of the Common Stock and Warrants.  Such prices represent inter-dealer
    quotations, without retail mark-up, mark-down or commissions, and may not
    necessarily represent actual transactions.

                           COMMON STOCK AND WARRANTS
<TABLE>
<CAPTION>
                                                      Common Stock  Warrants
                                                      ------------  --------
                                                          High        Low      High    Low
                                                      ------------  --------  ------  -----
<S>                                                   <C>           <C>       <C>     <C>
                      Quarter ended March 31, 1995          3 1/16         2    9/16    3/8
                      Quarter ended June 30, 1995            3 7/8     2 5/8    7/16    1/4
                      Quarter ended Sept. 30, 1995           4 5/8     3 5/8   11/16   5/16
                      Quarter ended Dec. 31, 1995            4 7/8     3 7/8   23/32  15/32
 
                      Quarter ended March 31, 1996          4 9/16     3 3/4    7/16    1/4
                      Quarter ended June 30, 1996           10 3/4    4 1/16   3 7/8    3/8
                      Quarter ended Sept. 30, 1996           8 5/8     5 3/8   2 3/4  13/16
                      Quarter ended Dec. 31, 1996            8 5/8     6 5/8  2 1/16    7/8
</TABLE>

    The Company has not paid out cash dividends since its inception and does not
    anticipate paying cash dividends in the foreseeable future on the Common
    Stock.  Cash dividends, if any, which may be paid in the future to holders
    of the Common Stock will be payable when, if and as declared by the Board of
    Directors of the Company, based upon the Board's assessment of, among other
    things, the financial condition of the Company, its earnings, need for
    funds, capital requirements and other factors, including any applicable
    laws.

    The Company estimates that as of December 31, 1996 there were approximately
    1,550 beneficial holders of the Common Stock.

                                      -18-
<PAGE>
 
    ITEM 5.    MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED
               --------------------------------------------------
               STOCKHOLDER MATTERS (continued)
               -------------------            

    Recent Sales of Unregistered Securities
    ---------------------------------------

    As additional compensation in connection with the initial public offering,
    the Company granted to the Company's Initial Public Offering underwriter an
    option to purchase options which covered 120,000 units, each unit consisted
    of 1.05 shares of Common Stock and one Company Warrant to purchase 1.05
    shares of Common Stock.  The Option was exercisable until March 4, 1997 and
    entitled the underwriter to purchase each unit at an exercise price equal to
    $5.94, subject to adjustment in certain events.  The underwriter
    subsequently transferred the Options to principles of the underwriter
    (Transferees), who exercised the Options during 1996 resulting in net
    proceeds to the Company of approximately $719,000. During August 1996, one
    of the Transferrees exercised 24,000 Warrants to purchase 25,200 shares of
    Common Stock of the Company resulting in additional proceeds to the Company
    of approximately $168,000.

    In February 1994, the Board of Directors granted additional vested options
    to purchase 42,000 shares of the Company's Common Stock at an exercise price
    of $1.78 per share, the fair market value of the Common Stock at the date of
    grant, to two non-management members of the Board of Directors.  During June
    and September 1996, the two non-management members of the Board of Directors
    (one now a former director), exercised the 42,000 options and sold 42,000
    shares of Common Stock received upon the option exercise.  The Company
    realized net proceeds of approximately $75,000 from the exercise of the
    42,000 options.

    On August 9, 1995, the Company adopted the 1995 Director Warrant Plan (the
    "Plan") pursuant to which eligible directors received unregistered warrants
    to purchase Common Stock (the "Directors' Warrants"). The Plan allows for
    issuance of warrants to purchase up to 700,000 shares of Common Stock.

    On August 9, 1995, warrants to purchase up to 500,000 shares of Common Stock
    at an initial exercise price of $3.875 (the closing price of the Company's
    stock on the date of issue) were issued to five directors pursuant to the
    Plan.  Separately, unregistered warrants to purchase 114,500 shares of
    Common Stock at an initial exercise price of $4.01 were also issued to an
    outside director, who was also a consultant to the Company, who was
    ineligible to participate in the Plan.

    During May 1996, the outside director who was also a consultant to the
    Company exercised the 114,500 Warrants and sold 114,500 shares of Common
    Stock.  The Company received cash proceeds of approximately $459,000 related
    to the exercise of such Warrants.

    During January 1997, the Company's three outside directors each exercised
    25,000 Director Warrants and sold 26,750 shares of Common Stock (after
    adjustment for the January 1997 7% Common Stock dividend).  The Company
    received cash proceeds of approximately $291,000 as a result of the exercise
    of the 75,000 Director Warrants.

                                      -19-
<PAGE>
 
    ITEM 5.     MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED
                --------------------------------------------------
                STOCKHOLDER MATTERS (Continued)
                -------------------            

    Recent Sales of Unregistered Securities (continued)
    ---------------------------------------            

    In October 1995, the Company signed an agreement retaining Commonwealth
    Associates ("Commonwealth") as its investment banking firm.  Commonwealth, a
    New York-based investment banking firm specializing in serving the financial
    needs of emerging growth companies, had been engaged to assist the Company
    in establishing a long-term financial strategy and in evaluating possible
    transactions involving other mobile diagnostic providers.  In addition to a
    cash retainer, the Company granted to Commonwealth 100,000 five-year
    Warrants to purchase the Company's Common Stock at $4.47, the closing bid
    price of the Common Stock on the day the Agreement was executed.  The
    agreement with Commonwealth expired in April 1996.  During July and October
    1996, Commonwealth or a designated employee of Commonwealth exercised the
    100,000 Warrants in a net transaction and the Company issued to Commonwealth
    or the designated employee an aggregate of 36,061 shares of Common Stock of
    the Company.

    All of the above Warrants, options and shares which were privately placed
    were issued without registration in reliance upon Section 4(2) of the
    Securities Act of 1933, as amended.

                                      -20-
<PAGE>
 
ITEM 6.     SELECTED FINANCIAL DATA
            -----------------------

The following table sets forth the consolidated financial data and operating
information of the Company.  The following data should be read in conjunction
with the Company's Consolidated Financial Statements and accompanying footnotes
to the Consolidated Financial Statements and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
                                                        Year Ended December 31,
                                   -----------------------------------------------------------------
                                      1996         1995          1994          1993         1992
                                   -----------  -----------  ------------  ------------  -----------
<S>                                <C>          <C>          <C>           <C>           <C>
Consolidated Statement of
  Earnings Data:
 
  Revenues                         $19,212,353  $15,157,845  $13,282,185   $11,906,319   $ 8,735,137
  Depreciation and
     amortization                    4,724,909    3,679,246    3,163,606     2,755,824     2,070,095
  Interest                           2,041,247    1,757,551    1,637,556     1,715,529     1,567,712
  Write-down of leased
     medical equipment                      --           --           --       625,000            --
  Income (loss) from
     continuing operations
     before income taxes             3,588,861    1,851,217      635,758      (105,217)      211,288
  Income (loss) attributable
     to Common Stockholders
     from continuing operations      2,410,861    1,373,217      542,258       (93,067)      198,486
  Net income (loss) from
     continuing operations per
     Common Share (1)                     $.61         $.46         $.20    ($     .04)         $.08
                                                                                 
 Weighted average
     Common Shares
     outstanding (1)                 3,232,505    2,770,230    2,705,388     2,641,188     2,258,128
 
 
                                                             December 31,
                                  -----------------------------------------------------------------
                                      1996          1995         1994         1993          1992
                                  ------------  -----------  -----------  -----------   -----------
 
Consolidated Balance
  Sheet Data:
  Working capital
    (deficit)                      $   587,040  $   405,349 ($   251,536) ($   421,086)  $ 1,956,009
  Total assets                      39,497,563   23,347,805   20,622,953    18,391,871    18,739,079
  Long-term debt and
    capital lease
    obligations less
    current portion                 20,859,964   12,709,905   12,618,013    11,077,532     9,477,846
  Minority interests                        --           --      145,188       165,356       122,435
  Stockholders' equity (2)          11,399,543    5,401,653    3,653,312     3,243,054     5,553,613
</TABLE>

(1)  Weighted average shares outstanding for 1996 and 1995 have been calculated
using the Modified Treasury Stock Method. Weighted average Common Shares
outstanding for all periods presented have been adjusted to reflect a 1995 5%
Common Stock dividend and a 7% Common Stock dividend paid January 1997 (See Note
2 and Note 12 to the Company's Consolidated Financial Statements included in
Item 8, which information is incorporated herein by reference).

(2)  During the periods presented, the Company did not pay any cash dividends on
its Common Stock.

                                      -21-
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         -----------------------------------------------------------------------
         OF OPERATIONS
         -------------

Any statements released by the Company that are forward-looking are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995.  Investors are cautioned that forward-looking statements
involve risks and uncertainties which may affect the Company's business and
prospects, including economic, competitive, governmental, technological and
other factors discussed in the Company's filings with the Securities and
Exchange Commission.

Results of Operations
---------------------

The following table sets forth, for the period indicated, the percentages which
the items in the Statement of Earnings bear to revenue and the dollar increase
(decrease) of such items as compared to the prior year.
<TABLE>
<CAPTION>
                                                              Percentage of Revenue                 Increase (Decrease)
                                                              -----------------------               -------------------
                                                              Year Ended December 31,
                                                              -----------------------
                                                                                                1996              1995
                                                                                               Versus            Versus
                                                   1996            1995        1994             1995               1994
                                             -----------------  ----------  -----------  -------------------  ---------------
<S>                                          <C>                <C>         <C>          <C>                  <C>
 
Revenues                                          100%                100%         100%          $4,055,000       $1,876,000
                                                 ----                ----         ----           ----------       ----------
Costs & expenses:                                             
                 Operating                         33%                 36%          44%             884,000         (496,000)
                 Depreciation and                             
                   amortization                    24%                 24%          24%           1,046,000          516,000
                 S, G & A                          15%                 16%          14%             405,000          578,000
                 Interest                          11%                 12%          13%             284,000          120,000
                 Other                         (   2%)                 --           --         (    300,000)              --
                                                 ----                ----         ----           ----------       ----------
                                                              
Total costs & expenses                             81%                 88%          95%           2,319,000          718,000
                                                 ----                ----         ----           ----------       ----------
                                                              
Income from continuing                                        
                 operations before taxes,                     
                 minority interests and                       
                 gain on sale                      19%                 12%           5%           1,736,000        1,158,000
                                                              
Minority interests                                 --                  --           --        (      50,000)       (   9,000)
                                                 ----                ----         ----           ----------       ----------
                                                              
Income from continuing                                        
                 operations before taxes                      
                 and gain on sale                  19%                 12%           5%           1,786,000        1,167,000
                                                              
Gain on sale of partnership                                   
                 interests                         --                  --           --        (      48,000)          48,000
                                                 ----                ----         ----           ----------       ----------
                                                              
Income from continuing                                        
                 operations before                            
                 income taxes                      19%                 12%           5%           1,738,000        1,215,000
                                                              
Income taxes                                        6%                  3%           1%             700,000          384,000
                                                 ----                ----         ----           ----------       ----------
                                                              
Income from continuing                                        
                 operations                        13%                  9%           4%           1,038,000          831,000
                                                              
Discontinued operations, net                       --                  --        (   1%)                 --          132,000
                                                 ----                ----         ----           ----------       ----------
                                                              
    Net income                                     13%                  9%           3%          $1,038,000       $  963,000
                                                 ====                ====         ====           ==========       ==========
</TABLE>

                                      -22-
<PAGE>
 
    ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
             ---------------------------------------------------------------
             RESULTS OF OPERATIONS (continued)
             ---------------------            

    1996 Versus 1995
    ----------------

    The Company achieved a considerable increase in profitability during 1996.
    Net income during 1996 increased $1,038,000, or 76%, to $2,411,000 (or $.61
    per share) from $1,373,000 (or $.46 per share) during 1995 (see Note 2 of
    the Company's Consolidated Financial Statements included in Item 8, which
    information is incorporated herein by reference, for a discussion of the
    Modified Treasury Stock Method of computing earnings per share).  The
    earnings per share data for both periods has been adjusted to reflect the 7%
    Common Stock dividend paid January 14, 1997 to all shareholders of record on
    January 10, 1997 (See Note 12 of the Company's Consolidated Financial
    Statements included in Item 8, which information is incorporated herein by
    reference).  The increase in profitability is principally due to increased
    revenues attributed to new units placed into service in late 1995, seven
    additional units placed into service throughout 1996, the upgrade of four
    units to newer technology in 1996, as well as increased utilization of the
    Company's mobile MRI units. Lower financing costs and higher down payments
    on new and upgraded mobile MRI units have also contributed to the increased
    profitability during 1996.  The Company operated an average of approximately
    14 units during 1996.

    Revenues during 1996 increased $4,055,000, or 27%, to $19,212,000 compared
    to $15,158,000 in 1995.  Excluding 1995 revenues of approximately $548,000
    related to the Company's cardiac partnerships, which were sold on June 30,
    1995, mobile MRI revenues increased approximately 32%.  This increase in
    revenue was primarily attributed to the aforementioned new units placed into
    service during late 1995, the seven additional units placed into service
    during 1996, the upgrade of four units to newer technology in 1996 and the
    increased utilization of the Company's existing mobile MRI units.  Revenues
    derived from hospitals which the Company serviced in both comparable periods
    increased approximately 13% in 1996 compared to 1995 primarily as a result
    of increased MRI procedures.  During 1996, the Company performed 45,185 MRI
    scans, representing an increase of 12,103 scans, or 37%, over the 33,082 MRI
    scans during 1995.  Average scans per day per unit increased .5 to 10.9
    scans per day during 1996 compared to 10.4 during 1995. The average fee per
    scan for 1996 approximated $408 for 1996 versus $435 for 1995.  The $27, or
    6% decrease in average fee per scan primarily related to discounted fees
    provided to customers based upon higher scan volumes.

    Operating expenses increased $884,000, or 16%, to $6,280,000 during 1996
    compared to $5,396,000 in 1995.  Excluding approximately $179,000 of
    operating expenses associated with the cardiac partnerships which were sold
    on June 30, 1995, mobile MRI operating expenses increased $1,063,000
    primarily due to approximately $1,350,000 of operating expenses associated
    with the Company's new units purchased in late 1995 and the seven units
    added during 1996, partially offset by a decrease of approximately $287,000,
    or 6%, in operating expenses of units in operation for both comparable
    periods.  This 6% decrease is primarily a result of $141,000 savings on
    state sales tax on certain units, $122,000 savings on lower maintenance and
    cryogen contracts, $64,000 savings on

                                      -23-
<PAGE>
 
    ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
             ---------------------------------------------------------------
             RESULTS OF OPERATIONS (continued)
             ---------------------            

    1996 Versus 1995 (continued)
    ----------------            

    the rental of tractors used to transport the MRI units and $42,000 savings
    on general repairs and maintenance costs, partially offset by higher payroll
    costs for operating personnel.  Operating expenses per scan decreased $24,
    or 15%, to approximately $139 compared to $163 per scan during 1995.

    Depreciation and amortization expenses increased $1,046,000, or 28%, in 1996
    to $4,725,000 from $3,679,000 in 1995.  This increase was primarily due to
    depreciation expense associated with the Company's new units purchased
    during late 1995, the seven additional units placed into service in 1996, as
    well as the four units upgraded during 1996.

    Selling, general and administrative costs for 1996 increased $405,000 to
    $2,877,000, or 15% of revenues, compared to $2,472,000, or 16% of revenues
    in 1995.  The increase is primarily due to an approximate $200,000 increase
    in executive compensation and costs related to the Company's management
    bonus plan.  The remaining increase is due to higher corporate expenses such
    as travel, insurance and costs associated with the Company's Joint
    Commission on Accreditation of Healthcare Organizations ("JCAHO")
    accreditation.

    Interest expense for 1996 increased $284,000 to $2,041,000 from $1,758,000
    in 1995, primarily as a result of the new units purchased during late 1995,
    the seven additional units placed into service in 1996 as well as the four
    units upgraded during 1996.  However, interest expense decreased as a
    percentage of revenue to 11% in 1996 compared to 12% of revenue in 1995.
    This decrease as a percentage of revenue is primarily due to higher down
    payments on new and upgraded mobile MRI units as well as more favorable
    lease terms obtained on unit financings and refinancings during 1995 and
    1996.

    Other expense in 1996 reflects a $300,000 net state sales tax refund.  The
    refund is the result of sales tax paid to a  certain state over a period of
    time which the Company determined (by obtaining a private letter ruling from
    the state) was actually exempt from such tax.  The Company obtained formal
    notice of the refund in September 1996 and received the cash refund in
    January 1997.

    The Company reported net income of $2,411,000, or $.61 per share, in 1996
    versus $1,373,000, or $.46 per share, in 1995.  Income tax expense for 1996
    was $1,178,000, an effective tax rate of approximately 33%, as compared to
    income tax expense of $478,000, an effective tax rate of approximately 26%,
    for 1995.  Income tax expense for 1996 reflects a net $105,000 deferred tax
    benefit resulting from an adjustment to the Company's federal net operating
    loss carryforward (see Note 4 of the Company's Consolidated Financial
    Statements included in Item 8, which information is incorporated herein by
    reference).  Excluding the $105,000 tax adjustment, the Company's effective
    tax rate for 1996 approximated 36%.  The increase in income tax expense
    reflects the significant increase in profitability of the Company during
    1996.

                                      -24-
<PAGE>
 
    ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
             ---------------------------------------------------------------
             RESULTS OF OPERATIONS (continued)
             ---------------------            

    1995 Versus 1994
    ----------------

    The Company realized a significant increase in profitability during 1995.
    Net income during 1995 increased $963,000, or 235%, to $1,373,000 (or $.46
    per share) from $410,000 (or $.15 per share) during 1994.  (Please refer to
    Note 2 of the Company's Consolidated Financial Statements included in Item
    8, which information is incorporated herein by reference, for a discussion
    of the Modified Treasury Stock Method of computing earnings per share).  The
    earnings per share data for both periods has been adjusted to reflect the 7%
    Common Stock dividend paid January 14, 1997 to all shareholders of record on
    January 10, 1997 (See Note 12 of the Company's Consolidated Financial
    Statements included in Item 8, which information is incorporated herein by
    reference).  The increase in profitability is primarily due to increased
    revenues, lower costs due to increased utilization of the Company's units,
    the impact of a cost reduction program begun in 1994 and lower financing
    costs.

    Revenues during 1995 increased $1,876,000, or 14%, to $15,158,000 in
    comparison to $13,282,000 in 1994.  Revenues, excluding $548,000 and
    $1,018,000 for 1995 and 1994, respectively, related to the Cardiac and
    Nuclear SPECT partnerships which the Company sold on June 30, 1995 (see Note
    14 of the Company's Consolidated Financial Statements included in Item 8,
    which information is incorporated herein by reference), increased 19% from
    1994 to 1995.  This increase is primarily due to increased utilization of
    the Company's MRI units.  Revenues of existing units increased approximately
    8% in 1995 compared to 1994.  Further, the Company operated an average of
    ten units during 1995 versus nine units in 1994.  During 1995, the Company
    performed 33,082 MRI scans, representing an increase of 7,587 scans, or 30%,
    over the 25,495 scans performed during 1994.  Average scans per day averaged
    10.4 during 1995 compared to approximately 9.0 scans per day during 1994.
    The average fee per scan for 1995 approximated $435 versus $476 per scan
    during 1994.  The $41, or 9% decrease in average fee per scan is primarily
    due to discounted fees provided to customers based upon higher scan volumes.

    Operating expenses during 1995 decreased $496,000, or 8%, to $5,396,000
    compared to $5,892,000 in 1994.  This decrease was primarily due to various
    cost containment measures implemented during late 1994 and early 1995, as
    well as the purchase and upgrade during November 1994 of a Mobile Unit which
    had previously been leased on an annual basis by the Company pursuant to an
    operating lease (accordingly, its lease payment was treated entirely as an
    operating expense).  As a result of the purchase and upgrade, the lease
    costs were treated as depreciation and interest expenses. Operating expenses
    of existing units decreased approximately 2% in 1995 compared to 1994,
    excluding the aforementioned lease adjustment.  During 1994 and early 1995,
    the Company renegotiated its mobile unit maintenance contracts, property
    insurance rates and several other major operating expenditures resulting in
    annual cost savings of approximately $250,000.  Operating expense per unit
    decreased $68, or 29%, to $163 from $231 per scan during 1994.

                                      -25-
<PAGE>
 
    ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
             ---------------------------------------------------------------
             RESULTS OF OPERATIONS (continued)
             ---------------------            

    1995 Versus 1994 (continued)
    ----------------            

    Depreciation and amortization expense increased $516,000, or 16%, to
    $3,679,000 in 1995 from $3,164,000 in 1994.  The increase was primarily due
    to higher depreciation expense associated with the Company's new units
    purchased in February and September of 1995 as well as its upgraded and
    refinanced units.

    Selling, general and administrative costs for 1995 increased $578,000 to
    $2,472,000, or 16% of revenues, compared to $1,894,000, or 14% of revenues
    for 1994.  The increase was primarily due to increased marketing expenses,
    increases in professional expenses related to the Company's shareholder
    rights plan and various securities filings and increased compensation costs
    related to the Company's management bonus plan.

    Interest expense for 1995 increased $120,000 to $1,758,000 from $1,638,000
    but decreased as a percentage of revenue to 12% of revenue versus 13% of
    revenue in 1994.  The increase in interest expense primarily reflects the
    interest payments on the two new units purchased during 1995.  The decrease
    in interest expense as a percentage of revenues reflects the more favorable
    lease terms obtained on the units refinanced during 1994 and 1995.

    Income tax expense for 1995 was $478,000 as compared to income tax expense
    of $94,000 for 1994. This increase reflects the significant increase in
    profitability of the Company during 1995 (see Note 4 of the Company's
    Consolidated Financial Statements included in Item 8, which information is
    incorporated herein by reference).


    Liquidity and Capital Resources
    -------------------------------

    During 1996, the Company's cash provided by operations was $7,441,000 as
    compared to $5,541,000 during 1995.  This increase of $1,900,000 is
    primarily due to approximately $2,084,000 of increased income before
    depreciation and amortization and $1,288,000 of deferred income tax expense,
    partially offset by a $545,000 increase in accounts and notes receivable and
    a $471,000 increase in other current assets.  The increase in other current
    assets is primarily due to a sales tax refund receivable which was collected
    in January 1997.

    The Company used cash in investing activities during 1996 of $2,567,000,
    primarily related to down payments and deposits on the purchase of new MRI
    units totaling approximately $2,977,000 as well as the purchase of a mobile
    MRI company in March 1996  for approximately $643,000 (see Note 16 of the
    Company's Consolidated Financial Statements included in Item 8, which
    information is incorporated herein by reference) partially offset by a
    reduction of $1,200,000 in the amount of restricted cash related to
    equipment financing.

                                      -26-
<PAGE>
 
    ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
             ---------------------------------------------------------------
             RESULTS OF OPERATIONS (continued)
             ---------------------            

    Liquidity and Capital Resources (continued)
    -------------------------------            

    The Company used cash in financing activities during 1996 of approximately
    $2,573,000 primarily related to $4,800,000 of principal payments under loan
    agreements and capital leases partially offset by approximately $2,227,000
    received upon exercise of stock options and warrants during 1996. The
    Company experienced a net increase in unrestricted cash and cash equivalents
    of approximately $2,302,000 during 1996 and maintained an unrestricted cash
    balance at December 31, 1996 of approximately $4,643,000.  The Company also
    maintained a restricted cash balance of $400,000 at December 31, 1996.

    The Company's trade accounts receivable balance increased by $667,000 to
    $1,726,000 at December 31, 1996, primarily due to higher service revenues
    during the fourth quarter of 1996.  In the experience of the Company,
    average accounts receivable collections typically do not exceed 40 days, as
    there are no billings subject to traditional third-party payors, and the
    accounts receivable balance turned over approximately fourteen times during
    1996.  Approximately 29% of the Company's billings and collections are
    processed through Hospital Shared Services ("HSS"), a representative of
    certain hospitals.  As a fee for these services, HSS retains approximately
    2.5% of gross billings to these hospitals and the Company records the
    service revenues and related receivables net of such fees.

    At December 31, 1996, the Company had a working capital surplus of $587,000.
    In addition, the Company's cash flow from operations totaled $7,441,000 for
    1996 and the Company continues a positive cash flow.  Further, $6,350,000 of
    the $7,238,000 of current liabilities relate to the current portion of
    capital leases and long-term debt which will be due over the next twelve
    months, as opposed to current assets of $7,825,000 which are highly liquid
    and turn over frequently.  The Company has been able to meet all past debt
    service obligations, currently is able to meet all such obligations, and
    anticipates it will continue to meet such obligations.  As in the past,
    management anticipates that such obligations will be funded by the revenues
    generated by the Mobile Units.

    To date, the Company has financed its equipment acquisitions and working
    capital requirements with loans and leases, from internal cash flow and
    capital contributions.  As of December 31, 1996, the Company was a party to
    leases and loans covering all of its mobile MRI units.  The aggregate
    outstanding principal balance of all such leases and loans was approximately
    $27,210,000 at December 31, 1996.

    The Company's mobile MRI operation grew at a record pace during 1996.  In
    1994, healthcare costs came under great scrutiny and the healthcare market
    forces began their own healthcare reform.  This reform continues, and mobile
    diagnostic imaging has benefited from such market reform of the healthcare
    system as shared equipment is a key to containing healthcare costs while
    still delivering advanced and cost effective medical technology.  As
    hospitals continue to look for ways to reduce

                                      -27-
<PAGE>
 
    ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
             ---------------------------------------------------------------
             RESULTS OF OPERATIONS (continued)
             ---------------------            

    Liquidity and Capital Resources (continued)
    -------------------------------            

    capital expenditures and contain costs, SMT and shared mobile diagnostic
    imaging units/systems allow hospitals to add or increase the range of
    quality, state-of-the-art diagnostic services with no capital expenditure by
    providing an outsourcing alternative.  Further, many states, including those
    in which the Company operates, have strengthened their Certificate of Need
    ("CON") review systems, whereby healthcare providers must justify a need in
    a community before the state will permit capital expenditures for medical
    equipment.  As a result of CON review systems, hospitals and other
    healthcare providers are less able to install fixed site facilities thus
    providing an opportunity for mobile suppliers whose equipment will be shared
    among many hospitals.

    The Company upgraded one of its .5 Tesla Signa units to a 1.0 Tesla Horizon
    unit.  The new unit was financed at a net total cost of approximately $2.0
    million and was delivered in late February 1996.  The Company financed the
    purchase of this new unit with a 60 month dollar-out lease requiring monthly
    payments of approximately $44,000.

    The Company contracted with several new hospital clients and purchased a new
    Siemens 1.0 Tesla Impact unit which began service in mid-February 1996.  The
    cost of this new unit approximated $1.9 million which was financed with a 60
    month loan requiring monthly payments of approximately $41,000.

    On March 21, 1996, the Company purchased certain assets of a mobile provider
    which operated mobile units in the state of North Carolina (the "Seller").
    The purchase price approximated $600,000 in cash [net of negotiated trade-in
    value of approximately $500,000 (which approximated the purchase price of
    the units acquired) for two of the Seller's mobile MRI units] in exchange
    for MRI Programs including Certificate of Need licenses or exemptions and
    certain customer service contracts.

    In April 1996, the Company upgraded one of the units purchased from the
    Seller to a Siemens 1.0 Tesla Impact unit with a net total cost of
    approximately $1.9 million.  The Company financed this new unit with a 60
    month loan requiring monthly payments of approximately $43,000.

    In June 1996, the Company upgraded one of its .5 Tesla Signas to a Siemens
    1.0 Tesla Impact unit. The new unit was financed at a net total cost of
    approximately $2.0 million with a 60 month dollar-out lease requiring
    monthly payments of approximately $43,000.

    The Company in May 1996 signed an agreement with Siemens Medical Systems to
    upgrade the second unit purchased from the Seller and to purchase a new unit
    during the fourth quarter of 1996. Delivery of the upgraded unit occurred in
    July 1996 and is currently contracted to provide temporary interim services
    to hospitals through July 1997.  The new unit was delivered and began
    operation on October 1, 1996.  The upgrades net cost approximated $1.9
    million and the Company financed approximately $1.7 million with a 60 month
    finance agreement requiring monthly payments of

                                      -28-
<PAGE>
 
    ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
             ---------------------------------------------------------------
             RESULTS OF OPERATIONS (continued)
             ---------------------            

    Liquidity and Capital Resources (continued)
    -------------------------------            

    approximately $36,000.  The Company's new unit cost approximately $1.9
    million and the Company financed approximately $1.7 million requiring a
    monthly payment of approximately $37,000.

    During September 1996, the Company upgraded an older unit to a new Siemens
    1.0 Tesla Impact. The cost of this new unit approximated $1.9 million which
    was financed with a 60 month loan requiring monthly payments of
    approximately $39,000.

    The Company purchased and took delivery of two new GE 1.0 Tesla Horizon
    units in mid-to-late September 1996.  These units were purchased at a cost
    of approximately $1.8 million each and the Company financed approximately
    $1.6 million and $1.5 million with 60 month finance agreements requiring
    monthly payments of approximately $34,000 and $32,000, respectively.

    The Company completed a previously negotiated upgrade of a .5 Tesla Signa to
    a 1.0 Tesla Horizon in November 1996.  The new unit was financed at a net
    cost of approximately $1.5 million with a 60 month finance agreement
    requiring monthly payments of approximately $32,000.

    On November 1, 1996, the Company purchased a mobile MRI unit from Palmetto
    Community Health Network (the "Network") for approximately $390,000 and
    signed new service contracts with six South Carolina hospitals which are
    members of the Network.  The Company began servicing the new hospitals
    immediately with the MRI unit purchased from the Network and subsequently
    upgraded the purchased unit to a new 1.0 Tesla Horizon in December 1996.
    The upgraded unit was financed at a net cost of approximately $1.4 million
    with a 60 month finance agreement requiring monthly payments of
    approximately $30,000.  This new unit represents the Company's eighteenth
    mobile MRI unit and the seventh new unit acquired during 1996.

    The Company has outstanding a letter-of-credit totaling $400,000 related to
    equipment financing at a freestanding diagnostic imaging center which it
    sold in June 1995 and on which it remains obligated (see Note 3 and Note 10
    of the Company's Consolidated Financial Statements incorporated herein by
    reference).

    In November 1994, the Company issued a letter-of-credit in the amount of
    $270,000 related to the purchase and financing of a new Mobile Unit.  The
    lessor holding this letter-of-credit allowed the letter-of-credit to
    terminate October 31, 1996.

    In relation to a refinancing of four Mobile Units in February and March
    1995, the Company issued two letters-of-credit in the aggregate amount of
    $930,000.  In February 1996, the lessor holding one of the letters-of-credit
    totaling $330,000 allowed the letter-of-credit to expire.

                                      -29-
<PAGE>
 
    ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
             ---------------------------------------------------------------
             RESULTS OF OPERATIONS (continued)
             ---------------------            

    Liquidity and Capital Resources (continued)
    -------------------------------            

    On July 31, 1996, the Company refinanced two MRI units which had previously
    been refinanced in March 1995 to more favorable lease terms.  The new leases
    totaled approximately $2.3 million (net of a $150,000 down payment) in the
    aggregate and are being financed over a thirty-six month period at an
    interest rate of 9.25%.  The refinancing resulted in annual cash flow
    savings to the Company of approximately $200,000.  As a result of this
    refinancing, the $600,000 letter-of-credit which had been issued in March
    1995 was terminated.

    During 1996, the Company signed long-term contracts with approximately 22
    new customers and extended for an additional two to three years
    approximately 27 existing customer contracts.  As of December 31, 1996, the
    Company serviced approximately 75 total customers.

    At December 31, 1996, the Company had net operating loss carryforwards for
    federal and state income tax purposes of approximately $8.2 million and
    $10.1 million, respectively, which are available to offset future federal
    and state taxable income through 2010 and 1999, respectively (See Note 4 of
    the Company's Consolidated Financial Statements).

    The Company had been named as a defendant, along with the hospital which
    contracts for the Company's MRI services, in a claim filed by a woman who
    alleged to have incurred partial paralysis as a result of being mishandled
    during an MRI procedure.  The claim had been filed for $6.0 million in
    damages.  The claim was settled by the Company's insurance company in
    November 1996 with no admission of liability and no financial effect to the
    Company.

    On January 14, 1997, the Company paid a 7% Common Stock dividend to all
    shareholders of record on January 10, 1997 (See Note 12 of the Company's
    Consolidated Financial Statements incorporated herein by reference).

    The Company received Accreditation with Commendation from the Joint
    Commission for the Accreditation of Healthcare Organizations ("JCAHO") in
    January 1997.

    During January through March 4, 1997, approximately 1,677,000 Warrants were
    exercised and the Company issued approximately 1,882,000 shares of its
    Common Stock.  The Company received net cash proceeds of approximately $11.7
    million as a result of such Warrant exercises (See Note 18 of the Company's
    Consolidated Financial Statements incorporated herein by reference).

                                      -30-
<PAGE>
 
    ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
             ---------------------------------------------------------------
             RESULTS OF OPERATIONS (continued)
             ---------------------            

    Liquidity and Capital Resources (continued)
    -------------------------------            

    In June 1996, the Financial Accounting Standards Board issued Statement of
    Financial Accounting Standards ("SFAS") No. 125, Accounting for Transfers
    and Servicing of Financial Assets and Extinguishments of Liabilities.  In
    summary, SFAS 125, as amended by SFAS 127, Deferral of the Effective Date of
    Certain Provisions of FASB Statement No. 125, provides accounting and
    reporting standards for transfers and servicing of financial assets and
    extinguishments of liabilities.  Those standards are based on consistent
    application of a financial-components approach that focuses on control.
    Under that approach, after a transfer of financial assets, an entity
    recognizes the financial and servicing assets it controls and the
    liabilities it has incurred, derecognizes financial assets when control has
    been surrendered, and derecognizes liabilities when extinguished.  SFAS 125
    provides consistent standards for distinguishing transfers of financial
    assets that are sales from transfers that are secured borrowings.  SFAS 125
    is effective beginning January 1, 1997 with certain provisions delayed to
    January 1, 1998 as a result of SFAS 127.  Earlier or retroactive application
    is not permitted.  The Company does not anticipate a material impact
    resulting from adoption of these pronouncements.

    Management believes that the healthcare industry continues to be in a period
    of consolidation characterized by mergers, joint ventures, acquisitions,
    sales of all or part of healthcare companies or their assets, and other
    partnering and investment transactions of various structures and sizes
    involving healthcare companies.  The Company continues to evaluate new
    opportunities that allow for the expansion of its business through the
    acquisition of additional Mobile Units in geographic proximity to its
    existing regional markets or in locations that can serve as a basis for new
    market areas.  The Company, like other healthcare companies, has
    participated from time to time and is participating in preliminary
    discussions with third parties regarding a variety of potential
    transactions, and the Company has considered and expects to continue to
    consider and explore potential transactions of various types with other
    healthcare companies.  However, no assurances can be given as to whether any
    such transactions may be consummated or, if so, when.

                                      -31-
<PAGE>
 
    ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
             -------------------------------------------


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



                   SMT Health Services Inc. and Subsidiaries



    Independent Auditors' Report of KPMG Peat Marwick LLP .................. 33


    Consolidated Balance Sheets as of December 31, 1996 and 1995............ 34


    Consolidated Statements of Earnings for the years ended
       December 31, 1996, 1995 and 1994 .................................... 36


    Consolidated Statements of Cash Flows for the years ended
       December 31, 1996, 1995 and 1994 .................................... 38


    Consolidated Statements of Changes in Stockholders' Equity for
       the years ended December 31, 1996, 1995 and 1994 .................... 40


    Notes to Consolidated Financial Statements.............................. 41

                                      -32-
<PAGE>
 
                          Independent Auditors' Report



    The Board of Directors and Stockholders
    SMT Health Services Inc.:



    We have audited the accompanying consolidated balance sheets of SMT Health
    Services Inc. and subsidiaries as of December 31, 1996 and 1995 and the
    related consolidated statements of earnings, changes in stockholders'
    equity, and cash flows for each of the years in the three-year period ended
    December 31, 1996.  In connection with our audits of the consolidated
    financial statements, we also have audited the consolidated financial
    statement schedule as of and for the years ended December 31, 1996, 1995 and
    1994, as listed in Item 14.  These consolidated financial statements and
    financial statement schedule are the responsibility of the Company's
    management.  Our responsibility is to express an opinion on these
    consolidated financial statements and financial statement schedule based on
    our audits.

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

    In our opinion, the consolidated financial statements referred to above
    present fairly, in all material respects, the financial position of SMT
    Health Services Inc. and subsidiaries as of December 31, 1996 and 1995 and
    the results of their operations and their cash flows for each of the years
    in the three-year period ended December 31, 1996, in conformity with
    generally accepted accounting principles.  Also in our opinion, the related
    consolidated financial statement schedule, when considered in relation to
    the basic consolidated financial statements taken as a whole, presents
    fairly, in all material respects, the information set forth therein.



    KPMG Peat Marwick LLP
    Pittsburgh, Pennsylvania
    January 31, 1997, except as to Note 18 which is as of March 4, 1997

                                      -33-
<PAGE>
 
                   SMT Health Services Inc. and Subsidiaries

                          Consolidated Balance Sheets
<TABLE>
<CAPTION>
                                                                     December 31,
                                                               ------------------------
                                                                  1996          1995
                                                               -----------  ------------
<S>                                                            <C>          <C>
ASSETS
-----
 
CURRENT ASSETS:
 Cash and cash equivalents - unrestricted                      $ 4,643,158  $ 2,341,519
 Cash and cash equivalents - restricted (Note 10)                  400,000    1,600,000
 Accounts receivable - no allowance for doubtful accounts        1,726,442    1,059,567
 Notes receivable - current portion                                 52,240       47,760
 Receivable from the sale of leases secured by equipment -
  current portion (Note 3)                                         387,999      342,789
 Other current assets                                              615,257      249,961
                                                               -----------  -----------
 
   Total current assets                                          7,825,096    5,641,596
                                                               ----------- -------------
 
PROPERTY AND EQUIPMENT:
 Equipment                                                         200,709      174,556
 Furniture and fixtures                                             43,055       59,712
 Vehicles                                                          162,915      125,103
 Leasehold improvements                                             28,495       27,915
 Leased medical equipment                                       35,932,207   22,167,551
                                                               -----------  -----------
 
   Total property and equipment                                 36,367,381   22,554,837
 
 Less accumulated depreciation and amortization                 (6,734,353)  (6,613,759)
                                                               -----------  -----------
 
   Property and equipment, net                                  29,633,028   15,941,078
                                                               -----------  -----------
 
OTHER ASSETS:
 Notes receivable - noncurrent                                          --       52,240
 Receivable from the sale of leases secured by equipment -
   noncurrent (Note 3)                                             490,591      878,590
 Contract and license acquisition costs, net of accumulated
   amortization of $889,000 and $788,000, respectively             631,933      109,260
 Deposits and other assets                                         594,915      506,041
 Deferred income taxes, net of valuation allowance
   of $103,000 at December 31, 1995 (Note 4)                       322,000      219,000
                                                               -----------  -----------
 
   Total other assets                                            2,039,439    1,765,131
                                                               -----------  -----------
 
TOTAL ASSETS                                                   $39,497,563  $23,347,805
                                                               ===========  ===========
 
</TABLE>



                See Notes to Consolidated Financial Statements.

                                      -34-
<PAGE>
 
                   SMT Health Services Inc. and Subsidiaries

                    Consolidated Balance Sheets (Continued)
<TABLE>
<CAPTION>
 
                                                                       December 31,
                                                                ------------------------
                                                                    1996        1995
                                                                ----------   -----------
<S>                                                             <C>          <C>
 
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
 
CURRENT LIABILITIES:
 Accounts payable                                               $  363,682     $   270,277
 Accrued wages and related taxes                                   111,664          57,823
 Current portion of long-term debt and capital
  lease obligations                                              6,349,962       4,380,930
 Other current liabilities                                         412,748         527,217
                                                               -----------     -----------
 
  Total current liabilities                                      7,238,056       5,236,247
                                                               -----------     -----------
 
LONG-TERM DEBT AND CAPITAL LEASE
 OBLIGATIONS - less current portion                             20,859,964      12,709,905
                                                               -----------     -----------
 
  Total liabilities                                             28,098,020      17,946,152
                                                               -----------     -----------
 
STOCKHOLDERS' EQUITY:
 Common Stock, $0.01 par value; authorized
  10,000,000 shares; issued and outstanding
  3,695,030 and 2,654,400, respectively                             36,950          26,544
 Cumulative Convertible Preferred Stock;
  $0.01 par value; authorized 994,600 shares;
  no shares issued and outstanding                                      --              --
 Additional paid-in capital (Note 5)                            12,081,614       6,636,070
 Retained earnings/(accumulated deficit)                          (719,021)     (1,260,961)
                                                               -----------     -----------
 
   Total Stockholders' equity                                   11,399,543       5,401,653
                                                               -----------     -----------
 
TOTAL LIABILITIES AND STOCKHOLDERS'
 EQUITY                                                        $39,497,563     $23,347,805
                                                               ===========     ===========
 
</TABLE>



                See Notes to Consolidated Financial Statements.

                                      -35-
<PAGE>
 
                   SMT Health Services Inc. and Subsidiaries

                      Consolidated Statements of Earnings
<TABLE>
<CAPTION>
 

                                                             Year Ended December 31,
                                                 -----------------------------------------------
                                                      1996            1995            1994
                                                 ---------------  ------------  ----------------
<S>                                              <C>              <C>           <C>
 
REVENUES:
  Service revenue                                   $19,021,954   $15,020,428       $13,235,019
  Interest income                                       190,399       137,417            47,166
                                                    -----------   -----------       -----------
 
    Total revenues                                   19,212,353    15,157,845        13,282,185
                                                    -----------   -----------       -----------
 
COSTS AND EXPENSES:
  Operating expenses - third parties                  6,279,915     5,216,121         5,054,997
  Operating expenses - lease expenses -
     related parties                                         --       180,000           837,000
  Depreciation and amortization                       4,724,909     3,679,246         3,163,606
  Selling, general and administrative                 2,877,421     2,472,023         1,894,037
  Interest - third parties                            2,005,429     1,671,013           239,193
  Interest - related parties                             35,818        86,538         1,398,363
  Other (Note 17)                                      (300,000)           --                --
                                                    -----------   -----------       -----------
 
    Total costs and expenses                         15,623,492    13,304,941        12,587,196
                                                    -----------   -----------       -----------
 
Income from continuing operations before
  income taxes, minority interests and gain
  on sale                                             3,588,861     1,852,904           694,989
 
Minority interests in earnings of
  subsidiaries (Note 14)                                     --        49,906            59,231
                                                    -----------   -----------       -----------
 
Income from continuing operations before
  income taxes and gain on sale                       3,588,861     1,802,998           635,758
 
Gain on sale of partnership interests                        --        48,219                --
                                                    -----------   -----------       -----------
 
Income from continuing operations
  before income taxes                                 3,588,861     1,851,217           635,758
 
Income taxes (Note 4)                                 1,178,000       478,000            93,500
                                                    -----------   -----------       -----------
 
Net income from continuing operations                 2,410,861     1,373,217           542,258
                                                    -----------   -----------       -----------
 
Discontinued operations:
 Loss on disposal of discontinued operations,
   net of tax benefit of $102,000 and $68,000
   in 1995 and 1994, respectively                            --      (198,000)         (132,000)
 Extraordinary item, debt forgiveness, net of
   income tax expense of $102,000                            --       198,000                --
                                                    -----------   -----------       -----------
                                                             --            --          (132,000)
                                                    -----------   -----------       -----------
 
 Net income                                         $ 2,410,861   $ 1,373,217       $   410,258
                                                    ===========   ===========       ===========
 
</TABLE>
                See Notes to Consolidated Financial Statements.

                                      -36-
<PAGE>
 
                   SMT Health Services Inc. and Subsidiaries

                Consolidated Statements of Earnings (Continued)
<TABLE>
<CAPTION>
 
 
                                                       Year Ended December 31,
                                                     ---------------------------
                                                      1996    1995   1994
                                                     -----   ------ -----
<S>                                                  <C>     <C>    C>
                                                                              
Earnings (Loss) per Common                                                    
  Share (Note 2):                                                             
                                                                              
Primary:                                                                      
       Continuing operations                          $ .61  $ .46   $  .20
       Discontinued operations                           --     --     (.05)
                                                      -----  -----   ------
                                                                    
       Earnings Per Common Share                      $ .61  $ .46   $  .15
                                                      =====  =====   ======
                                                                           
Fully Diluted:                                                                
       Continuing operations                          $ .59  $ .46   $  .20
       Discontinued operations                           --     --     (.05)
                                                      -----  -----   ------
                                                                              
Earnings Per Common Share                             $ .59  $ .46   $  .15
                                                      =====  =====   ======
 
</TABLE>



                See Notes to Consolidated Financial Statements.

                                      -37-
<PAGE>
 
                   SMT Health Services Inc. and Subsidiaries

                     Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
 
 
                                                              Year Ended December 31,
                                                        ---------------------------------------
                                                           1996        1995           1994
                                                        ----------  ----------    -------------
<S>                                                     <C>         <C>           <C>
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net income from continuing operations                  $2,410,861   $ 1,373,217    $    542,258
 Adjustments to reconcile net income to net cash
  provided by continuing operating activities:
  Depreciation and amortization                          4,724,909     3,679,246       3,163,606
  Negative amortization on capital lease obligations            --         5,521          51,017
  Minority interests in subsidiaries                            --        49,906          59,231
  Deferred income tax expense                            1,288,000       288,000          48,500
  Gain on sale of partnership interests                         --       (48,219)             --
  Other                                                         --        10,467         110,658
 Changes in assets and liabilities of continuing
   operations:
  Accounts and notes receivable                           (544,660)       17,705         143,231
  Other current assets                                    (470,751)       12,182         (72,347)
  Accounts payable and other                               (21,064)      143,049         (14,348)
  Accrued wages and related taxes                           53,841        10,134           8,073
                                                        ----------   -----------    ------------
NET CASH PROVIDED BY CONTINUING
 OPERATING ACTIVITIES                                    7,441,136     5,541,208       4,039,879
                                                        ----------   -----------    ------------

NET CASH USED IN DISCONTINUED
 OPERATING ACTIVITIES                                           --       (64,264)       (410,108)
                                                        ----------   -----------    ------------
 
NET CASH PROVIDED BY OPERATING ACTIVITIES                7,441,136     5,476,944       3,629,771
                                                        ----------   -----------    ------------
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 Purchase of equipment                                  (2,977,334)     (269,354)       (234,833)
 Payment for purchase of acquired entities,
  net of cash acquired                                    (642,840)           --         (44,000)
 Net change in cash restricted for equipment
  financing purposes                                     1,200,000    (1,131,500)       (270,000)
 Net cash received for sale of partnership interests            --       122,854              --
 Net cash received for sale of discontinued entities            --       110,000         380,183
 Other                                                    (146,472)     (212,409)        (92,496)
                                                        ----------   -----------    ------------
 
NET CASH USED IN INVESTING ACTIVITIES                   (2,566,646)   (1,380,409)       (261,146)
                                                        ----------   -----------    ------------
 
</TABLE>



                See Notes to Consolidated Financial Statements.

                                      -38-
<PAGE>
 
                   SMT Health Services Inc. and Subsidiaries

               Consolidated Statements of Cash Flows (Continued)
<TABLE>
<CAPTION>
 
                                                                                        Year Ended December 31,
                                                                               ------------------------------------------
                                                                                  1996            1995          1994
                                                                               ----------      ----------    ------------
<S>                                                                           <C>              <C>           <C>        
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 Principal payments under long-term debt and capital leases:
   Continuing operations:
     Third parties                                                              (4,735,551)    (3,241,524)     (633,485)
     Related parties                                                               (64,329)      (329,627)   (2,593,808)
   Discontinued operations:
     Third parties                                                                      --             --      (254,612)
     Related parties                                                                    --         (27,807)    (182,918)
 Issuance of Common Stock from exercise of stock
   options and warrants                                                          2,227,029              --           --
 Other                                                                                  --          (4,562)     116,505
                                                                                ----------    ------------   ----------
 
NET CASH USED IN FINANCING ACTIVITIES                                           (2,572,851)    (3,603,520)   (3,548,318)
                                                                                ----------    ------------   ----------
 
NET INCREASE (DECREASE) IN CASH AND CASH
  EQUIVALENTS                                                                    2,301,639        493,015      (179,693)
 
CASH AND CASH EQUIVALENTS - (unrestricted) -
 Beginning of year                                                               2,341,519      1,848,504     2,028,197
                                                                                ----------    ------------   ----------
 
CASH AND CASH EQUIVALENTS - (unrestricted) -
 End of year                                                                    $4,643,158     $2,341,519   $ 1,848,504
                                                                                ==========     ==========   ===========
 
</TABLE>



                See Notes to Consolidated Financial Statements.

                                      -39-
<PAGE>
 
                   SMT Health Services Inc. and Subsidiaries

           Consolidated Statements of Changes in Stockholders' Equity

                  Years Ended December 31, 1994, 1995 and 1996

<TABLE>
<CAPTION>
 
 
                                                                                                          
                                                                                                            Retained
                                               Common Stock             Preferred Stock      Additional     Earnings/      Total
                                      -----------------------------  ---------------------     Paid-In    (Accumulated Stockholders'
                                         Shares         Amount       Shares      Amount        Capital       Deficit)      Equity
                                      ------------  ---------------  -------  ------------  -------------  ------------  -----------

<S>                                   <C>           <C>              <C>      <C>           <C>            <C>         <C>
 
BALANCES - December 31, 1994             2,408,000          $24,080       --            --    $ 5,940,858  ($2,311,626)  $ 3,653,312

 
 Stock Dividend (Note 12)                  120,400            1,204       --            --        321,348     (322,552)           --

 Issuance of Common Stock (Note 9)         120,000            1,200       --            --        358,800           --       360,000

 Exercise of Stock Options                   6,000               60       --            --         15,064           --        15,124

 Net Income                                     --               --       --            --             --    1,373,217     1,373,217
                                         ---------          -------  -------  ------------    -----------  -----------   -----------
 
 
BALANCES - December 31, 1995             2,654,400           26,544       --            --      6,636,070   (1,260,961)    5,401,653

 
 Exercise of Stock Options and
  Warrants (Notes 5 and 7)                 793,500            7,935       --            --      2,219,094           --     2,227,029

 Tax Adjustment Regarding Stock
  Option and Warrant Exercises
  (Notes 4, 5 and 7)                            --               --       --            --      1,360,000           --     1,360,000

 Stock Dividend (Note 12)                  247,130            2,471       --            --      1,866,450   (1,868,921)           --

 Net Income                                     --               --       --            --             --    2,410,861     2,410,861
                                         ---------          -------  -------  ------------    -----------  -----------   -----------

BALANCES - December 31, 1996             3,695,030          $36,950       --   $        --    $12,081,614   ($ 719,021)  $11,399,543
                                         =========          =======  =======  ============    ===========   ==========   ===========

 
</TABLE>



                See Notes to Consolidated Financial Statements.

                                      -40-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                   ------------------------------------------

    Note 1.  ORGANIZATION
             ------------

    SMT Health Services Inc. and its wholly-owned subsidiaries (the "Company")
    are engaged primarily in providing medical diagnostic imaging services to
    hospitals, physicians and patients.  The Company, through its subsidiaries,
    operates eighteen mobile Magnetic Resonance Imaging (MRI) Units ("MRI
    Units") in Pennsylvania, West Virginia, North Carolina, Virginia, South
    Carolina, Kentucky and Ohio.  The Company began operation of seven new MRI
    units during 1996, including four MRI units which began operations during
    the last four months of the year.

    The Company's Common Stock and Warrants (Note 18) trade on the National
    Association of Securities Dealers, Inc. Automated Quotations Systems
    (NASDAQ) National Market System under the symbols "SHED" and "SHEDW",
    respectively.


    Note 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
             ------------------------------------------

      Consolidation Policy:  The consolidated financial statements include the
      --------------------                                                    
    accounts   of SMT Health Services Inc. and its wholly owned subsidiaries.
    All significant intercompany balances and transactions have been eliminated.

      Revenue Recognition:  Revenue from diagnostic imaging services is
      -------------------                                              
    recognized as patient services are performed.

      Service Agreements:  The Company provides services directly to hospitals
      ------------------                                                      
    under   Mobile MRI Service Agreements which expire at various times between
    1997 and 2002 and accordingly, bills and collects the fees for such services
    directly from the hospitals.  Approximately 29% of the Company's billings
    and collections under these service contracts are processed through Hospital
    Shared Services (HSS), a representative of certain hospitals.  As a fee for
    these services, HSS retains approximately 2.5% of gross billings to these
    hospitals and, accordingly, the Company records related revenues on a net
    basis.  Such fees totaled approximately $150,000, $146,000 and $120,000 for
    1996, 1995 and 1994, respectively.
 
      Cash and Cash Equivalents:  Cash equivalents include highly-liquid
      --------------------------                                        
    investments with original maturities of ninety days or less.

      Property and Equipment:  Property and equipment are stated at cost
      -----------------------                                           
    and are   depreciated using the straight-line method over the estimated
    useful lives of the related assets, which is generally five years.  Leased
    medical equipment is being amortized to its estimated residual value using
    the straight-line method over the lease or finance term of generally five
    years.

                                      -41-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
             ------------------------------------------            

    Contract and License Acquisition Costs:  Contract acquisition costs
    ---------------------------------------                            
    primarily represent the value of mobile service contracts acquired relating
    to the purchase of VA-MRI in November 1994 (Note 9) and are being amortized
    over an approximate four-year period which approximates the lives of the
    contracts.

    License acquisition costs represent the value of Certificate of Need
    licenses acquired in March 1996 (Note 16) and are being amortized over a ten
    year period.

    Income Taxes:  The Company files a consolidated federal income tax return.
    -------------                                                             
    Deferred tax assets and liabilities are recognized for the future tax
    consequences attributable to differences between the financial statement
    carrying amounts of existing assets and liabilities and their respective tax
    bases and operating loss and tax credit carryforwards.  Deferred tax assets
    and liabilities are measured using enacted tax rates expected to apply to
    taxable income in the years in which those temporary differences are
    expected to be recovered or settled.  The effect on deferred tax assets and
    liabilities of a change in tax rates is recognized in income in the period
    that includes the enactment date.

    Net Earnings Per Common and Common Share Equivalent:  The net earnings
    ---------------------------------------------------          
    per common and common share equivalent are calculated using the weighted
    average common and common share equivalents outstanding during the year,
    except where anti-dilutive. Common share equivalents include shares issuable
    upon the exercise of stock options, rights and warrants less the number of
    shares assumed purchased with the proceeds available from the assumed
    exercise of the options, rights and warrants.

    The Treasury Stock Method of reflecting the use of proceeds from options and
    warrants may not adequately reflect potential dilution if options and
    warrants to acquire a substantial number of Common Shares (greater than 20%
    of the number of Common Shares outstanding for the period for which the
    computation is being made) are outstanding.  In such instances, the Modified
    Treasury Stock Method must be utilized.

    The Company's options and warrants to acquire Common Shares exceeded 20% of
    the number of Common Shares outstanding for 1996 and 1995 and accordingly,
    the Treasury Stock Method has been modified in determining the dilutive
    effect of the options and warrants on earnings per share data for those
    years.

                                      -42-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
             ------------------------------------------            

    For purposes of the earnings per share calculation, the Modified Treasury
    Stock Method resulted in adjusted net income for the year ended 1996 of
    approximately $3,435,000 and adjusted shares outstanding of 5,668,000,
    resulting in earnings per Common Share of $.61 for the year ended December
    31, 1996 after giving effect to a seven percent (7%) Common Stock dividend
    paid to shareholders in January 1997 (Note 12).  Actual net income for the
    year ended December 31, 1996 of $2,410,861 divided by the actual weighted
    average shares outstanding for the year of 3,232,505 resulted in earnings
    per Common Share of $.75 for the year ended December 31, 1996.

    The Modified Treasury Stock Method resulted in adjusted net income for the
    year ended 1995 of approximately $2,699,000 and adjusted shares outstanding
    of approximately 5,884,000, resulting in earnings per Common Share of $.46
    for the year ended December 31, 1995.  Actual net income for the year ended
    December 31, 1995 of $1,373,217 divided by the actual weighted average
    shares outstanding for the year of 2,770,230 resulted in earnings per Common
    Share of $.50 for the year ended December 31, 1995.  The 1995 earnings per
    share calculations have reflected a retroactive adjustment to reflect the
    January 1997 7% stock dividend (Note 12).

    Earnings per share for the year ended December 31, 1994 were not subject to
    the Modified Treasury Stock Method as this method was anti-dilutive.
    Accordingly, weighted average shares outstanding were 2,705,400 for 1994.
    The weighted average shares outstanding for 1994 reflect a retroactive
    adjustment increasing the weighted average shares outstanding by 297,400
    shares to reflect the July 1995 5% and January 1997 7% stock dividends as if
    such dividends had occurred at the beginning of the respective period (Note
    12).

    Fully diluted earnings per Common Share for 1996 were $.59 reflecting the
    higher year-end stock price.  Fully diluted earnings per Common Share were
    anti-dilutive in 1995 and 1994.

    Certain Concentrations and Significant Risks and Uncertainties:  The Company
    ---------------------------------------------------------------             
    is engaged primarily in providing mobile MRI services to small-to-medium-
    sized hospitals in Pennsylvania, West Virginia, North Carolina, Virginia,
    South Carolina, Kentucky and Ohio.

                                      -43-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
             ------------------------------------------            

    The preparation of financial statements in conformity with generally
    accepted accounting principles requires management to make estimates and
    assumptions that affect the reported amounts of assets and liabilities and
    disclosure of contingent assets and liabilities at the date of the financial
    statements and the reported amounts of revenues and expenses during the
    reporting period.  Actual results could differ from those estimates.

    Certain Significant Estimates:  The Company operates mobile MRI units which
    ------------------------------                                             
    are capital intensive and subject to changes in technology.  The Company
    primarily finances such equipment over a 48 to 60 month period and
    depreciates the equipment over the respective finance period to an estimated
    residual value which typically approximates 20% of the original cost of the
    equipment.  The useful lives and residual values estimated by management are
    considered significant estimates. During 1995 and 1996, the Company upgraded
    its fleet of mobile MRI units to newer state-of-the-art technology.
    Management does not currently anticipate significant technological advances
    which could materially affect its estimates.

    The Company is not dependent on any one customer or geographic region as a
    source of its revenues.  However, the Company utilizes the services of HSS
    to process approximately 29% of its billings and collections (Note 2 -
    Service Agreements).

    Long-Lived Assets:  Effective January 1, 1996, the Company adopted Statement
    ------------------                                                          
    of Financial Accounting Standards (SFAS) No. 121, Accounting for the
    Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.
    In accordance with SFAS 121, management evaluates long-lived assets and
    related intangible assets for impairment whenever events or circumstances
    indicate the carrying amount may not be recoverable.  No evidence existed
    which indicated any long-lived assets and related intangible assets were
    impaired and, therefore no write-down of recorded assets was necessary.

    Financial Instruments:  Management believes that the carrying values of its
    ----------------------                                                     
    financial instruments approximates their fair values and any differences
    which may exist between the carrying values and fair values are not
    material.

    Stock-Based Compensation:  During 1996, the Company adopted SFAS 123,
    -------------------------                                            
    Accounting for Stock-Based Compensation.  As permitted for under SFAS 123,
    the Company has elected to continue to follow the guidance of Accounting
    Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,
    in accounting for its stock-based employee compensation arrangements.
    Because the Company elected

                                      -44-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
             ------------------------------------------            

    the disclosure-only method available under SFAS 123, the adoption of SFAS
    123 did not have any impact on the Consolidated Financial Statements (Note
    7).

    Common Stock Dividend:  On January 14, 1997, a 7% Common Stock dividend was
    ----------------------                                                     
    paid to shareholders of record at the close of business on January 10, 1997.
    All stock related data in the Consolidated Financial Statements reflect the
    stock dividend for all periods presented (Note 12).


    Note 3.  LONG-TERM DEBT AND LEASE OBLIGATIONS
             ------------------------------------

    Long-term debt and capital lease obligations consist of the following:
<TABLE>
<CAPTION>
 
                                                December 31,
                                          ------------------------
                                             1996         1995
                                          -----------  -----------
<S>                                       <C>          <C>
 
    Capital lease and loan obligations    $27,209,926  $17,090,835
 
    Less current portion                    6,349,962    4,380,930
                                          -----------  -----------
                                          $20,859,964  $12,709,905
                                          ===========  ===========
 
</TABLE>
 Future minimum lease payments under capital leases and maturities of long-term
 debt as of December 31, 1996 are as follows:

<TABLE>
<CAPTION>
 
              Year Ending             Long-Term   Capital Lease
              December 31,               Debt       Obligations
              -----------             -----------  --------------
             <S>                      <C>          <C>
                 1997                  $2,037,232    $ 5,792,078
                 1998                   2,223,518      5,537,301
                 1999                   2,291,825      4,686,822
                 2000                   2,476,641      3,098,604
                 2001                   1,107,289      1,440,719
                                       ----------    -----------
                                                      20,555,524
 
Less amounts representing interest                    (3,482,103)
                                                     -----------
                                      $10,136,505    $17,073,421
                                      ===========    ===========
</TABLE>

                                      -45-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 3.  LONG-TERM DEBT AND LEASE OBLIGATIONS (continued)
             ------------------------------------            

    As of December 31, 1996, the cost and accumulated amortization of property
    securing capital lease and loan obligations were $35,932,000 and $6,508,000,
    respectively.  Interest rates under the long-term debt and capital leases
    ranged from approximately 8.0% to 13.5%.

    On July 31, 1996, the Company refinanced two MRI units which had previously
    been refinanced in March 1995 to more favorable lease terms.  The new leases
    totaled approximately $2.3 million (net of a $150,000 down payment) in the
    aggregate and are being financed over a thirty-six month period at an
    interest rate of 9.25%.  The refinancing resulted in annual cashflow savings
    to the Company of approximately $200,000 (Note 10).

    The Company upgraded one of its .5 Tesla Signa units to a 1.0 Tesla Horizon
    unit.  The new unit was financed at a net total cost of approximately $2.0
    million and was delivered in late February 1996.  The Company financed the
    purchase of this new unit with a 60 month dollar-out (bargain purchase
    option of one dollar) lease requiring monthly payments of approximately
    $44,000.

    The Company contracted with several new hospital clients and purchased a new
    Siemens 1.0 Tesla Impact unit which began service in mid-February 1996.  The
    cost of this new unit approximated $1.9 million which was financed with a 60
    month loan requiring monthly payments of approximately $41,000.

    In April 1996, the Company upgraded one of the units purchased from another
    mobile provider (Note 16) to a Siemens 1.0 Tesla Impact unit.  The new unit
    was financed at a net total cost of approximately $1.9 million.  The Company
    financed this new unit with a 60 month loan requiring monthly payments of
    approximately $43,000.

    In June 1996, the Company upgraded one of its .5 Tesla Signas to a Siemens
    1.0 Tesla Impact unit. The new unit was financed at a net total cost of
    approximately $2.0 million with a 60 month dollar-out lease requiring
    monthly payments of approximately $43,000.

    The Company in May 1996 signed an agreement with Siemens Medical Systems to
    upgrade the second unit purchased from another mobile provider (Note 16) and
    to purchase a new unit during the fourth quarter of 1996.  Delivery of the
    upgraded unit occurred in July 1996 and the new unit was delivered and began
    operation on October 1, 1996.  The upgrade's net cost approximated $1.9
    million and the Company financed approximately $1.7 million with a 60 month
    finance agreement requiring monthly payments of approximately $36,000.  The
    Company's new unit cost approximately $1.9 million and the Company financed
    approximately $1.7 million requiring a monthly payment of approximately
    $37,000.

                                      -46-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 3.  LONG-TERM DEBT AND LEASE OBLIGATIONS (continued)
             ------------------------------------            

    During September 1996, the Company upgraded an older unit to a new Siemens
    1.0 Tesla Impact. The cost of this new unit approximated $1.9 million which
    was financed with a 60 month loan requiring monthly payments of
    approximately $39,000.

    The Company purchased and took delivery of two new GE 1.0 Tesla Horizon
    units in September 1996.  These units were purchased at a cost of
    approximately $1.8 million each and the Company financed approximately $1.6
    million and $1.5 million with 60 month finance agreements requiring monthly
    payments of approximately $34,000 and $32,000, respectively.

    The Company completed a previously negotiated upgrade of a .5 Tesla Signa to
    a 1.0 Tesla Horizon on November 2, 1996.  The new unit was financed at a net
    cost of approximately $1.5 million with a 60 month finance agreement
    requiring monthly payments of approximately $32,000.

    On November 1, 1996, the Company purchased a mobile MRI unit from Palmetto
    Community Health Network (the "Network") for approximately $390,000 and
    signed new service contracts with six South Carolina hospitals which are
    members of the Network.  This new unit represents the Company's eighteenth
    mobile MRI unit and the seventh new unit acquired during 1996.

    In December 1996, the Company upgraded the mobile MRI unit purchased from
    the Network to a new 1.0 Tesla Horizon.  The new unit was financed at a net
    cost of approximately $1.4 million with a 60 month finance agreement
    requiring monthly payments of approximately $30,000.

    The long-term debt and capital lease obligations balance includes
    approximately $880,000 of capital lease obligations due to third parties
    related to the equipment at the Auburn Regional Center for Cancer Care and
    Airport Regional Imaging Center which the Company had treated as
    discontinued operations and sold in October 1994 and in June 1995,
    respectively.  Accordingly, the Company has recorded an offsetting
    receivable for the lease receivables due from the purchaser of the centers.
    Such lease receivables are secured by the equipment and accounts receivable
    of the centers (Note 13).

    The Company leases certain tractors for the transportation of Mobile Units.
    Operating lease expenses related to such tractor rentals totaled $346,000,
    $313,000 and $257,000 for 1996, 1995 and 1994 respectively.  Prior to July
    1, 1995, the Company rented certain tractors from Shared Mobile Enterprises
    (Note 9).

                                      -47-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

  Note 3.  LONG-TERM DEBT AND LEASE OBLIGATIONS (continued)
           ------------------------------------            

  The future minimum lease payments (excluding variable mileage costs of $.063
  per mile) required under these operating leases are as follows:
<TABLE>
<CAPTION>
 
             Year Ended
            December 31,
            -----------
            <S>                <C>
 
               1997            $  349,300
               1998               326,700
               1999               326,700
               2000               326,700
               2001               169,600
               Thereafter           3,300
                               ----------
               Total           $1,502,300
                               ==========
 
</TABLE>

  Note 4.        INCOME TAXES
                 ------------

  Income tax expense attributable to income from continuing operations for the
  years ended December 31, 1996, 1995 and 1994 are as follows:
<TABLE>
<CAPTION>
 
 
                            Current                   Deferred                          Total
             ------------------------------  -----------------------------  -----------------------------
                1996        1995     1994       1996       1995     1994       1996       1995     1994
             -----------  --------  -------  ----------  --------  -------  ----------  --------  -------
<S>          <C>          <C>       <C>      <C>         <C>       <C>      <C>         <C>       <C>
 
  Federal      $     --   $ 10,000  $    --  $1,014,000  $254,000  $44,000  $1,014,000  $264,000  $44,000
 
  State        (110,000)   180,000   45,000     274,000    34,000    4,500     164,000   214,000   49,500
             ----------   --------  -------  ----------  --------  -------  ----------  --------  -------
 
              ($110,000)  $190,000  $45,000  $1,288,000  $288,000  $48,500  $1,178,000  $478,000  $93,500
             ==========   ========  =======  ==========  ========  =======  ==========  ========  =======
 
</TABLE>

  In addition to the deferred tax expense disclosed above, approximately
  $1,360,000 of deferred tax benefits were allocated to equity in connection
  with the tax deductions generated by the exercise of certain stock options and
  warrants.

                                      -48-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    NOTE 4.  INCOME TAXES (continued)
             ------------            

    The difference between the Company's effective income tax rate and its
    statutory rate is reconciled below:
<TABLE>
<CAPTION>
 
                                            1996       1995       1994
                                          --------  ----------  ---------
<S>                                      <C>         <C>        <C> 
 Income tax expense at statutory rate    $1,220,213  $629,414   $ 216,158
 
 Increase (reduction) in income taxes
  resulting from:
 
State and local income taxes,
net of Federal income tax benefit           110,000   137,000      32,670
 
Change in state net operating loss
  carryforward rules                        (61,000)       --     (90,000)
 
Decrease in valuation allowance            (103,000) (312,000)    (72,500)
 
Other items                                  11,787    23,586       7,172
                                         ---------- ---------   ---------
                                         $1,178,000   478,000   $  93,500
                                         ========== =========   =========
</TABLE>
    The components of the net deferred tax asset recognized in the December 31,
    1996 and 1995 consolidated balance sheets of the Company are presented
    below:
<TABLE>
<CAPTION>
 
                                                 1996         1995
                                              ---------     ----------
<S>                                           <C>           <C>
 
Deferred tax assets:
  Net operating loss carryforwards            $3,518,800    $1,415,794
 
  Non-deductible accrued expenses                 75,000       139,291
 
  Other                                           19,000        37,203
                                              ----------    ----------
                                               3,612,800     1,592,288
Deferred tax liabilities:
Diagnostic medical equipment, principally
 due to differences in depreciation           (3,290,800)   (1,270,288)
                                              ----------    ----------
                                                 322,000       322,000
 
Less valuation allowance                              --      (103,000)
                                              ----------    ----------
 
Net deferred tax asset                        $  322,000   $   219,000
                                              ==========   ============
</TABLE>

                                      -49-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 4.  INCOME TAXES (continued)
             ------------            

    Deferred income taxes are provided to account for temporary differences
    between financial statement accounting and income tax reporting and relate
    principally to differences in reporting for diagnostic medical equipment,
    depreciation and net operating loss carryforwards.  The net change in the
    total valuation allowance for the years ended December 31, 1996 and 1995 was
    a decrease of $103,000 and a decrease of $312,000, respectively.  In
    assessing the realizability of deferred tax assets, management considers
    whether it is more likely than not that some portion or all of the deferred
    tax assets will not be realized.  The ultimate relation of deferred tax
    assets is dependent upon the generation of future taxable income during the
    periods in which those temporary differences become deductible.  Management
    considers the scheduled reversal of deferred tax liabilities, projected
    future taxable income, and tax planning strategies in making this
    assessment.  Based upon the level of historical taxable income and
    projections for future taxable income over the periods which the deferred
    tax assets are deductible, management believes it is more likely than not
    the Company will realize the benefits for these deductible differences.  The
    amount of the deferred tax asset considered realizable, however, could be
    reduced if estimates of future taxable income during the carryforward period
    are reduced.

    At December 31, 1996, the Company had net operating loss carryforwards for
    federal income tax purposes of approximately $8,200,000 which are available
    to offset future federal taxable income through 2010.  The Company has
    approximately $10,100,000 of available carryforwards as of December 31, 1996
    for state purposes which are available principally through 1999.


    Note 5.  STOCKHOLDERS' EQUITY
             --------------------

    In accordance with the Company's March 1992 Initial Public Offering, the
    Company issued Warrants to purchase shares of Common Stock of the Company.
    Pursuant to the Warrant Agreement, the outstanding Warrants have been
    recapitalized to reflect the July 1995 5% and January 1997 7% Common Stock
    dividends (Note 12).  Accordingly, the outstanding Warrants' exercise price
    of $7.00 entitled the holder to purchase 1.1235 shares of Common Stock of
    the Company (Note 18).

    As additional compensation in connection with the initial public offering,
    the Company granted to the Company's Initial Public Offering underwriter an
    option to purchase options which covered 120,000 units, each unit consisted
    of 1.05 shares of Common Stock and one Company Warrant to purchase 1.05
    shares of Common Stock.  The Option was exercisable until March 4, 1997 and
    entitled the underwriter to purchase each unit at an exercise price equal to
    $5.94, subject to adjustment in certain events.  The underwriter
    subsequently transferred the Options to principles of the underwriter
    (Transferees), who exercised the Options during 1996 resulting in net
    proceeds to the Company of approximately $719,000.  During August 1996, one
    of the Transferees exercised 24,000 Warrants to purchase 25,200 shares of
    Common Stock of the Company resulting in additional proceeds to the Company
    of approximately $168,000.  As a result of the 7% Common Stock dividend paid
    in January 1997 (Note 12), the remaining 96,000 underwriter Warrants were
    convertible to 107,856 shares of Common Stock.

                                      -50-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 5.  STOCKHOLDERS' EQUITY (continued)
             --------------------            

    On August 9, 1995, the Company adopted the 1995 Director Warrant Plan (the
    "Plan") pursuant to which eligible directors received unregistered warrants
    to purchase Common Stock (the "Directors' Warrants").  The Plan allows for
    issuance of warrants to purchase up to 700,000 shares of Common Stock.

    On August 9, 1995, warrants to purchase up to 500,000 shares of Common Stock
    at an initial exercise price of $3.875 (the closing price of the Company's
    stock on the date of issue) were issued to five directors pursuant to the
    Plan.  Separately, unregistered warrants to purchase 114,500 shares of
    Common Stock at an initial exercise price of $4.01 were also issued to an
    outside director, who was also a consultant to the Company, who was
    ineligible to participate in the Plan.

    During May 1996, the outside director who was also a consultant to the
    Company exercised the 114,500 Warrants and sold 114,500 shares of Common
    Stock.  The Company received cash proceeds of approximately $459,000 related
    to the exercise of such Warrants.

    During January 1997, the Company's three outside directors each exercised
    25,000 Director Warrants and sold 26,750 shares of Common Stock (after
    adjustment for the January 1997 7% Common Stock dividend - Note 12).  The
    Company received cash proceeds of approximately $291,000 as a result of the
    exercise of the 75,000 Director Warrants.

    Pursuant to the 1995 Director Warrant Plan, the Director Warrants have been
    recapitalized to reflect the January 1997 7% Common Stock dividend (Note
    12).  Accordingly, the outstanding Director Warrants' exercise price of
    $3.875 now entitles the holder to purchase 1.07 shares of Common Stock of
    the Company.  As of January 31, 1997, 425,000 Director Warrants to purchase
    454,750 shares of Common Stock of the Company were outstanding.

    In October 1995, the Company signed an agreement retaining Commonwealth
    Associates ("Commonwealth") as its investment banking firm.  Commonwealth, a
    New York-based investment banking firm specializing in serving the financial
    needs of emerging growth companies, had been engaged to assist the Company
    in establishing a long-term financial strategy and in evaluating possible
    transactions involving other mobile diagnostic providers.  In addition to a
    cash retainer, the Company granted to Commonwealth 100,000 five-year
    Warrants to purchase the Company's Common Stock at $4.47, the closing bid
    price of the Common Stock on the day the Agreement was executed.  The
    agreement with Commonwealth expired in April 1996.  During July and October
    1996, Commonwealth or a designated employee of Commonwealth exercised the
    100,000 Warrants in a net transaction and the Company issued to Commonwealth
    or the designated employee an aggregate of 36,061 shares of Common Stock of
    the Company.

                                      -51-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES
                                        
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 5.  STOCKHOLDERS' EQUITY (continued)
             --------------------            

    In November 1995, the Company adopted a Preferred Stock Purchase Rights Plan
    (the "Rights Plan") which contains provisions to protect the Company in the
    event of an unsolicited offer to acquire control of the Company on terms
    which the Company's Board of Directors determines not to be in the best
    interest of the Company.

    The Rights Plan provides for the distribution to shareholders of one right
    for each share of Company Common Stock outstanding.  When exercisable, each
    right will entitle shareholders to buy one one-hundredth of a newly issued
    share of the Company's Class A Series One Preferred Stock at an exercise
    price of $22.00.  Each right has terms designed to make it substantially the
    economic equivalent of one share of Common Stock.  Shareholders of record as
    of the close of business on November 8, 1995 and thereafter will receive the
    rights.  The rights will expire on November 30, 2005, unless further
    extended, and will be subject to redemption by the Board of Directors at
    $.01 per right at any time prior to the first date upon which they become
    exercisable.  The rights themselves have no voting power, nor will they
    entitle a holder to receive dividends.


    Note 6.  PREFERRED STOCK
             ---------------

    The Company is authorized to issue 994,600 shares of preferred stock
    ("Preferred Stock") issuable in series.  The Company had one authorized
    series of 5,400 Preferred Shares, par value $.01, designated as Series A
    Preferred Stock, which was converted to Common Stock in July 1993.


    Note 7.  STOCK OPTION PLANS
             ------------------

    The Company's 1991 and 1996 Employee Stock Option Plans (the "Employee
    Plans") currently provide for the granting of options to employees to
    purchase up to 1,110,125 shares of the Company's Common Stock at the fair
    market value at the date of grant.  Options granted to employees may either
    be incentive stock options (as defined in the Internal Revenue Code of 1986,
    as amended) or non-qualified stock options and expire ten years from date of
    grant.

                                      -52-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES
                                        
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 7.  STOCK OPTION PLANS (continued)
             ------------------            
<TABLE>
<CAPTION>
 
                                            Options Outstanding
                                        ---------------------------
                                         Number   Price Per Share
                                        --------   ---------------
<S>                                     <C>        <C> 
Balance - December 31, 1993              145,514         $3.11
 Granted                                 203,179     $1.28 - $2.00
 Exercised                                    --          --
 Expired                                      --          --
                                         -------
Balance - December 31, 1994              348,693     $1.28 - $3.11
 Granted                                 431,349     $2.30 - $3.56
 Exercised                                    --           --
 Expired                                      --           --
                                         -------
Balance - December 31, 1995              780,042     $1.28 - $3.56
 Granted                                 309,770     $3.92 - $6.43
  Exercised                             (439,900)    $1.28 - $3.11
  Expired                                (10,480)        $3.11
                                        --------
Balance - December 31, 1996              639,432     $1.28 - $6.43
                                        ========
 
</TABLE>
    All of the above outstanding options are non-qualified options.

    At December 31, 1996, options to purchase 639,432 shares were exercisable
    and no additional shares were available for future grant in accordance with
    the Employee Plans.

    The total number of options to purchase shares of Common Stock and the
    exercise prices of any options which were granted pursuant to the Employee
    Plan prior to July 1995 have been adjusted to reflect the July 1995 5%
    Common Stock dividend (Note 12).

    In January 1997, the Company granted a 7% Common Stock dividend.  The
    aforementioned number of options to purchase shares of Common Stock and the
    exercise prices of such options reported above have been adjusted to reflect
    the January 1997 dividend (Note 12).

    The Company's 1991 Director Stock Option Plan for non-employee directors
    (the "Directors' Plan") currently provides for the granting of options to
    non-employee directors to purchase up to 112,350 shares of the Company's
    Common Stock at the fair market value on the date of grant.  Under the
    Directors' Plan, each eligible director automatically receives options to
    purchase 2,247 shares of the Company's Common Stock on December 31 of each
    year.  Options granted under the Directors' Plan may be exercised within ten
    years of the date of grant and while the recipient of the option is a
    director of the Company.

                                      -53-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES
                                        
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 7.     STOCK OPTION PLANS (continued)
                ------------------            
<TABLE>
<CAPTION>
 
                               Options Outstanding
                            --------------------------
                              Number   Price Per Share
                            ---------- ---------------
<S>                         <C>        <C>
Balance - December 31, 1993    21,294  $1.66 - $3.00
 Granted                       10,647      $2.06
 Exercised                         --        --
 Expired                           --        --
                              -------
 
Balance - December 31, 1994    31,941  $1.66 - $3.00
 Granted                        8,547     $4.09
 Exercised                     (6,000) $1.66 - $3.00
 Expired                         (300) $1.66 - $3.00
                              -------
 
Balance - December 31, 1995    34,188  $1.66 - $4.09
  Granted                       6,741     $7.94
  Exercised                   (23,100) $1.66 - $4.09
  Expired                      (2,100)    $4.09
                              -------
 
Balance - December 31, 1996    15,729  $1.66 - $7.94
                              =======
</TABLE>

    As of December 31, 1996, options to purchase 15,729 shares of Common Stock
    were exercisable under the Directors' Plan and 65,484 shares were available
    for future grant in accordance with the Director Plan.

    The total number of options to purchase shares of Common Stock and the
    exercise prices of any options which were granted pursuant to the Directors'
    Plan prior to July 1995 have been adjusted to reflect the July 1995 5%
    Common Stock dividend (Note 12).

    In February 1994, the Board of Directors granted additional vested options
    to purchase 42,000 shares of the Company's Common Stock at an exercise price
    of $1.78 per share, the fair market value of the Common Stock at the date of
    grant, to two non-management members of the Board of Directors. During June
    and September 1996, the two non-management members of the Board of Directors
    (one now a former director), exercised the 42,000 options and sold 42,000
    shares of Common Stock received upon the option exercise.  The Company
    realized net proceeds of approximately $75,000 from the exercise of the
    42,000 options.

    In January 1997, the Company granted a 7% Common Stock dividend.  The
    aforementioned number of options to purchase shares of Common Stock and the
    exercise prices of such options reported above have been adjusted to reflect
    the January 1997 dividend (Note 12).

                                      -54-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES
                                        
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 7.  STOCK OPTION PLANS (continued)
             ------------------            

    SFAS 123 requires companies who continue to apply APB Opinion No. 25 to
    account for their stock-based employee compensation arrangements to provide
    pro forma net income and earnings per share as if the fair value based
    method had been used to account for compensation cost (Note 2). The per
    share weighted average fair value of stock options granted during 1996 and
    1995 approximated $393,000 and $672,000 on the date of grant using the Black
    Scholes option - pricing model with the following weighted-average
    assumptions:  1996 - expected dividend yield 0.0%, risk-free interest rate
    of 7.05%, expected volatility of the stock 33%, and expected life of three
    years; 1995 - expected dividend yield 0.0%, risk-free interest rate of
    7.05%, expected volatility of the stock of 33%, an expected life of three
    years.  Accordingly, pro forma net income and earnings per share would have
    been $2,017,000 ($.54 per share) and $771,000 ($.37 per share) for the years
    ended December 31, 1996 and 1995, respectively, if the Company had accounted
    for its stock based employee compensation arrangements using the fair value
    method.  The 1995 and 1996 effects of applying SFAS 123 for providing pro
    forma disclosures are not likely to be representative of the effects on pro
    forma net income and earnings per share for future years because the number
    of option grants and the fair value assigned to the grants could differ.


    Note 8.     BENEFIT PLANS
                -------------

    The Company maintains an annual bonus plan for key executives and employees
    which is based primarily upon the pre-tax earnings of the Company.  The
    Company expensed approximately $584,000, $348,000 and $115,000 for the
    program during 1996, 1995 and 1994, respectively.

    The Company maintains and administers an employee savings plan pursuant to
    Internal Revenue Code Section 401(k).  The Plan provides for discretionary
    contributions as determined by the Company's Board of Directors.  The
    Company contributed approximately $34,000, $18,000 and $18,000 to the Plan
    in 1996, 1995 and 1994, respectively.


    Note 9.  RELATED PARTY TRANSACTIONS
             --------------------------

    A former shareholder/director of the Company was also a consultant to the
    Company and the Company had entered into a five-year consulting agreement
    with him through November 1996 pursuant to which he was to receive a fee of
    $75,000 per year.  On March 27, 1996, the Company prepaid the remaining
    $50,000 due under the Consulting Agreement and terminated the Consultant
    Agreement.  Fees paid to this former shareholder/director totaled
    approximately $75,000 for each of the past three years.

                                      -55-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 9.  RELATED PARTY TRANSACTIONS (continued)
             --------------------------            

    Prior to July 1, 1995, the Company subleased certain truck cabs from Shared
    Mobile Enterprises ("SME"), which, in turn, leased such truck cabs from an
    independent third party leasing company. Effective July 1, 1995, SME
    released the Company from its obligations under ten long-term subleases in
    exchange for the issuance to SME of 120,000 unregistered Common Shares
    valued at $3 per share, the weighted average closing price for the stock for
    the prior thirty trading days.  The Company received an opinion from an
    independent financial advisor that the transaction was fair to the Company
    and its shareholders.  At the same time, with the concurrence of the third
    party leasing company, the Company assumed SME's obligations under its
    original lease and modified that lease by (1) extending the lease term by
    one additional year and (2) adding one additional truck cab to the schedule
    of leased property with a corresponding increase in base rental payments.
    The $360,000 value of the shares represents the present value of the excess
    of the sublease payments over the original lease payments.  The Company has
    capitalized the $360,000 and is amortizing this prepaid rent over a period
    which approximates the lease term.  SME was one hundred percent beneficially
    owned by certain officers/directors and a former director/consultant of the
    Company who owned approximately 14% of the Company's outstanding Common
    Shares.  Total rental expense paid to SME for the years ended December 31,
    1995 and 1994 were approximately $180,000 and $257,000, respectively (Note
    3).

    Certain shareholders/officers of the Company, who own approximately 14% of
    the outstanding Common Stock of the Company, also collectively owned 50% of
    the outstanding capital stock of Upstate MRI, Inc., a.k.a., Virginia MRI,
    Inc. ("VA MRI"), which owned and operated a Mobile Unit which provided
    service in Virginia and North Carolina.  The Company and the
    shareholders/officers of the Company guaranteed the lease on such Mobile
    Unit.

    On June 1, 1993, the Company entered into a one-year operating lease with VA
    MRI where the Company leased the VA MRI Mobile Unit ("VA Mobile Unit") and
    related service contracts in return for a monthly rental of $58,000, which
    lease was renewed on June 1, 1994.  A previously negotiated management
    agreement between VA MRI and the Company, pursuant to which the Company
    received $5,000 per month in administrative fees, plus reimbursement of all
    expenses, in return for managing the operations of VA MRI was terminated.

    On November 14, 1994, the Company purchased the VA Mobile Unit in
    consideration for the assumption of all of VA MRI's lease obligations
    totaling approximately $400,000 (approximate fair market value of the
    equipment).  In addition, VA MRI transferred and assigned to the Company its
    rights in the service contracts related to the VA Mobile Unit in
    consideration for the forgiveness of the remaining approximately $50,000
    owed to the Company pursuant to a note and the payment by the Company of
    $44,000.  The Company capitalized the approximately $94,000 as contract
    acquisition costs which are being amortized over the term of the service
    contracts which approximates four years (Note 2).

                                      -56-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 9.  RELATED PARTY TRANSACTIONS (continued)
             --------------------------            

    In addition, on November 14, 1994, upon completion of the VA Mobile Unit
    purchase, the Company traded in the VA Mobile Unit and upgraded this Unit to
    a General Electric 1.0 Tesla Signa which the Company has financed with a 66
    month lease requiring monthly payments of approximately $41,000.  This new
    lease transfers the ownership of such Mobile Unit to the Company at the
    completion of the lease.  The original VA Mobile Unit lease assumed by the
    Company has been terminated in conjunction with this transaction.

    A certain director of the Company is a director of, consultant to and
    shareholder of DVI Inc., the parent of DVI Financial Services Inc. ("DVI").

    During 1992 and 1993, the Company entered into numerous leasing transactions
    with DVI pertaining to both continuing and discontinued operations involving
    total financing of approximately $15.6 million.  During 1994, the Company
    did not enter into any new leases with DVI and refinanced with third parties
    $3.2 million of leases held by DVI.  During the first quarter of 1995, the
    Company refinanced its remaining leases with DVI, totaling approximately
    $6.5 million, with third-party lease companies.  Interest rates under
    financing agreements with DVI ranged from 11% to 14%.  During 1996, the
    Company financed the acquisition of a new mobile MRI unit with DVI.  The
    Company and DVI entered into a 60 month capital lease financing
    approximately $1.5 million at an interest rate of approximately 9.5%.  Total
    payments to DVI during 1996, 1995 and 1994 with respect to capital lease
    obligations were approximately $100,000, $440,000 and $3.9 million,
    respectively, including $36,000, $87,000, and $1.4 million, respectively, of
    interest expense associated with such capital leases.

    In March 1995, DVI sold 368,000 shares of the Company's Common Stock which
    it had received during the Company's Initial Public Offering, pursuant to
    registration statements under the Securities Act of 1933, as amended (the
    "Securities Act").


    Note 10.  COMMITMENTS AND CONTINGENCIES
              -----------------------------

    The lease for the Company's principal facility expires in April 1999.  Rent
    expense for the Company's principal facility was $76,000, $76,000 and
    $69,000 for 1996, 1995 and 1994, respectively.  Future minimum lease
    payments under this lease are as follows:
<TABLE>
<CAPTION>
 
   Year Ended            Future Minimum
   December 31,          Lease Payments
   ------------          --------------
   <S>                   <C>
      1997                    87,900
      1998                    87,900
      1999                    29,300
                            --------
 
            Total           $205,100
                            ========
</TABLE>

                                      -57-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES
                                        
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 10.  COMMITMENTS AND CONTINGENCIES (continued)
              -----------------------------            

    Pursuant to capital lease obligations (Note 3) and related maintenance
    contracts, which begin upon expiration of the manufacturer's warranty period
    of generally 12 to 18 months and which contracts expire at various dates
    through the year 2001, the Company is currently obligated to pay
    approximately $118,000 per month for maintenance of equipment.

    In November 1992, the Company issued a letter-of-credit in the amount of
    $198,500 pursuant to a lease transaction related to its freestanding full-
    service diagnostic imaging center (Note 13).  In exchange for restructuring
    the terms of the debt of this Center, the Company increased the outstanding
    letter-of-credit to an aggregate $400,000.

    In November 1994, the Company issued a letter-of-credit in the amount of
    $270,000 related to the purchase and financing of a new Mobile Unit.  The
    lessor holding this letter-of-credit allowed the letter-of-credit to
    terminate on October 31, 1996.

    In relation to the refinancing of four Mobile Units in February and March
    1995 (Note 3), the Company issued two letters-of-credit in the aggregate
    amount of $930,000.  In February 1996, the lessor holding one of the
    letters-of-credit totaling $330,000 allowed the letter-of-credit to expire.

    On July 31, 1996, the Company refinanced two MRI units which had previously
    been refinanced in March 1995 to more favorable lease terms.  As a result of
    this refinancing, the $600,000 letter-of-credit which had been issued in
    March 1995 was terminated (Note 3).

    The Company must maintain a cash balance of $400,000 on deposit with the
    bank which issued the aforementioned letter-of-credit.


    Note 11.  SUPPLEMENTAL CASH FLOW INFORMATION
              ----------------------------------

    The Company entered into various capital leases or financing arrangements
    (including new units and unit upgrades) aggregating approximately
    $15,135,000, $4,800,000 and $4,350,000 during 1996, 1995 and 1994,
    respectively.  These amounts were recorded as obligations under capital
    leases and as leased diagnostic medical equipment.

    The Company refinanced various capital leases during 1996,  1995 and 1994
    aggregating approximately $2,474,000, $7,092,000 and $3,231,000,
    respectively.

    Interest paid during 1996, 1995 and 1994 was approximately $2,062,000,
    $1,736,000 and $1,474,000, respectively.

    Taxes paid during 1996, 1995 and 1994 approximated $240,000, $71,000 and
    $46,000.

                                      -58-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES
                                        
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 12.  COMMON STOCK DIVIDENDS
              ----------------------

    On July 10, 1995, the Company issued 120,400 Common Shares in conjunction
    with a 5% Common Stock dividend for all shareholders of record on June 30,
    1995.  As a result of the stock dividend, approximately $323,000 was charged
    to accumulated deficit and, in accordance with Accounting Principles Board
    Opinion 15, Earnings Per Share, (APB 15), the Company reflected the 5%
    Common Stock dividend in calculating earnings per share for 1994.

    On January 14, 1997, the Company issued 247,130 Common Shares in accordance
    with a 7% Common Stock dividend for all shareholders of record on January
    10, 1997.  The December 31, 1996 financial statements have been adjusted to
    reflect this post balance sheet equity activity (Note 2).  Further, in
    accordance with APB 15, the Company has reflected the 7% Common Stock
    dividend in calculating earnings per share for all periods presented (Note
    2).

    In accordance with the Company's Warrant Agreement, the Company's publicly-
    traded Warrants were recapitalized to reflect the Common Stock dividend.  As
    a result, each Warrant certificate entitled the holder to purchase 1.1235
    shares of stock for $7.00.  In July 1995, the Company issued a similar 5%
    Common Stock dividend.  Such publicly traded warrants expired on March 4,
    1997 (Note 18).


    Note 13. DISCONTINUED OPERATIONS
             -----------------------

    On December 30, 1993, the Company formally adopted a plan to sell its
    freestanding full-service diagnostic imaging center and its radiation
    oncology center during 1994 and 1995.

    The following table presents net revenues, net losses from discontinued
    operations, net losses on disposal of discontinued operations and selected
    balance sheet information relating to the freestanding full-service
    diagnostic imaging and radiation oncology businesses as of, and for the
    years ended, December 31, 1995 and 1994:
<TABLE>
<CAPTION>
 
                                                      1995       1994
                                                    --------  ----------
<S>                                                 <C>       <C>
 
    Net revenues                                    $821,000  $1,660,077
    Loss from discontinued operations                     --          --
    Loss on disposal of discontinued operations,
      net of tax benefit of $68,000 in 1994               --     132,000
    Accounts receivable, net                              --     148,189
    Leased medical equipment, net                         --   1,305,897
    Leasehold improvements, net                           --     277,176
    Deferred costs, net                                   --     197,297
    Other assets, net                                     --     137,291
    Accounts payable and accrued expenses                 --      88,154
    Long-term debt and capital lease obligations          --   1,305,728
    Reserve for loss on discontinued operations           --     456,302
</TABLE>

                                      -59-
<PAGE>
 
                   SMT HEALTH SERVICES INC. AND SUBSIDIARIES
                                        
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 13.  DISCONTINUED OPERATIONS (continued)
              -----------------------            

    The Company sold substantially all of the assets of the Auburn Regional
    Center for Cancer Care on October 31, 1994.  The sale price of the Center
    was approximately $1.3 million comprised of $400,000 in cash and the
    assumption of the Center's liabilities.  The Company remains obligated on
    approximately $270,000 of capital leases as of December 31, 1996.  The buyer
    has agreed to use its best efforts to have the Company released from these
    leases and has secured its obligations to the Company to perform on these
    leases through a pledge of certain assets in favor of the Company (Note 3).
    The Company had previously established a discontinued operations reserve and
    accordingly, no gain or loss was recorded as a result of this sale.

    In January 1995, the Company restructured the majority of the long-term debt
    and capital lease obligations of the freestanding imaging center resulting
    in debt forgiveness of approximately $300,000, a lower interest rate and
    extension of the term to 66 months, including interest only payments for the
    first six months.  The debt forgiveness was considered in determining the
    adequacy of the reserve for loss on discontinued operations as of December
    31, 1994.  In relation to this debt restructuring, the Company increased the
    letter-of-credit outstanding to $400,000 (Note 10).

    On June 30, 1995, the Company completed the sale of substantially all of the
    assets of its remaining freestanding diagnostic imaging center, Airport
    Regional Imaging Center ("Airport Center"), located in Coraopolis,
    Pennsylvania for a total sale price of approximately $300,000, including
    cash and net trade receivables.  Although the buyer assumed all future
    operating liabilities of the Airport Center, the Company remains obligated
    on approximately $600,000 of capital leases as of December 31, 1996.  The
    buyer has agreed to use its best efforts to have the Company released from
    these leases and has secured its obligations to the Company to perform on
    these leases through a pledge of stock and certain assets in favor of the
    Company (Note 3).  The Company had previously established a discontinued
    operations reserve and accordingly, no gain or loss was recognized as a
    result of this sale.


    Note 14.                SALE OF PARTNERSHIP INTERESTS
                            -----------------------------

    On June 30, 1995, in conjunction with the sale of the Airport Center which
    had been treated as a discontinued operation (Note 13), the Company sold its
    majority ownership and general partner rights in four cardiac care
    partnerships for a total sale price of $300,000 comprised of $200,000 in
    cash and a $100,000, thirty-month note.  The Company recognized a pre-tax
    gain on this sale of $48,219.  The partnerships, which constituted
    approximately seven percent of the Company's revenues, had total assets of
    approximately $1.4 million, comprised primarily of diagnostic equipment and
    accounts receivable, and total liabilities of approximately $1.2 million
    comprised primarily of capital lease obligations associated with the
    diagnostic equipment.

                                      -60-
<PAGE>
 
                    SMT HEALTH SERVICES INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             ------------------------------------------            

    Note 15. LITIGATION
             ----------

    The Company had been named as a defendant, along with a hospital which
    contracts for the Company's MRI services, in a claim filed by a woman who
    alleged to have incurred partial paralysis as a result of being mishandled
    during an MRI procedure.  The claim had been filed for $6.0 million in
    damages.  The claim was settled by the Company's insurance company in
    November 1996 with no admission of liability by the Company and no financial
    effect to the Company.


    Note 16. ACQUISITION
             -----------

    On March 21, 1996, the Company purchased certain assets of a mobile provider
    which operated mobile units in the state of North Carolina (the "Seller").
    The purchase price approximated $600,000 in cash [net of negotiated trade-in
    value of approximately $500,000 (which approximated the purchase price of
    the units acquired) for two of the Seller's mobile MRI units] in exchange
    for MRI Programs including Certificate of Need licenses or exemptions and
    certain customer service contracts.  The Company traded-in and upgraded one
    of the purchased units to newer technology in April 1996 and traded-in and
    upgraded the second unit during July 1996 (Note 3).


    Note 17. SALES TAX REFUND
             ----------------

    During September 1996, the Company received formal notification of a state
    sales tax refund of approximately $300,000, net of expenses.  The refund is
    the result of sales tax paid to a certain state over a period of time which
    the Company determined (by obtaining a private letter ruling from the state)
    was actually exempt from such tax.  Payment of the refund was received in
    January 1997.


    Note 18. SUBSEQUENT EVENT
             ----------------

    During January through March 4, 1997 (the Warrants expired at 5:00 p.m. on
    March 4, 1997) 1,677,000 Warrants (Note 5) were exercised and the Company
    issued 1,882,000 shares of Common Stock of the Company.  The Company
    received net cash proceeds of approximately $11.7 million as a result of
    such Warrant exercises.  The Warrants ceased trading on March 5, 1997.

                                      -61-
<PAGE>
 
                                    PART III


    ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
              --------------------------------------------------

    The information set forth above in Part I under the caption "Executive
    Officers of the Registrant" is incorporated herein by reference.  The other
    information required by this item is incorporated herein by reference to the
    information set forth under the captions "Election of Directors", "Board of
    Directors and Certain Board Committees" and "Section 16(a) Beneficial
    Ownership Reporting Compliance" in the Company's definitive proxy statement
    (the "Proxy Statement") for the May 7, 1997, Annual Meeting of Stockholders
    filed or to be filed pursuant to Regulation 14A of the Securities Exchange
    Act of 1934, as amended (the "Exchange Act").


    ITEM 11.  EXECUTIVE COMPENSATION
              ----------------------

    The information required by this item is incorporated herein by reference to
    the information set forth in the second paragraph under the caption "Board
    of Directors and Certain Board Committees" and the information set forth
    under the caption "Executive Compensation and Other Information" in the
    Proxy Statement.


    ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
              --------------------------------------------------------------

    The information required by this item is incorporated herein by reference to
    the information set forth under the caption "Security Ownership of Certain
    Beneficial Owners and Management" in the Proxy Statement.


    ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
              ----------------------------------------------

    The information required by this item is incorporated herein by reference to
    the information set forth under the caption "Certain Relationships and
    Related Transactions" in the Proxy Statement.

                                      -62-
<PAGE>
 
                                    PART IV

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

 Financial statements, financial statement schedules and exhibits not listed
 have been omitted where the required information is included in the
 consolidated financial statements or notes thereto, or is not applicable or
 required.

 (a)  (1)  A listing of the consolidated financial statements, notes and
           independent auditors' report required hereunder is set forth in Item
           8 of this Report on Form 10-K.

      (2)  Financial Statement Schedule:
 
           The following are included in this Report:
 
            Schedule II - Valuation and Qualifying Accounts
 
      (3)  Exhibits.

<TABLE>
<CAPTION>

Exhibit No.                                                                       Reference
-----------                                                                       ---------
<S>             <C>                                               <C>
 3.1            Certificate of Incorporation of SMT, as amended   Incorporated herein by reference is Exhibit 3.1 to
                                                                  Registration Statement No. 33-44329 on Form S-1 (the "Form S-1")
 
 
 3.2            By-Laws of SMT                                    Incorporated herein by reference is Exhibit 3.2 to
                                                                  the Form S-1.
 
 4.1            Warrant Agreement dated March 11, 1992            Incorporated herein by reference is Exhibit 4.2 to
                                                                  SMT's Annual Report on Form 10-K for the Fiscal Year Ended 
                                                                  December 31, 1992.                              
 
 
 
 4.2            Rights Agreement between SMT Health               Incorporated herein by reference is Exhibit 1 to
                Services Inc. and American Stock Transfer         the Registrant's Registration Statement on Form
                and Trust Company dated November 8, 1995          8-A Amendment No. 1, filed on December 6, 1995.
 
 10.1           Lease for SMT's facility                          Incorporated herein by reference is Exhibit 10.01
                                                                  to SMT's Quarterly Report on Form 10-Q for the Quarter Ended 
                                                                  September 30, 1994.                                  
 
 10.2*          Employment Agreements with Jeff D. Bergman        Incorporated herein by reference are Exhibit 10.41 to SMT's 
                                                                  Annual Report on Form 10-K for the Fiscal Year Ended 
                                                                  December 31, 1994 and Exhibit 10.01 to the Company's Form 10-Q for
                                                                  the Quarterly Period Ended September 30, 1996.

</TABLE>
 __________________
 *Denotes management agreement or compensatory plan or arrangement.

                                      -63-
<PAGE>
 
<TABLE>
<CAPTION>

<S>             <C>                                               <C>
 10.3*          Employment Agreements with Daniel Dickman         Incorporated herein by reference are Exhibit 10.41 to SMT's 
                                                                  Annual Report on Form 10-K for the Fiscal Year Ended 
                                                                  December 31, 1994 and Exhibit 10.02 to the Company's Form 10-Q 
                                                                  for the Quarterly Period Ended September 30, 1996.
 
 10.4*          1996 Employee Stock Option Plan                   Filed herewith.
 
 10.5*          1991 Employee Stock Option Plan (as amended       Incorporated herein by reference is Exhibit 10.04
                on April 27, 1995)                                to the Company's Form 10-Q for the Quarter Ended June 30, 1995.
 
 10.6*          1991 Directors Stock Option Plan for Non-         Incorporated herein by reference is Exhibit 10.05
                Employee Directors (as amended April 27,          to the Company's Form 10-Q for the Quarter
                1995)                                             Ended June 30, 1995.
 
 10.7*          SMT Profit Sharing Plan                           Incorporated herein by reference is Exhibit 10.30
                                                                  to SMT's Annual Report on Form 10-K for the
                                                                  Fiscal Year Ended December 31, 1992.          
 
 
 10.8           Master Security Agreement, dated October 6,       Incorporated herein by reference is Exhibit 10.42
                1992, between U.S. Concord, Inc. and Airport      to SMT's Annual Report on Form 10-K for the
                Regional Imaging Center, L.P. , including         Fiscal Year Ended December 31, 1992.
                exhibits thereto
 
 10.9           Lease renewal and upgrade dated March 15,         Incorporated herein by reference is Exhibit
                1993, between SMT Health Services Inc. and        10.03 to the Company's Form 10-Q for the Quarter
                GE Medical Systems                                Ended September 30, 1994.
                                                                  
 10.10          Master Equipment Lease Agreement dated as         Incorporated herein by reference is Exhibit 10.06
                of September 15, 1994, between Financing for      to the Company's Form 10-Q for the Quarter
                Science International, Inc. and SMT Health        Ended September 30, 1994.
                Services Inc., including exhibits thereto         
                                                                  
 10.11          Master Maxi-service Agreement Number              Incorporated herein by reference is Exhibit 10.07
                dated October 6, 1994, by and between GE          to the Company's Form 10-Q for the Quarter Ended
                Medical Systems and SMT Health Services           September 30, 1994.
                Inc., including exhibits thereto                  
                                                                  
 10.12          Asset Purchase Agreement between Universal        Incorporated herein by reference is Exhibit 10.08
                Treatment Centers, Inc. and SMT Health            to the Company's Form 10-Q for the Quarter Ended
                Services Inc., dated as of October 31, 1994,      September 30, 1994.
                including schedules thereto                       
                                                                  
 10.13          Master Equipment Lease dated November 21,         Incorporated herein by reference is Exhibit 10.31
                1994, by and between Laurel Capital Corpora-      to SMT's Annual Report on Form 10-K for the
                tion and SMT Health Services Inc. and exhibits    Fiscal Year Ended December 31, 1994.
                thereto
</TABLE>
 __________________
 *Denotes management agreement or compensatory plan or arrangement.

                                      -64-
<PAGE>
 
<TABLE>
<CAPTION>

<S>             <C>                                               <C>
 10.14          Master Equipment Lease dated January 26,          Incorporated herein by reference is Exhibit 10.32
                1995, by and between Laurel Capital Corpora-      to SMT's Annual Report on Form 10-K for the
                tion and SMT Health Services Inc. and exhibits    Fiscal Year Ended December 31, 1994.
                thereto
 
 10.15          Master Equipment Lease dated January 26,          Incorporated herein by reference is Exhibit 10.33
                1995, by and between Laurel Capital Corpora-      to SMT's Annual Report on Form 10-K for the
                tion and SMT Health Services Inc. and exhibits    Fiscal Year Ended December 31, 1994.
                thereto
 
 10.16          Master Equipment Lease dated February 3,          Incorporated herein by reference is Exhibit 10.34
                1995, by and between Copelco Capital, Inc.        to SMT's Annual Report on Form 10-K for the
                and SMT Health Services Inc. and exhibits         Fiscal Year Ended December 31, 1994.
                thereto
 
 10.17          Master Equipment Lease dated February 20,         Incorporated herein by reference is Exhibit 10.35
                1995, by and between Heller Financial Leasing,    to SMT's Annual Report on Form 10-K for the
                Inc. and SMT Health Services Inc. and exhibits    Fiscal Year Ended December 31, 1994.
                thereto
 
 10.18          Master Equipment Lease dated February 20,         Incorporated herein by reference is Exhibit 10.36
                1995, by and between Heller Financial Leasing,    to SMT's Annual Report on Form 10-K for the
                Inc. and SMT Health Services Inc. and exhibits    Fiscal Year Ended December 31, 1994.
                thereto
 
 10.19          Loan Modification Agreement dated January 1,      Incorporated herein by reference is Exhibit 10.37
                1995, by and between Airport Regional Imaging     to SMT's Annual Report on Form 10-K for the
                Center, L.P. and Marine Midland Business Loans,   Fiscal Year Ended December 31, 1994.
                Inc., formerly known as U.S. Concord, Inc.
 
 10.20          Master Lease/Service Agreement, Agreement         Incorporated herein by reference is Exhibit 10.01
                Number 8003 dated March 28, 1995 by and           to the Company's Form 10-Q for the Quarter Ended
                between G.E. Medical Systems and SMT              June 30, 1995.
                Health Services Inc.
 
10.21           Agreement of Purchase and Sale By and             Incorporated herein by reference is Exhibit 10.02
                Between Airport Regional Imaging Center,          to the Company's Form 10-Q for the Quarter Ended
                L.P. and SMT Cardiac Corp., as Seller and         June 30, 1995.
                C.F. Services, Inc. and C.F. Airport Health
                Services, Inc. as Buyers (and related schedules;
                Equipment Sublease by and between Airport
                Regional Imaging Center, L.P. and C.F.
                Airport Health Services, Inc. dated June 30,
                1995;  Credit Agreement dated June 30, 1995;
                Security Agreement dated June 30, 1995;
                Pledge of Securities Agreement dated June
                30, 1995; and Continuing Agreement of
                Guaranty and Suretyship including Authority
                to Confess Judgment after Default)
</TABLE>

                                      -65-
<PAGE>
 
<TABLE>
<CAPTION>

<S>             <C>                                               <C>
 10.22          Agreement between Shared Medical Enterprises      Incorporated herein by reference is Exhibit 10.03
                and SMT Health Services Inc. dated July 1, 1995   to the Company's Form 10-Q for the Quarter
                                                                  Ended June 30, 1995.

 10.23          Loan and Security Agreement, Agreement            Incorporated herein by reference is Exhibit 10.01
                Number 130-0001386-000 dated September            to the Company's Form 10-Q for the Quarter
                27, 1995 by and between Siemens Credit            Ended September 30, 1995.
                Corporation and SMT Health Services Inc.

 10.24*         Employment Agreements with David A. Zynn          Incorporated herein by reference is Exhibit 10.04 to the
                                                                  Company's Form 10-Q for the Quarterly Period Ended 
                                                                  September 30, 1996 and Exhibit 10.44 to SMT's Annual Report on 
                                                                  Form 10-K for Fiscal Year Ended December 31, 1995.

 10.25*         Employment Agreements with David Spindler         Incorporated herein by reference is Exhibit 10.03 to the 
                                                                  Company's Form 10-Q for the Quarterly Period Ended 
                                                                  September 30, 1996 and Exhibit 10.45 to SMT's Annual Report on 
                                                                  Form 10-K for Fiscal Year Ended December 31, 1995.

 10.26*         Warrant Agreement dated August 9, 1995 by         Incorporated herein by reference is Exhibit 10.46
                and between SMT Health Services Inc. and          to the Company's Annual Report on Form 10-K for
                Mark A. DeSimone                                  the Fiscal Year Ended December 31, 1995.
 
 10.27*         Warrant Agreement dated August 9, 1995 by         Incorporated herein by reference in Exhibit 10.47
                and among Jeff D. Bergman, Daniel Dickman,        to SMT's Annual Report on Form 10-K for the
                Gerald Cohn, Alan Novich and David J. Malone      Fiscal Year Ended December 31, 1995.
 
 10.28          Agreement of Purchase and Sale Between            Incorporated herein by reference is Exhibit 10.49
                Trans-Carolina Imaging, LLC, as Seller, and       to SMT's Annual Report on Form 10-K for the
                SMT Mobile V Corp., as Buyer dated as of          Fiscal Year Ended December 31, 1995.
                February 27, 1996
 
 10.29          Engagement Letter by and among SMT Health         Incorporated herein by reference is Exhibit 10.02
                Services Inc. and Commonwealth Associates         to the Company's Form 10-Q for the Period Ended
                September 30, 1995.
 
 10.30          Warrant Agreement by and among SMT Health         Incorporated herein by reference is Exhibit 10.03
                Services Inc. and Commonwealth Associates         to the Company's Form 10-Q for the Period Ended
                September 30, 1995.
 
 10.31          Promissory Note and Loan and Security             Incorporated herein by reference is Exhibit 10.52
                Agreement by and between Siemens Credit           to SMT's Annual Report on Form 10-K for the
                Corporation and SMT Health Services Inc.          Fiscal Year Ended December 31, 1995.
                dated February 9, 1996

</TABLE>
 __________________
 *Denotes management agreement or compensatory plan or arrangement.

                                      -66-
<PAGE>
 
<TABLE>
<CAPTION>

<S>             <C>                                               <C>
 10.32          Amended Schedule of Leased Equipment by           Incorporated herein by reference is Exhibit 10.53
                and between Laurel Capital Corporation and        to SMT's Annual Report on Form 10-K for the
                SMT Health Services Inc. dated January 4, 1996    Fiscal Year Ended December 31, 1995.
 
 10.33*         SMT Health Services Inc. 1995 Directors           Incorporated herein by reference is Exhibit 10.54
                Warrant Plan                                      to SMT's Annual Report on Form 10-K for the
                                                                  Fiscal Year Ended December 31, 1995.
 
10.34           Master Equipment Lease dated August 28, 1996      Incorporated herein by reference is Exhibit 10.05
                by and between SMT Health Services Inc. and       to the Company's Form 10-Q for the Quarterly
                DVI Financial Services Inc.                       Period Ended September 30, 1996
 
 10.35          Loan and Security Agreement dated September       Incorporated herein by reference is Exhibit 10.06
                11, 1996 by and between Siemens Credit            to the Company's Form 10-Q for the Quarterly
                Corporation and SMT Health Services               Period Ended September 30, 1996

 10.36          Finance Lease and Security Agreement dated        Incorporated herein by reference is Exhibit 10.07
                September 26, 1996 by and between Laurel          to the Company's Form 10-Q for the Quarterly
                Capital Corporation and SMT Health Services       Period Ended September 30, 1996
                Inc.
 
 10.37          Finance Lease and Security Agreement dated        Incorporated herein by reference is Exhibit 10.08
                July 26, 1996 by and between Laurel Capital       to the Company's Form 10-Q for the Quarterly
                Corporation and SMT Health Services Inc.          Period Ended September 30, 1996
 
 
 10.38          Finance Lease and Security Agreement dated        Incorporated herein by reference is Exhibit 10.09
                July 26, 1991 by and between Laurel Capital       to the Company's Form 10-Q for the Quarterly
                Corporation and SMT Health Services Inc.          Period ended September 30, 1996
                (Lease 2166)
 
 10.39          Finance Lease and Security Agreement dated        Filed herewith.
                December 15, 1996 by and between Laurel
                Capital Corporation and SMT Health Services Inc.
 
 10.40          Agreement of Purchase and Sale between Palmetto   Filed herewith.
                Community Health Network and SMT Health
                Services Inc.
 
 11.1           Computation of Earnings Per Share                 Filed herewith.
 
 21.1           List of Subsidiaries                              Filed herewith.
 
 23.1           Consent of Independent Public Accountants         Filed herewith.
 
 27.1           Financial Data Schedule                           Filed herewith.
 
 99.1           Press Release dated March 17, 1997                Filed herewith.
</TABLE>
 __________________
 *Denotes management agreement or compensatory plan or arrangement.

                                      -67-
<PAGE>
 
                                     PART V


 SMT will furnish to the Commission upon request copies of any instruments not
 filed herewith, if any, which authorize the issuance of long-term obligations
 of SMT not in excess of 10% of SMT's total assets on a consolidated basis.

  (b) During the quarter ended December 31, 1996, SMT filed no report on 
      Form 8-K.

  (c) SMT hereby files as exhibits to this Form 10-K the exhibits set forth in
      Items 14(a)(3) hereof which are not incorporated by reference.

  (d) SMT hereby files as financial statement schedules to this Form 10-K the
      financial statement schedules set forth in Item 14(a)(2) hereof.

                                      -68-
<PAGE>
 
                            SMT HEALTH SERVICES INC.
                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                -----------------------------------------------
<TABLE>
<CAPTION>
 
 
                              Balance at     Additions        Additions                  Balance
                              Beginning      Charged to       Charged to                 at End
Descriptions                  of Period   Costs & Expenses  Other Accounts  Deductions  of Period
----------------------------  ----------  ----------------  --------------  ----------  ---------
<S>                           <C>         <C>               <C>             <C>         <C>
 
     Year Ended
 December 31, 1994
 
 Provision for loss on
  disposal of discontinued
  operations                  $1,400,000          $200,000          $   --  $1,144,000   $456,000
                              ==========          ========          ======  ==========  =========
 
 Valuation allowance
  related to deferred
  tax assets                  $  487,500          $     --          $   --  $   72,500   $415,000
                              ==========          ========          ======  ==========  =========
 
 Allowance for doubtful
  accounts                    $   13,000          $     --          $   --  $   13,000  $      --
                              ==========          ========          ======  ==========  =========
 

    Year Ended
 December 31, 1995

 Provision for loss on
 disposal of discontinued
 operations                   $  456,000          $     --          $   --  $  456,000  $      --
                              ==========          ========          ======  ==========  =========

 Valuation allowance
 related to deferred
 tax assets                   $  415,000          $     --          $   --  $  312,000  $ 103,000
                              ==========          ========          ======  ==========  =========



    Year Ended
 December 31, 1996

 Valuation allowance
 related to deferred
 tax assets                   $  103,000          $     --          $   --  $  103,000  $      --
                              ==========          ========          ======  ==========  =========

</TABLE>

                                      -69-
<PAGE>
 
                                   SIGNATURES

 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
 Act of 1934, the Registrant has duly caused this report to be signed on its
 behalf by the undersigned, thereunto duly authorized in the city of Pittsburgh,
 Commonwealth of Pennsylvania, on March 20, 1997.


                    SMT HEALTH SERVICES INC.

                    By:       /s/ Jeff D. Bergman
                         ---------------------------------------
                         Jeff D. Bergman, President, Chief
                           Executive Officer and Director

 Pursuant to 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 indicated on March 20, 1997.

    Signature                        Title
    ---------                        -----

    Principal Executive Officer:

    /s/ Jeff D. Bergman
    ----------------------------
    Jeff D. Bergman                  President, Chief Executive Officer and
                                     Director

    Principal Financial and
      Accounting Officer:

    /s/ David A. Zynn
    ----------------------------
    David A. Zynn                    Chief Financial Officer, Treasurer, Chief
                                     Accounting Officer and Assistant Secretary

    Directors:


    /s/   Gerald L. Cohn             /s/  Alan Novich
    ----------------------------     --------------------------
    Gerald L. Cohn                   Alan Novich


    /s/ Daniel Dickman                /s/ David J. Malone
    ----------------------------     --------------------------
    Daniel Dickman                   David J. Malone


 

                                      -70-