SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549
                                  FORM 10-KSB

(Mark One)

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

               FOR THE FISCAL YEAR ENDED MAY 31, 1997

                                  OR

[ ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                 SECURITIES EXCHANGE ACT OF 1934
               For the transition period from             to
                                              -----------    ------------

                         Commission file number   0-13281

                              DIAGNON CORPORATION
                 ----------------------------------------------
                 (Name of small business issuer in its charter)

       State of Delaware                              13-3078199
 -------------------------------                   -------------------
 (State or other jurisdiction of                    (I.R.S. Employer
 incorporation or organization)                    Identification No.)

9600 Medical Center Drive, Rockville, Maryland           20850
----------------------------------------------         ----------
   (Address of principal executive office)             (Zip Code)

Issuer's telephone number, including area code    (301) 251-2801

Securities registered under Section 12(b) of the Exchange Act:

                                         Name of each exchange on
      Title of class                         which registered

           None                                  None
      --------------                     ------------------------

         Securities registered under Section 12(g) of the Exchange Act:
                          Common Shares $.01 Par Value
         --------------------------------------------------------------
                                 Title of Class

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months, and (2)
has been subject to such filing requirement for the past 90 days. Yes X   No
                                                                     ---    ---

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

The issuer's revenues for the fiscal year ended May 31, 1997 were $8,939,210.

The aggregate market value of voting stock held by non-affiliates, valued using
the average closing bid-and-ask prices at July 23, 1997 is $1,407,777.

Common Stock, $.01 par value per share; authorized 25,000,000 shares; 5,398,244
shares outstanding as of July 23, 1997.

Convertible Preferred Stock, $1.00 par value per share; authorized 325,000
shares; no shares outstanding as of July 23, 1997.

Documents Incorporated by Reference: Parts III and IV -Exhibits to Registration
Statement dated July 13, 1983 and Form 10-K and 10-KSB for the fiscal years
ended May 31, 1986, 1989, 1990, 1991, 1992, 1994, 1995 and 1996.


<PAGE>


                                     PART I

ITEM 1.  DESCRIPTION OF BUSINESS

GENERAL DEVELOPMENT OF BUSINESS

Diagnon Corporation (the "Company") was founded in 1981 to develop, produce and
sell diagnostic test kits incorporating monoclonal antibodies to diagnose
certain anemias, infections, and parasitic diseases. In fiscal year 1988, the
Company discontinued the diagnostic test kit segment of its business to
concentrate on and to expand its contract research base with the National
Institutes of Health (NIH).

Beginning with fiscal year 1988, the Company has been profitable each year.
Recently, Company management, recognizing the limited number of new NIH contract
opportunities, has concentrated on maintaining its core base of long-term
contracts, competing on new opportunities when available, and concurrently
pursuing other related business elements.

In the first quarter of fiscal year 1995, the Company entered into agreements
with The Johns Hopkins University to pursue development, testing and possible
commercialization of certain cancer treatment and drug delivery approaches that
had been developed by members of the faculty of The Johns Hopkins' University
(JHU). The transaction was contingent on the obtaining of financing through a
private placement on a best efforts, non-underwritten basis by Slusser
Associates, Inc., a New York investment banking firm. The project was to be
implemented by Enhanced Therapeutics, Inc. (ET), a new company formed by
Diagnon, JHU, certain JHU faculty members, and certain other investors.

During the second quarter of fiscal year 1995, the Company announced the
termination of the agreements between Diagnon and The Johns Hopkins University.
The termination was the result of the inability to obtain financing through a
private placement within the time-frame required by the agreements. On September
5, 1995, ET became a wholly owned subsidiary of Diagnon.

In fiscal year 1996, the Company's research and development activities in cancer
treatment and drug delivery and purified IgG products were assigned to the
Company's Corporate Support Services (now the Division of Bioresearch) business
element and the first IgG product, equine IgG was introduced. Immunoglobulins
used therapeutically provide passive immunity against infectious diseases.

At the end of fiscal year 1997, the Company reorganized into five divisions to
more fully reflect and manage the new business focuses. These are: Division of
Primate Biology and Medicine, Division of Laboratory Animal Sciences, Division
of Reproductive Endocrinology and Toxicology, Division of Bioresearch and the
Division of Neurobiology and Behavior.

CURRENT OPERATIONS

The Company is currently comprised of two subsidiaries, the above mentioned ET
and, BIOQUAL, Inc., which is comprised of three divisions, Primate Biology and
Medicine, Laboratory Animal Sciences, and Reproductive Endocrinology and
Toxicology.

                                      -1-


<PAGE>




In fiscal year 1998, the BIOQUAL subsidiary is expected to generate more than 95
percent of the Company's revenues, with the remaining revenues arising from the
company's Division of Bioresearch business element. As revenues grow from sales
of IgG products and other research and development activities, the Company may
transfer these products and/or contracts to the currently inactive ET
subsidiary.

Administratively, the Company's current business is divided into five elements
corresponding to the business emphases of the divisions.

DIVISION OF LABORATORY ANIMAL SCIENCES - immunological, reproductive and
transgenic studies and services with emphasis on small animal models.

DIVISION OF REPRODUCTIVE ENDOCRINOLOGY AND TOXICOLOGY - Immunoassays,
biochemistry, endocrine bioassays and safety testing as related to reproduction.

DIVISION OF NEUROBIOLOGY AND BEHAVIOR - behavioral and neurological testing and
comparative studies in support of research on neurodegenerative disorders in
humans (e.g. Alzheimer's, Parkinson's, etc.).

DIVISION OF PRIMATE BIOLOGY AND MEDICINE - research and services in human
diseases using nonhuman primate models.

DIVISION OF BIORESEARCH - discovery research in cancer treatment, digestive
diseases and drug delivery systems and developmental and applied research in
veterinary therapeutics.

Financially, the Company combines the first three divisions as they are co-
located in the Medical Center Dr. facility.  The Division of Bioresearch is also
located at the Medical Center Dr. facility, however, it is accounted for
separate from the first three divisions.  The Division of Primate Biology and
Medicine is located in the Research Blvd. facility.

     MEDICAL CENTER DR. FACILITY - DIVISIONS OF LABORATORY ANIMAL SCIENCES,
     ----------------------------------------------------------------------
    REPRODUCTIVE ENDOCRINOLOGY AND TOXICOLOGY AND NEUROBIOLOGY AND BEHAVIOR
    -----------------------------------------------------------------------

For the past twenty-two years, BIOQUAL, Inc. (through its Medical Center Dr.
Division from February 25, 1991 until May 31, 1997 and presently as the
Divisions of Laboratory Animal Sciences, Reproductive Endocrinology and
Toxicology and Neurobiology and Behavior) has operated cost-plus-fixed-fee
("CPFF") contracts for the United States Government (the "Government") to
provide research and services in the areas of cancer, immunology, transgenics,
allophenic development, contraception and congenic animal breeding. Currently,
the three divisions operate five contracts which generate more than 85% of the
division's revenue:

      1.   Maintenance of an Animal Holding Facility and provision of Attendant
           Research Services.  (ends 10/31/97)

      2.   Facility for Preparing and Housing Virus Infected Mice, Genetically
           Manipulated Mice and Chimeric Mice.  (ends 9/30/97)

      3.   Biological Testing Facility.  (Efficacy and Safety of Reproductive
           Compounds)  (ends 6/30/01)

      4.   Provide Animal Housing/Maintenance/Bleeds/Immunizations as Specified
           Herein.  (ends 2/20/02)

                                      -2-


<PAGE>




      5.   Development of New Methods and Strategies for Diagnosis, Treatment
           and Prevention of Invasive Fungal Infection in Patients with Cancer
           and HIV Infection.  (ends 09/30/99)

The Company has been notified by the National Cancer Institute (NCI) of it's
intent to extend the first two contracts on a sole source basis for up to four
years. Such extensions are subject to negotiations with the NCI.

Contract revenues are charged on the basis of direct labor and supplies provided
by these divisions. Due to the relatively constant required level of effort on
the contracts, revenue is evenly spread over each month of the year. The
Government traditionally pays promptly (barring any unforeseen circumstances
such as a government shut-down). The divisions' revenues totalled $5,035,996 for
the most recent fiscal year.

      RESEARCH BLVD. FACILITY - DIVISION OF PRIMATE BIOLOGY AND MEDICINE
      ------------------------------------------------------------------

For over twenty-four years, BIOQUAL, Inc., and SEMA, Inc., prior to its merger
with BIOQUAL; (through its Research Blvd. Division from February 25, 1991 until
May 31, 1997 and presently the Division of Primate Biology and Medicine), have
operated CPFF and Fixed Price contracts for the Government using nonhuman
primates to provide research and services in the disease areas of cancer, AIDS,
hepatitis, cystic fibrosis and influenza. Currently, this division operates six
contracts:

      1.   Studies Using Primate Models for AIDS Vaccine Research.  (ends
           11/27/99)

      2.   Facility for Animal Models Utilized for Viral Hepatitis Experiments.
           (ends 12/27/99)

      3.   Facility for Nonhuman Primates Utilized in Infectious Disease
           Research.  (ends 12/30/99)

      4.   Mechanisms of Chemical Carcinogenesis in Old World Monkeys.  (ends
           12/18/00)

      5.   Care and Housing of SIV Infected Research Animals.  (ends 01/18/00)

      6.   MAO/Evaluation of AIDS Vaccines in Non-Human Primates.  (ends
           11/15/97)

As part of the predecessor contract to the second contract listed above, the
division developed and has a patent on specially designed animal housing units
under the division's animal environmental enrichment program.

Contract revenues are charged on the basis of direct labor and supplies provided
by the division. Due to the relatively constant required level of effort on the
contracts, revenue is evenly spread over each month of the year. The Government
traditionally pays promptly (barring any unforeseen circumstances such as a
government shut-down). Contract revenues totalled $3,883,298 for the most recent
fiscal year.

BIOQUAL plans to bid on renewals for the three divisions' contracts as they come
up for recompetition.

The Government is the major source of funding for all of BIOQUAL's services. All
of BIOQUAL's contracts are subject to renegotiation of profits or termination at
the election of the Government.  Termination of a contract or

                                      -3-


<PAGE>



failure to win a renewal competition adversely affects the Company's revenues
and operating capital until the vacated facility space is taken up by another
contract.

      DIVISION OF BIORESEARCH (FORMERLY CORPORATE SUPPORT SERVICES)
      -------------------------------------------------------------

The Division of Bioresearch has one product in the marketplace, purified equine
IgG which is sold under the brand name Lyphomune(TM). This division is also
responsible for the Company's research and development activities.

      EQUINE IGG
      ----------

In January, 1995, the Company entered into a Licensing and Manufacturing
Agreement with ZooQuest Technologies Ltd. for an exclusive worldwide license to
manufacture and sell Equine Immunoglobulin for oral administration
(Lyphomune(TM) IgG) purified by a patented process assigned to ZooQuest. A sale
agreement was reached in the first quarter of fiscal year 1997 for the Company
to acquire the assets of ZooQuest. On June 11, 1997, the Company was granted
United States Department of Agriculture approval to sell and distribute it's
oral/intravenous equine IgG also being sold under the name Lyphomune(TM).

The highly purified equine IgG is used for treatment for Failure of Passive
Transfer (FPT) of immunity in newborn foals. During the first twenty-four hours
postpartum the foals showing symptoms of FPT can be, under normal circumstances,
administered IgG orally; however, after twenty-four hours postpartum, the foals,
generally, must be treated using intravenous methods.

There are approximately 250,000 foals born in the United States annually. It is
estimated that 20-25% of these (about 55,000) will experience FPT in some form
which can be beneficially treated with Equine IgG therapy. The European Union
produces in the vicinity of 40,000 foals annually, yielding an anticipated 9,000
foals with FPT. Brazil presently has in the vicinity of 6,000,000 horses
yielding in the range of 150,000 foals annually. The remainder of North and
South America have an additional 17,000,000 horses with upwards of 400,000 foals
a year. Australia and New Zealand produce in the range of 13,000 foals a year.
Treatment of a foal requires $60-$240 worth of the IgG product. The potential
United States market is estimated at $6-8,000,000 annually. The Company will
strive to capture as large a portion of the market as possible; however, there
can be no assurance of future sales.

The United States and Europe are the first market areas for Lyphomune(TM).  A
distributor is presently serving the market in the U.S.  Other distributors are
being contacted to add to U.S. and international coverage.

      RESEARCH AND DEVELOPMENT ACTIVITIES
      -----------------------------------

           CANCER TREATMENT AND DRUG DELIVERY
           ----------------------------------

During this fiscal year, the Company is continuing the evaluation of a new
approach to cancer treatment which began in fiscal year 1996, and if these
preliminary studies show promise, the Company will seek support for further
development (e.g. SBIR contracts).

                                      -4-


<PAGE>



           PURIFIED IgG PRODUCTS
           ---------------------

Currently the product, Lyphomune(TM), is being distributed as a combined
oral/intravenous dose. The process for producing the product is being reviewed
in an effort to lower unit cost of production.

This division is also working to produce purified IgG from serum from other
species (e.g. dogs). These IgG products will be clinically tested for efficacy
and safety. If these IgG products prove efficacious and safe and capable of
being delivered at an acceptable market price, the Company will move to
production of purified IgG for other species.

           IMMUNOTHERAPY
           -------------

During this fiscal year, Diagnon scientists successfully experimentally infected
Erthyrocebus patas monkeys with human Helicobacter pylori. Infection with H.
pylori is associated with most duodenal and gastric ulcers and is a risk factor
in the development of gastric adenocarcinoma.  Initial research on this project
has focused on three specific aspects of H. pylori: 1. development of a nonhuman
primate model, 2. identification and characterization of potential protective
antigens for vaccine development, and 3. identification of novel targets for
antibiotic development.

In connection with this research, on May 1, 1997, the Company entered into a two
year Cooperative Research and Development Agreement (CRADA) with the National
Institute of Diabetes and Digestive and Kidney Diseases (NIDDK) for the
"Identification and Characterization of Novel Targets for the Development of
Antibiotic and Protective Vaccines Directed Against Helicobacter pylori", and on
May 15, 1997, the Company entered into a two year Cooperative Research Agreement
with the Uniformed Services University of the Health Sciences (USUHS) for the
"Identification of Helicobacter pylori Antigens for Development of Protective
Vaccines".

The incremental costs of both the USUHS and NIDDK agreements are not material to
Diagnon's financial position.

      SMALL BUSINESS INNOVATIVE RESEARCH PROGRAM (SBIR)
      -------------------------------------------------

The Government offers to commercial entities "Phase I" SBIR grants which are to
fund feasibility studies costing up to $100,000 and lasting six months. If the
feasibility study shows sufficient promise, then a "Phase II" program providing
grants up to $750,000 may be awarded. "Phase III" of the program consists of
establishing the project on a commercial basis. The Company regularly submits
SBIR proposals and has been awarded and has completed five Phase I grants and
one Phase II grant. On February 1, 1997, BIOQUAL was awarded a Phase I SBIR
grant to explore the feasibility of establishing a "Comparative Neurobiology of
Aging Research Resource". The funding for this grant was $93,900. The study was
completed on July 31, 1997. The Phase II SBIR application for this program was
submitted on August 15, 1997. The Company continues to compete for the
Government's SBIR contract and grant mechanisms to further the Company's
proprietary research. Proprietary positions and/or patents arising from these
programs will be the property of the Company with free licensing available to
the Government. There can be no assurance, however, that additional SBIR grants
will be awarded, or that grants, if awarded, will result in proprietary
positions or patents for the Company.

                                      -5-


<PAGE>




Backlogs
--------

The divisions of Laboratory Animal Sciences, Reproductive Endocrinology and
Toxicology and Primate Biology and Medicine operate under Government contracts
which typically run three to five years. Therefore, the backlogs of the
divisions are significantly increased in a year in which a long-term contract is
awarded. Most of the contracts included in the following totals are
incrementally funded on an annual basis. Therefore much of the backlog is not
"firm" in that the funds will not be committed until a later date.

<TABLE>
<CAPTION>                                                                                             Backlog
                                                  Backlog                     Backlog                Unfilled
                                                   FY 97                       FY 98                 in FY 98
                                                as of 6/1/96                as of 6/1/97             Projected
                                                ------------                ------------             ---------
<S><C>
      Med. Ctr. Dr. Facility                    $ 3,089,000                 $13,615,000             $ 9,514,000
      Res. Blvd. Facility                        14,090,000                  10,725,000               7,219,000
                                                -----------                 -----------             -----------

      TOTAL                                     $17,179,000                 $24,340,000             $16,733,000
</TABLE>

SUPERVISION AND REGULATION
--------------------------

      Animal Model Contracts
      ----------------------

Over the last few decades, there has been an increasing awareness of the need
for adequate oversight and regulation of the utilization and husbandry of
animals.

BIOQUAL, Inc. utilizes animals and, by contract, is required to observe the
regulations and guidelines of the Institute of Laboratory Animal Resources,
Guide for the Care and Use of Laboratory Animals. Furthermore, BIOQUAL, Inc.
must meet the Public Health Service (PHS) Policy on Humane Care and Use of
Laboratory Animals. This policy mandates that BIOQUAL, Inc. file annually an
assurance as to compliance with the NIH Office for Protection from Research
Risks. BIOQUAL, Inc. also comes under the jurisdiction of the U.S. Department of
Agriculture (USDA), which regularly inspects both of the Company's facilities
for adherence to its rules and regulations regarding care and treatment of
animals. To ensure compliance with the several laws and regulations regarding
animal care, both facilities are accredited as complying laboratories by the
Association for Assessment and Accreditation of Laboratory Animal Care
International (AAALAC).

The supervision and regulation programs described herein are costly in terms of
ongoing operation and maintenance, but are essential because lack of compliance
can lead to cessation of operations and loss of contracts.

      Environmental Compliance
      ------------------------

The Company incurs minimal costs in the disposal of the waste generated by its
operations. These costs are reimbursable under government contracts.

      Veterinary Products
      -------------------

The USDA is responsible for regulation of veterinary products and the Company's
product testing, approval, production and packaging are governed by Part 9 of
the Code of Federal Regulations (CFR).

                                      -6-


<PAGE>



      Cancer Treatment Products
      -------------------------

In the upcoming year, work on these products will not involve humans and thus
the Food and Drug Administration (FDA) will not be involved. However, the work
leading up to FDA submission will be performed under Good Laboratory Practices
(GLPs) in order to be acceptable for future presentation. Any work involving
animals will also fall under regulation by the entities described in the prior
"Animal Model Contracts" discussion.

COMPETITION
------------

      Animal Model Contracts
      ----------------------

The Company is classified as a "small business" in Government contracting
procedures. So long as the Company continues to qualify as a "small business,"
this classification effectively limits competition for several of the Company's
current research contracts to other "small businesses" in the Washington, D.C.
area. Other barriers to competition include the general requirement of location
in the D.C. area (to serve the NIH scientists) and the high capital costs to
establish animal holding facilities.

The Company's main "small business" competitors are Taconic Farms, BIOCON, ROW
Sciences, Priority One and MA Bioproducts.

The Company also competes on open contracts for animal research work and its
competitors at this level are Covance, ABL, Bionetics, Southern Research
Institute and universities.

Due to the specialized nature of the work and the facilities, relatively few
companies compete for contracts in small animal and nonhuman primate
applications. The Government generally selects winners among the competitors
through evaluation of the merit of the written technical proposals with price
being an important but not an overriding factor.

      Veterinary Products
      -------------------

Equine IgG, the Company's product which was introduced into the market in fiscal
year 1996, is a purified immunoglobulin sold as a lyophilized (freeze-dried)
product. Competing products currently on the market involve the use of
unpurified equine serum/plasma maintained in a liquid or frozen state (thawed
for use). Principal suppliers of these competing alternative products are
Veterinary Dynamics, Inc. and Sera, Inc.

EMPLOYEES
---------

At the end of fiscal year 1997, the Company employed 104 people (98 of which
were full-time) as follows: Diagnon general and administrative, 18 employees;
Research Blvd. Facility, 41 employees; and Medical Center Dr. Facility, 45
employees. The Company expects to encounter competition for the technical
management positions necessary for the Company's business, but there is an ample
labor pool of laboratory technicians, animal caretakers, support/maintenance
personnel and the like.

                                      -7-


<PAGE>



ITEM 2.  DESCRIPTION OF PROPERTY

The Company's current leases are as follows:

<TABLE>
<CAPTION>

Division/Facility                  Location                      Sq. Ft.         Exp. Date            Options
-----------------                  --------                      -------         ---------            -------
<S><C>
Diagnon                            Rockville, MD                  6,937          5/31/01
Res. Blvd. Fac.                    Rockville, MD                 30,000          5/31/01              5 years
Med. Ctr. Dr. Fac.                 Rockville, MD                 51,066          3/31/99              5 years
</TABLE>

ITEM 3. LEGAL PROCEEDINGS

None

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

Annual Meeting  -  October 16, 1996

Election of Directors

                  Four directors were elected:

                  J. Thomas August, M.D.
                  Charles C. Francisco
                  Charles F. Gauvin
                  John C. Landon, Ph.D.

There were no other directors whose term of office as a director continued after
the meeting.

Other Matters Voted Upon at the Meeting

                  PROPOSAL 2 To approve the appointment of Deloitte & Touche LLP
                  as independent public accountants for the Company.

                  Affirmative Votes                4,729,573
                  Negative Votes                       2,000
                  Abstain                              1,300


                                    PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The approximate number of holders of record of the Registrant's Common Stock on
July 23, 1997 was 1,000. The Registrant has paid no dividends with respect to
its Common Stock during the past five years, and does not anticipate doing so in
the near future. The Companys' Line-of-Credit Agreement requires that no
dividends be declared or paid until all obligations have been satisfied.

The Common Stock is traded in the over-the-counter market.

The following table sets forth, for the periods indicated, the high and low per
share closing bid prices for the Common Stock as advised to the Company by the
principal market maker in the Common Stock.

                                      -8-


<PAGE>


<TABLE>
<CAPTION>
                                                                      Bid or Closing Quotations*
                                                                      --------------------------
                           Fiscal Year                                     High          Low
                           -----------                                     ----          ---
<S><C>
                             1998
                           1st Quarter
                           (thru 7/23/97)                                  7/16           1/3

                             1997
                           4th Quarter                                    11/32          11/32
                           3rd Quarter                                     5/16           5/16
                           2nd Quarter                                     5/16           1/4
                           1st Quarter                                     1/4            1/4

                             1996
                           4th Quarter                                     1/4           1/4
                           3rd Quarter                                     9/32          1/4
                           2nd Quarter                                     5/16          3/16
                           1st Quarter                                    13/32          5/16
</TABLE>

*Prices are interdealer quotations and do not necessarily reflect retail
markups, markdowns or commissions, and may not necessarily represent actual
transactions.

The Company's Common Stock, $.01 par value per share, carries one vote per
share. There are no outstanding shares of preferred stock.

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR
         PLAN OF OPERATION

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

The Company currently has a $1,000,000 secured revolving line of credit with
First National Bank of Maryland. This line of credit is annually renewable and
the Company believes, although there is no assurance, that the line of credit
will be renewed in October, 1997. During the renewal process in October 1996,
the interest rate of the line of credit was reduced from the prime rate plus
 .75% to the prime rate plus .25%. As of May 31, 1997, there were $536,120 of
borrowings under this line of credit. In the opinion of the Company, total
current assets, the line of credit resources and the capital provided by future
operations will provide adequate liquidity and capital resources to maintain
operations.

The Company leases equipment under various capital leases which expire in fiscal
years 1999, 2000 and 2001. At May 31, 1997, the present value of the minimum
lease payments was $288,345.

The Company's revenues result primarily from Government CPFF and Fixed Price
contracts. Continued success in winning these contracts is essential to
maintaining liquidity and capital resources. Since the 1996 FORM 10-KSB report,
the Company has not been awarded any material new contracts.

During this fiscal year the Company completed an audit with the Financial
Advisory Services Branch of the National Institutes of Health and finalized its
indirect rates for fiscal years 1992 through 1995. The Company invoiced $179,484
of previously unbilled indirect rate variances during this fiscal year (the
invoices were paid on June 2, 1997). The results of the audit did not have a
material impact on the results of operations for this fiscal year.

                                      -9-


<PAGE>



Revenue generated by these costs had been recognized during the fiscal year in
which they were incurred.

Changes in Financial Position - 1997 versus 1996
------------------------------------------------

Assets

In the twelve months of operation in this fiscal year, Total Assets increased
$463,537. This amount is primarily attributable to an increase to Accounts
Receivable of $313,945 consisting mainly of 1) an increase of $314,694 to Trade
Accounts Receivable reflecting a slower collection rate compared to the previous
fiscal year end and the billing of $179,484 of previously unbilled indirect rate
variances from prior years, 2) a $23,323 decrease to Unbilled Accounts
Receivable primarily resulting from a $179,484 decrease in reimbursable indirect
rate variances as a result of the billing of previously unbilled variances from
prior fiscal years, a $94,602 increase in reimbursable indirect rate variances
for the current fiscal year and the $61,237 recording of unbilled contract fee
retention to be billed at the completion of the respective contracts, and 3) a
$22,574 increase in Other Accounts Receivable reflecting a $26,212 receivable
with the landlord of the Medical Center Dr. Facility, for reimbursement of a
facility improvement paid for by BIOQUAL. An increase in Fixed Assets, net of
Accumulated Depreciation and Amortization of $203,923, reflecting an increase in
fixed asset purchases of $465,141 (mainly nonhuman primate enclosures) offset by
depreciation and amortization of $261,218 during this fiscal year. Other
Noncurrent Assets increased $102,456 due to deposits for a nonhuman primate
housing unit order ($54,000) and a $48,456 increase in the cash value of
officers split dollar life insurance policies. The balance of the increase is
due to other miscellaneous factors.

The increases above were partially offset by:  a $155,905 decrease in Cash and
Cash Equivalents reflecting 1) the increase in Fixed Assets, 2) the increase in
Trade Receivables and 3) the costs associated with the continuing R&D efforts
related to certain cancer treatments, drug delivery approaches and immunotherapy
and clinical and pre-clinical trials of various purified IgG products.

Liabilities

In the twelve months of operation in this fiscal year, Total Liabilities
increased $458,982. This amount is primarily due to 1) a $536,120 increase in
Borrowings Under Line-of-Credit reflecting the increase in Fixed Assets, the
increase in Trade Receivables and the costs associated with the continuing R&D
efforts related to certain cancer treatments, drug delivery approaches and
immunotherapy and clinical and pre-clinical trials of various purified IgG
products, 2) an increase in Accounts Payable of $16,497, and 3) a $17,162
increase in Accrued Compensation and Related Costs. The balance of the increase
is due to other miscellaneous factors.

The increases above are partially offset by a decrease in Long-Term Debt of
$113,918 reflecting payments on capital leases.

On June 2, 1997, the Company received a wire transfer payment totalling $491,231
covering outstanding invoices of several contracts (this includes the $179,484
in prior year indirect rate variances mentioned previously). This payment was
applied to the outstanding balance of the line of credit. As of July 31, 1997,
over 98% of the May 31, 1997 Trade Receivables balance was collected.

                                      -10-


<PAGE>




Changes in Financial Position - 1996 versus 1995
------------------------------------------------

Assets

In the twelve months of operation in fiscal year 1996, Total Assets increased
$292,415. This amount was primarily attributable to an increase in Fixed Assets,
net of Accumulated Depreciation and Amortization of $304,360, reflecting an
increase in fixed asset purchases of $574,421 (mainly nonhuman primate
enclosures and an autoclave) offset by depreciation and amortization of $270,061
during fiscal year 1996. Inventories increased $52,755 as the Company continued
to produce equine IgG. The balance of the increase was due to other
miscellaneous factors.

The increases above were partially offset by: a decrease to Accounts Receivable
of $45,196 consisting mainly of 1) a $105,801 decrease to Unbilled Accounts
Receivable resulting from a $232,973 decrease in reimbursable indirect rate
variances as a result of collections of previously unbilled variances from prior
fiscal years and a $127,171 increase in the accrual of unbilled direct costs
that were billed in the subsequent fiscal year, and 2) an increase of $57,240 to
Trade Accounts Receivable. Other Noncurrent Assets decreased $28,677 primarily
due to the net result of the completion of a nonhuman primate housing unit order
($52,553) from the previous fiscal year and a $24,226 increase in the cash
surrender value of a $1,000,000 split dollar life insurance policy held by John
C. Landon, the President, and the Company.

Liabilities

In the twelve months of operation in fiscal year 1996, Total Liabilities
increased $200,217. This amount was primarily due to an increase in Long- Term
Debt of $176,376 related to capital leases of $289,614 for nonhuman primate
enclosures at the Research Boulevard Facility, offset by $113,238 of payments on
capital leases, and an increase in Accounts Payable of $18,926. The balance of
the decrease was due to other miscellaneous factors.

Results of Operations  - 1997 versus 1996
-----------------------------------------

Revenues

Contract revenues increased by 1.2% compared to the prior year primarily due to
increased contract activity. Product sales increased to $19,916 compared to
$7,189 in fiscal year 1996.

Operating Expenses

Contract expenses increased 1.6% compared to the prior year primarily due to an
increase in contract activity. The greater increase in contract expenses over
contract revenues are primarily due to total overhead expenses exceeding
reimbursable overhead expenses during the current fiscal year. Costs of Goods
Sold increased to $18,941 compared to $6,846 in the prior year. Research and
Development (R&D) Costs increased to $349,199 compared to $235,071 in the prior
year. This increase is primarily due to the increased costs incurred associated
with pre-clinical and clinical trials for the Company's various purified IgG
products and increased costs related to certain cancer treatment and drug
delivery approaches and immunotherapy (primarily research of Helicobacter
pylori). General and Administrative Expenses (G&A) decreased 2.0% compared to
the prior fiscal year. The

                                      -11-


<PAGE>



decrease is primarily due to a decrease in administrative salaries as a result
of the elimination of certain administrative positions.

Operating Income

Operating income decreased 52.6% compared to the prior year primarily due to
increased costs incurred associated with R&D expenses relating to certain cancer
treatments and drug delivery approaches and immunotherapy.

Interest Expense

For this fiscal year, Diagnon had interest expense of $49,320 compared to
$49,602 in the prior year.

Provision For Income Tax

In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
reported a deferred federal income tax benefit of $1,900 for the year ended May
31, 1997. The Company provided for state income tax which is estimated at
$32,800. State income tax expense is reimbursable under government contracting
regulations.

Results of Operations  - 1996 versus 1995
-----------------------------------------

Revenues

Contract revenues decreased by 6.8% compared to fiscal year 1995 primarily due
to decreased contract activity (two contracts ended at the end of fiscal year
1995 and the first quarter of this fiscal year respectively representing
approximately 13.4% of the prior fiscal year sales). Also affecting last fiscal
year's sales is approximately $34,700 of applied indirect costs on four
contracts which caused the total incurred costs of each contract to exceed its
funding. These indirect costs are currently not available for reimbursement and
therefore revenue cannot be recognized. According to Federal Acquisition
Regulations, the Company may be able to recover all or part of these costs after
a government indirect cost audit for this fiscal year 1996 has been completed.
The Company is currently attempting to enter into negotiations with the
government regarding these rate variances as well as rate variances from fiscal
years 1992 through 1995.

Operating Expenses

Contract expenses decreased 7.0% compared to fiscal year 1995 primarily due to a
decrease in contract activity (primarily the two expired contracts mentioned
above). Cost of Goods Sold was $6,846 for fiscal year 1996, the year the Company
began production of it's equine IgG product LyphomuneTM. Research and
Development expenses increased to $235,071 compared to $18,809 in fiscal year
1995. This increase reflects the hire of a molecular biologist (Dr. A. Welch)
and the beginning of the Company's research related to certain cancer treatment
and drug delivery approaches and increased efforts to develop certain other
purified IgG products. General and Administrative Expenses (G&A) decreased 8.2%
compared to fiscal year 1995. The decrease is primarily due to the net result of
fiscal year 1995 $119,000 write-off related to the termination of the agreements
between Diagnon and The Johns Hopkins University and increases in fiscal year
1996 expenses resulting from annual salary increases and the addition of a
full-time legal counsel. Also contributing to the net decrease was a reduction
of the use of outside legal counsel as compared to fiscal year 1995. The
combination of

                                      -12-


<PAGE>



these net decreases resulted in an overall decrease in operating expenses of
4.8%.

Operating Income

Operating income decreased 56.8% compared to fiscal year 1995 due to decreased
contract activity, costs incurred associated with the production of equine IgG,
R&D expenses relating to certain cancer treatment and drug delivery approaches,
and the "Blizzard of '96" as discussed in Form 10-KSB for the year ended May 31,
1996.

Interest Expense

For fiscal year 1996, Diagnon had interest expense of $49,602 compared to
$49,086 in the prior year.

Provision For Income Tax

In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
reported a deferred federal income tax benefit of $2,300 for the year ended May
31, 1996. The Company also provided for state income tax which is estimated at
$27,600. State income tax expense is reimbursable under government contracting
regulations.

Inflation and Price Changes for Fiscal Year
-------------------------------------------

For fiscal years 1995, 1996, and 1997 neither inflation nor price changes had
any material effect on net sales, revenues, or income from operations.

ITEM 7.  FINANCIAL STATEMENTS

Financial statements are listed in the Table of Contents on page 27 as Financial
Statements filed as part of this FORM 10-KSB.

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

None

                                    PART III

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

Set forth below is information with respect to the present directors, and
executive officers.

<TABLE>
<CAPTION>

NAME                                  DIRECTOR SINCE             AGE      POSITIONS
----                                  --------------             ---      ---------
<S><C>
John C. Landon, Ph.D.                      1986                  60       Chairman of the Board; President &
                                                                          Chief Executive Officer; Director

J. Thomas August, M.D.                     1982                  70       Director; Consultant; Scientific
                                                                          Advisor

Charles C. Francisco                       1991                  59       Director; Member of Compensation
                                                                          Committee; Member of Audit
                                                                          Committee
</TABLE>

                                      -13-


<PAGE>



<TABLE>

<S><C>
Charles F. Gauvin                          1992                  42       Director; Member of Compensation
                                                                          Committee; Member of Audit
                                                                          Committee

Michael P. O'Flaherty                                            59       Secretary; Chief Operating Officer

David A. Newcomer                                                36       Chief Financial Officer

Leanne DeNenno                                                   43       Vice President, BIOQUAL, Inc.
                                                                          (Subsidiary)

Richard P. Bradbury, DVM                                         62       Vice President, BIOQUAL, Inc.
                                                                          (Subsidiary)

Jerry R. Reel, Ph.D.                                             59       Vice President, BIOQUAL, Inc.
                                                                          (Subsidiary)
</TABLE>

Each director is elected to hold office until the next annual meeting of
stockholders and until his successor is elected and qualified.  Officers serve
at the discretion of the Board of Directors.

Dr. John C. Landon was elected President and Chief Executive Officer of the
Company in May, 1986 and has been Chairman of the Board since February, 1987.
Dr. Landon has been President of BIOQUAL, Inc. from January 1982 to the present.
Dr. Landon is also the President, Chief Executive Officer, Treasurer and a
Director of the Company's subsidiaries.  Dr. Landon's experience includes
positions with the National Cancer Institute and with Litton Industries as
Scientific Director of the Frederick Cancer Research Facility and as President
of EG&G Mason Research Institute.

Dr. J. Thomas August is a consultant to the Company, a principal stockholder and
a founder of the Company, as well as a Director. He is Professor and Director of
the Department of Pharmacology and Molecular Sciences at the Johns Hopkins
University School of Medicine, Baltimore, Maryland and has served in those
positions since 1976. Dr. August's previous experience includes positions as
Director of the Division of Biological Sciences and Chairman of the Department
of Molecular Biology at the Albert Einstein College of Medicine. He has also
held posts as a Research Fellow in Medicine at Harvard Medical School, as an
Instructor and Assistant Professor of Medicine at Stanford University School of
Medicine, and as an Associate Professor in Medicine (assigned to microbiology)
at the New York University School of Medicine.

Mr. Charles C. Francisco is President, CEO and a Director of Victoreen, Inc., a
manufacturer of radiation measuring instrumentation, located in Cleveland, Ohio.
From 1992 to 1995, he was a director of R. E. Wright & Associates, Inc. and
Environmental Restoration Systems, Inc., earth resources consultants and
pollution removal equipment makers, respectively.  For part of 1996, he was a
director of R.E. Wright Environmental, Inc., an SAIC company and successor to
R.E. Wright & Associates, Inc.

Mr. Charles F. Gauvin is the President and CEO of Trout Unlimited, a non-profit
organization dedicated to protection and conservation of trout and salmon and
their habitats, located in Arlington, Virginia. From 1986 - 1991, he was
associated with the law firm of Beveridge & Diamond, P.C. in Washington, D.C.,
where his practice included corporate and securities work for the Company.

                                      -14-


<PAGE>



Mr. Michael P. O'Flaherty joined the Company in June 1986, as a Vice President
of BIOQUAL.  Mr. O'Flaherty is currently the Chief Operating Officer and the
Secretary of the Company.  Mr. O'Flaherty's duties for the Company include most
functions of general management.

Mr. David A. Newcomer joined the Company in May, 1989 as the Acting Controller
of the Company.  Mr. Newcomer is currently the Chief Financial Officer of the
Company.  Mr. Newcomer's duties include managing the Company's financial
functions.

Ms. Leanne DeNenno has been an employee of Diagnon's subsidiary, BIOQUAL, Inc.,
since its inception in 1982. From that date to the present, she has been a
Project Manager on a major National Cancer Institute contract. In 1988, she was
named head of Animal Research Programs for BIOQUAL, Inc. and in 1991, she was
named Vice President in charge of the Medical Center Dr. Division of BIOQUAL,
Inc. and (in 1997) the Vice President of the Division of Laboratory Animal
Sciences.

Dr. Richard P. Bradbury, D.V.M., an American College of Laboratory Animal
Medicine Diplomate, joined the Company in 1989 as the Vice President of the
Company's subsidiary, SEMA, Inc. Since the 1991 merger of SEMA into BIOQUAL, Dr.
Bradbury has been the Vice President of BIOQUAL in charge of the Research Blvd.
Division and (in 1997) became the Vice President of the Division of Primate
Biology and Medicine.

Dr. Jerry R. Reel, Ph.D., an American Board of Toxicology Diplomate, joined the
Company in 1991 as Vice President, Science and (in 1997) became the Vice
President of the Division of Reproductive Endocrinology and Toxicology for
BIOQUAL. Prior to joining BIOQUAL, Dr. Reel had his own consulting company.

                                      -15-


<PAGE>



Item 10.  EXECUTIVE COMPENSATION

The following table sets forth information with respect to remuneration paid
during the last three fiscal years to the Chief Executive Officer of the Company
and other company officers whose compensation exceeded $100,000.

                           SUMMARY COMPENSATION TABLE

                              Annual Compensation

<TABLE>
<CAPTION>
                                                                                                            Other
                                                                                                            Annual
Name and Principal                                                    Salary             Bonus           Compensation
     Position                                           Year            ($)               ($)              ($)(1,2)
------------------                                      ----          ------             -----           ------------
<S><C>
John C. Landon                                          1997          160,000           101,863              32,723
                                                        ----
CEO, President, Chairman                                1996          160,000           116,946              32,723
                                                        ----
  of the Board                                          1995          160,000           139,963              32,723
                                                        ----

Michael P. O'Flaherty                                   1997          116,690            21,660              10,593
                                                        ----
Chief Operating Officer,                                1996          120,818            11,944              10,593
                                                        ----
  Secretary                                             1995          108,675            17,115               8,827
                                                        ----

Jerry R. Reel                                           1997          118,614             9,179
                                                        ----
Vice President, Bioqual, Inc.                           1996          109,481             2,949
                                                        ----
  (Subsidiary)                                          1995          110,636             3,405
                                                        ----

Richard P. Bradbury                                     1997           99,573             4,000
                                                        ----
Vice President, Bioqual, Inc.                           1996           99,205             3,102
                                                        ----
  (Subsidiary)                                          1995           91,504             1,160
                                                        ----
</TABLE>

-------------------
 (1) Other Annual Compensation for the CEO for the years 1997, 1996 and 1995
     represents premiums for a $1,000,000 Split Dollar Life Insurance Policy.

 (2) Other Annual Compensation for the Chief Operating Officer for the years
     1997, 1996 and 1995 represents premiums for a $250,000 Split Dollar Life
     Insurance Policy.

                    STOCK OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
                                                   Number of                 % of Total
                                                   Securities               Stock Options
                                                   Underlying                Granted to             Exercise
                                                  Stock Options             Employees in             Price           Expiration
          Name                                     Granted (#)              Fiscal Year              ($/Sh)             Date
-------------------------                         -------------             ------------            --------         ----------
<S><C>
John C. Landon                                       10,000 (1)                 10.3%               $.378125           7/29/01
CEO, President and
 Chairman of the Board

Michael P. O'Flaherty                                10,000 (1)                 10.3%                   $.42           5/30/07
Chief Operating Officer,
 Secretary

Jerry R. Reel                                         4,000 (1)                  4.1%                   $.42           5/30/07
Vice President, Subsidiary

Richard P. Bradbury                                   3,000 (1)                  3.1%                   $.42           5/30/07
Vice President, Subsidiary
</TABLE>

-------------------
  (1) All options reported in this table are fully exercisable.

                                      -16-


<PAGE>



AGGREGATED STOCK OPTION EXERCISES IN LAST FISCAL YEAR, AND FY-END OPTION VALUE

<TABLE>
<CAPTION>
                                                                                                                       Value of
                                                                                            Number of                Unexercised
                                                                                           Unexercised               In-the-Money
                                                     Shares                                  Options                   Options
                                                    Acquired                Value          at FY-End (#)             at FY-End ($)
                                                   on Exercise             Realized
           Name                                        (#)                   ($)            Exercisable               Exercisable
--------------------------                         -----------             --------        -------------             ------------
<S><C>
John C. Landon                                                                             150,000 (1,2)                    N/A
CEO, President,                                                                             10,000 (1)                      438
 Chairman of the Board

Michael P. O'Flaherty                                                                       95,000 (1)                   14,114
Chief Operating Officer,                                                                    10,000 (1,2)                    N/A
 Secretary

Jerry R. Reel                                                                                7,000 (1)                      373
Vice President, Subsidiary                                                                   4,000 (1,2)                    N/A

Richard P. Bradbury                                                                         10,000 (1)                    1,959
Vice President, Subsidiary                                                                   4,000 (1,2)                    N/A
</TABLE>

-------------------
 (1)  All options reported in the table are fully exercisable.
 (2)  All options are out-of-the-money.

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

Compensation of Directors
-------------------------

During fiscal year 1997, the Company paid to Directors:

<TABLE>
<CAPTION>
                                                                Attendance of
                                                                Board Meetings                       Travel to
                                          Directors            and Consultation                    Board Meetings
                                           Fees ($)                Fees ($)                         Expenses ($)
                                          ---------            ----------------                    -------------
<S><C>
J. Thomas August, M.D.                      4,000                   11,500                               100
Charles C. Francisco                        4,000                    1,500                               627
Charles F. Gauvin                           4,000                    1,500                               -0-
</TABLE>

Messrs. Francisco, August and Gauvin have agreements with the Company extending
through the term of their election. The agreements for Messrs. Francisco, August
and Gauvin provide for quarterly payments of $1,000 each as directors fees and
payments of $500 each for attendance at Board of Director meetings. The
agreement for Dr. August also provides payments of $2,500 per quarter for
services rendered to the Company as Scientific Adviser. The Company also
reimburses Company related travel expenses incurred by any of the directors.

                                      -17-


<PAGE>



Employment Contracts
--------------------

Dr. Landon had an employment agreement with the Company which expired May 31,
1996, subsequently, the Board of Directors extended the agreement until May 31,
1997 at the same terms and conditions. Pursuant to this agreement, Dr. Landon's
base compensation was $160,000 per year. The agreement provided for various
additional incentive compensation dependent upon the results of the Company's
operations each year through the term of employment. Currently, the Compensation
Committee of the Board of Directors is negotiating a new employment agreement
with Dr. Landon.

COMPENSATION PURSUANT TO PLANS

Stock Option Plan - The Company adopted a Stock Option Plan (the "Plan") in
November 1988 which permits the granting of options to all employees to purchase
up to an aggregate of ten percent of the outstanding shares of Common Stock. The
Plan is designed to qualify as an "incentive stock option plan" under Section
422 of the Internal Revenue Code, but also permits the Company to grant
nonqualified options to persons, such as consultants and outside directors.
Under the Plan, options to purchase shares of Common Stock are granted at not
less than 100% of the fair market value of the underlying shares on the date
granted. The Plan is administered by a committee of the Board of Directors,
which has the authority to select optionees, evaluate suggestions presented by
the Company in order to determine the number of options to be granted to the
selected optionees, designate the number of shares to be covered by each option
and, subject to certain restrictions, specify other terms of the options. During
fiscal year 1997, the committee was comprised of Messrs. Gauvin and Francisco.

As of May 31, 1997, the following options to the officers and directors were
outstanding:

<TABLE>
<CAPTION>
                                                                    Percentage           Option                Date
           Name            Service                Shares             of Total            Price                Granted
           ----            -------                ------            ----------           ------               -------
<S><C>
John C. Landon             CEO, President,        150,000              34.2%             $ .4469              1/19/94
                           Director,               10,000               2.3%             $ .378125            7/29/96
                             Chairman
Michael P. O'Flaherty      Chief Operating         45,000              10.3%             $ .3125             12/30/88
                             Officer,              20,000               4.6%             $ .25               10/26/89
                             Secretary             15,000               3.4%             $ .08                 2/8/90
                                                    5,000               1.1%             $ .30                8/14/92
                                                   10,000               2.3%             $ .5625               6/5/95
                                                   10,000               2.3%             $ .42                5/30/97
Richard Bradbury           Vice President,          5,000               1.1%             $ .08                 2/8/90
                             BIOQUAL                2,000                .5%             $ .30                8/14/92
                                                    4,000                .9%             $ .5625               6/5/95
                                                    3,000                .7%             $ .42                5/30/97
Leanne DeNenno             Vice President,          5,000               1.1%             $ .08                 2/8/90
                             BIOQUAL                2,000                .5%             $ .30                8/14/92
                                                    4,000                .9%             $ .5625               6/5/95
                                                    3,000                .7%             $ .42                5/30/97
Jerry Reel                 Vice President,          3,000                .7%             $ .30                8/14/92
                             BIOQUAL                4,000                .9%             $ .5625               6/5/95
                                                    4,000                .9%             $ .42                 5/30/97
David A. Newcomer          Chief Financial          4,000                .9%             $ .08                 2/8/90
                             Officer                2,000                .5%             $ .30                 8/14/92
                                                    4,000                .9%             $ .5625               6/5/95
                                                    6,000               1.3%             $ .42                 5/30/97
Charles C. Francisco       Director                10,000               2.3%             $ .09                 8/14/92
                                                   10,000               2.3%             $ .34375              7/29/96
Charles F. Gauvin          Director                10,000               2.3%             $ .30                 8/14/92
                                                   10,000               2.3%             $ .34375              7/29/96
J. Thomas August           Director                10,000               2.3%             $ .34375              7/29/96
All officers and                                  370,000              84.5%             $ .08 to              12/30/88 to
directors as a group                                                                     $ .5625               5/30/97
(9 persons)
</TABLE>
                                      -18-


<PAGE>




A total of 438,000 options were granted and outstanding at May 31, 1997. No
options have been exercised to date, however all options are exercisable. Of the
options granted, 408,000 are from the 1988 Stock Option Plan (described herein)
which was established for a ten year period beginning November 17, 1988. Options
to purchase 30,000 shares of common stock were granted outside the plan.

The options granted from the 1988 Plan are effective for a ten year period from
the date of grant, with the exception of John C. Landon whose option for 150,000
shares expires January 19, 1999.

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Security ownership of certain beneficial owners
-----------------------------------------------

The following table sets forth information as of July 23, 1997, with respect to
the stock ownership of all holders of 5% or more of the Company's Common Stock.

<TABLE>
<CAPTION>

Name and Address                                Number of Shares                    Percentage (1)
----------------                                ----------------                    --------------
<S><C>
Dr. John C. Landon
8213 Raymond Lane
Potomac, MD  20854                              1,208,092 (2),(3)                        21.74

S. David Leibowitt
2295 South Ocean Blvd.
Palm Beach, FL  33480                             598,840 (4)                            11.09

Dr. J. Thomas August
905 Poplar Hill Road
Baltimore, MD  21210                            1,022,140 (5)                            18.90

Carole Knieter Bishop
100 W. 57th Street
New York, New York  10019                         363,040                                 6.73
</TABLE>

           (1)      Assumes the exercise by such person or persons of the
                    currently exercisable options and does not give effect to
                    any shares issuable upon exercise by any other person or
                    persons of options.

           (2)      Includes 54,330 shares in the names of members of Dr.
                    Landon's family.

           (3)      Assumes the exercise of currently exercisable options to
                    purchase 160,000 shares.

           (4)      Includes 30,000 shares in the name of S. David Leibowitt's
                    spouse.

           (5)      Assumes the exercise of currently exercisable options to
                    purchase 10,000 shares.

Security ownership of management
--------------------------------

The following table sets forth information as of July 23, 1997, with respect to
the stock ownership of all: directors; executive officers included in the
Summary Compensation Table on page 16; directors and officers as a group, of the
Company's Common Stock.

                                      -19-


<PAGE>



<TABLE>
<CAPTION>

Name and Address                                Number of Shares                    Percentage (1)
----------------                                ----------------                    --------------
<S><C>
Dr. John C. Landon
8213 Raymond Lane
Potomac, MD  20854                              1,208,092 (2),(3)                        21.74

Charles C. Francisco
25 Ridge Creek Trail
Moreland Hills, OH  44022                          20,000 (4)                              .37

Dr. J. Thomas August
905 Poplar Hill Road
Baltimore, MD  21210                            1,022,140 (5)                            18.90

Charles F. Gauvin
4100 Hamilton Street
Hyattsville, MD  20781                             20,000 (6)                              .37

Michael P. O'Flaherty
1213 Bradfield Drive
Leesburg, VA  22075                               109,000 (7)                             1.98

Dr. Jerry R. Reel
933 Hillside Lake Terrace
Gaithersburg, MD  20878                            11,000 (8)                              .20

Dr. Richard P. Bradbury
16708 Briardale Road
Rockville, MD  20855                               14,000 (9)                              .26

All executive officers
and directors (7, of
whom all beneficially
own shares) as a group                          2,404,232 (10)                           41.90
</TABLE>

           (1)      Assumes the exercise by such person or persons of the
                    currently exercisable options owned by him or them and does
                    not give effect to any shares issuable upon exercise by any
                    other person or persons of options.

           (2)      Includes 54,330 shares in the names of members of Dr.
                    Landon's family, as to which he retains beneficial
                    ownership.

           (3)      Assumes the exercise of currently exercisable options to
                    purchase 160,000 shares.

           (4)      Assumes the exercise of currently exercisable options to
                    purchase 20,000 shares.

           (5)      Assumes the exercise of currently exercisable options to
                    purchase 10,000 shares.

           (6)      Assumes the exercise of currently exercisable options to
                    purchase 20,000 shares.

           (7)      Assumes the exercise of currently exercisable options to
                    purchase 105,000 shares.

                                      -20-


<PAGE>




           (8)      Assumes the exercise of currently exercisable options to
                    purchase 11,000 shares

           (9)      Assumes the exercise of currently exercisable options to
                    purchase 14,000 shares.

           (10)     See Notes (2) through (9) above.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

On June 1, 1988 the Company and Dr. Landon agreed to consolidate the previous
loan facilities available to Dr. Landon into a single loan of $100,000. The loan
had a five year term with repayment of principal deferred for three years. The
loan bears interest at the six month certificate of deposit rate paid by Signet
Bank, Maryland and the rate is adjusted quarterly. On September 29, 1989 the
Company agreed to increase the loan to $125,000. On September 21, 1990, the
Company agreed to increase the loan to $150,000. Pursuant to Dr. Landon's
current employment agreement, the loan was to be repaid in five installments of
$30,000 plus interest within six weeks after the end of each of the next five
fiscal years beginning with fiscal year 1992.

The largest amount owed by Dr. Landon during the fiscal year ended May 31, 1997
in respect to his loan facilities was $90,000, excluding interest accrued
amounting to $13,005. There was no addition to the loan during this fiscal year.
On July 1, 1994, Dr. Landon made a payment of $2,745 on accrued interest. On
June 6, 1994, the Company agreed to defer Dr. Landon's third $30,000 repayment
and make the payment due as two $15,000 installments paid with the fourth and
fifth $30,000 repayments respectively. On October 11, 1995, the Company's
shareholders affirmatively voted to approve the purchase of Company stock from
Dr. Landon at market value to fund the repayment by Dr. Landon of the remainder
of the Company loan. On October 16, 1996 the Board of Directors affirmatively
voted to extend the due date of the loan, maintaining all other terms and
conditions, until October 31, 1998. As of July 23, 1997, neither the stock
purchase or the loan repayment transaction have occurred.

ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

                (a)     See Table of Contents to Financial Statements, on page
                        27.

                (b)     The Registrant filed no reports on FORM 8-K during the
                        final quarter of its fiscal year ended May 31, 1997.

                (c)     Exhibits filed (Exhibits incorporated by reference
                        listed separately.)

                        (21)       List of Subsidiaries

                        Exhibits incorporated by reference to the Company's FORM
                        10-KSB for the fiscal year ended May 31, 1997 (filed
                        with the Company's FORM 10-QSB for the quarter ended
                        August 31, 1996).

                        (10)       1. Agreement of Sale by and between ZooQuest
                                      Technologies, LTD. and Diagnon
                                      Corporation.

                                      -21-


<PAGE>



                        Exhibits incorporated by reference to the Company's
                        Registration Statement No. 2-83803.

                        (3)      (a)  Amended and Restated Certificate of
                                     Incorporation.

                                 (b)  By-laws.

                        (4)      Stock certificate representing shares of Common
                                 Stock.

                        Exhibits incorporated by reference to the Company's FORM
                        10-K for the fiscal year ended May 31, 1986.

                        (3)      Amendment dated April 15, 1986 to Certificate
                                 of Incorporation.

                        (10)     (a)  Agreement of Sale dated February 28, 1986
                                      between Meloy Laboratories, Inc. and SEMA,
                                      Inc.

                                 (b)  Stock Purchase Agreement dated May 30,
                                      1986 between BIOQUAL, Inc. and Diagnon
                                      Corporation.

                        Exhibits incorporated by reference to the Company's FORM
                        10-K for the fiscal year ended May 31, 1989.

                        (3)      Amendments dated April 7, 1989 to Certificate
                                 of Incorporation.

                        (10) (a) The Company's 1988 Stock Option Plan, adopted
                                 November 17, 1988.

                        Exhibits incorporated by reference to the Company's FORM
                        10-K for the fiscal year ended May 31, 1990.

                        (10)     Government Contracts.

<TABLE>

<S><C>
                                 1.   Title:                   Facility for Animal Models Utilized
                                                               for Viral Hepatitis Research
                                      Institute:               National Institute of Allergy
                                                               and Infectious Diseases
                                      Dates Funded:            12/28/89 - 12/27/94

                                 2.   Title:                   Care and Housing of AIDS Research
                                                               Animals
                                      Institute:               National Institute of Allergy and
                                                               Infectious Diseases
                                      Dates Funded:            1/1/90 - 1/18/95

                                 3.   Title:                   Facility for Nonhuman Primates Utilized
                                                               in Infectious Disease Research
                                      Institute:               National Institute of Allergy
                                                               and Infectious Diseases
                                      Dates Funded:            1/1/90 - 12/30/94
</TABLE>


                                      -22-


<PAGE>

<TABLE>

<S><C>

                                       4.   Title:             Mouse Breeding Facility
                                            Institute:         National Institutes of Allergy
                                                               and Infectious Diseases
                                            Dates Funded:      1/1/90 - 5/31/95

                        Exhibits incorporated by reference to the Company's FORM
                        10-K for the fiscal year ended May 31, 1991.

                        (10)           Government Contracts.

</TABLE>
<TABLE>

<S><C>
                                       1.   Title:                   SIV Rhesus Macaque Model for Pediatric
                                                                     AIDS
                                            Institute:               National Institute of Mental Health
                                            Dates Funded:            11/7/90 - 6/30/95

                                       2.   Title:                   Transplacental Carcinogenesis and Tumor
                                                                     Promotion in Old World Monkeys
                                            Institute:               National Cancer Institute
                                            Dates Funded:            12/19/90 - 12/18/95

                                       3.   Title:                   Biological Testing Facility
                                            Institute:               National Institute of Child Health and
                                                                     Human Development
                                            Dates Funded:            6/1/91 - 5/31/96
</TABLE>

                        Exhibits incorporated by reference to the Company's FORM
                        10-K for the fiscal year ended May 31, 1992.

                        (10) (a) Leases.

                                 1. Medical Center Drive Facility
                                 2. Research Boulevard Facility

                             (b) Employment Agreement dated January 23, 1991
                                 between John C. Landon and Diagnon Corporation.

                        Exhibits incorporated by reference to the Company's FORM
                        10-KSB for the fiscal year ended May 31, 1994.

                        (10)     Government Contracts.

<TABLE>

<S><C>
                                       1. Title:                     Facility for Preparing and Housing
                                                                     Virus Infected Mice, Genetically
                                                                     Manipulated Mice, and Chimeric Mice.
                                          Institute:                 National Cancer Institute
                                          Dates Funded:              10/1/93 - 9/30/97

                                       2. Title:                     Maintenance of an Animal Holding and
                                                                     Breeding Facility and Provision of
                                                                     Attendant Research Services.
                                          Institute:                 National Cancer Institute
                                          Dates Funded:              11/1/93 - 10/31/97

                                       3. Title:                     Provide Animal Housing/Maintenance/
                                                                     Bleeds/Immunizations as Specified
                                                                     Herein.
</TABLE>

                                      -23-


<PAGE>


<TABLE>

<S><C>
                                          Institute:                 National Institute of Diabetes and
                                                                     Digestive and Kidney Diseases

                                          Dates Funded:              2/21/92 - 2/20/97

                                       4. Title:                     Development of Transgenic Mouse Models
                                                                     for HIV Drug Testing
                                          Institute:                 National Institute of Dental Research
                                          Dates Funded:              6/28/94 - 6/27/97

                        Exhibits incorporated by reference to the Company's FORM
                        10-KSB for the fiscal year ended May 31, 1995 (filed
                        with the Company's FORM 10-QSB's during the fiscal year
                        ended May 31, 1995).

                        (10)           (a)                           Option and Pre-Incorporation Agreement
                                                                     dated March 25, 1994 between Johns
                                                                     Hopkins University, Diagnon
                                                                     Corporation, and Slusser Associates,
                                                                     Inc.

                                       (b)                           First Amendment to Option and Pre-
                                                                     Incorporation Agreement dated June 8,
                                                                     1994.

                                       (c)                           Second Amendment to Option and Pre-
                                                                     Incorporation Agreement dated June 29,
                                                                     1994.

                                       (d)                           Service Agreement dated July 1, 1994
                                                                     between Enhanced Therapeutics, Inc. and
                                                                     Diagnon Corporation.

                                       (e)                           Stockholders' Agreement of Enhanced
                                                                     Therapeutics, Inc. dated July 1, 1994.

                                       (f)                           Licensing and Manufacturing Agreement
                                                                     dated January 12, 1995 between ZooQuest
                                                                     Technologies Ltd., Inc., Equilab
                                                                     Associates, Inc., and Diagnon
                                                                     Corporation.

                                       (g)                           Government Contracts.

                                            1.       Title:          Care and Housing of Research
                                                                     Animals for Hepatitis Studies.
                                                     Institute:      National Institute of Allergy
                                                                     and Infectious Diseases
                                                     Dates Funded:   12/28/94 - 12/27/99

                                            2.       Title:          Facility for Non-Human Primates
                                                                     Utilized in Infectious Disease
                                                                     Research.
                                                     Institute:      National Institute of Allergy
                                                                     and Infectious Diseases
                                                     Dates Funded:   12/31/94 - 12/30/99
</TABLE>

                                      -24-


<PAGE>


<TABLE>

<S><C>
                                            3.       Title:          Care and Housing of SIV Infected
                                                                     Research Animals.
                                                     Institute:      National Institute of Allergy
                                                                     and Infectious Diseases
                                                     Dates Funded:   1/19/95 - 1/18/00

                                            4.       Title:          Development of New Methods and
                                                                     Strategies for Diagnosis,
                                                                     Treatment, and Prevention of
                                                                     Invasive Fungal Infection in
                                                                     Patients with Cancer and HIV
                                                                     Infection.
                                                     Institute:      National Cancer Institute
                                                     Dates Funded:   10/1/94 - 9/30/99

                                            5.       Title:          Studies Using Primate Models for
                                                                     AIDS Vaccine Research.
                                                     Institute:      National Cancer Institute
                                                     Dates Funded:   11/30/94 - 11/29/98

                        Exhibits incorporated by reference to the Company's FORM
                        10-KSB for the fiscal year ended May 31, 1996

                        (10)           Government Contracts.

                                        1.      Title:               Biological Testing
                                                                     Facility.
                                                Institute:           National Institute of Child
                                                                     Health and Human
                                                                     Development
                                                Dates Funded:        7/1/96 - 6/30/01

                        Exhibits incorporated by reference to the Company's FORM
                        10-KSB for the fiscal year ended May 31, 1996 (filed
                        with the Company's FORM 10-QSB for the quarter ended
                        November 30, 1995).

                        (10)            Government Contracts.

                                        1.      Title:               MAO/Evaluation of AIDS
                                                                     Vaccines in Non-Human
                                                                     Primates.
                                                Institute:           National Institute of
                                                                     Allergy and Infectious
                                                                     Diseases
                                                Dates Funded:        9/30/95 - 11/15/97

                                        2.      Title:               Mechanisms of Chemical
                                                                     Carcinogenesis in Old World
                                                                     Monkeys.
                                                Institute:           National Cancer Institute
                                                Dates Funded:        12/19/95 - 12/18/00
</TABLE>

                                      -25-


<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 Annual Report to be signed on
its behalf by the undersigned thereunto duly authorized on August 28, 1997.

                                   DIAGNON CORPORATION

                                   /s/ John C. Landon
                                   --------------------------
                                   BY:  John C. Landon
                                        Chairman of the Board
                                        President 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 Registrant in
the capacities and on the dates indicated.

Signature                        Title                               Date
---------                        -----                               ----
                                 Chairman of the
                                 Board, President and
                                 Director (Chief Executive
/s/ John C. Landon               Officer)                           8/28/97
---------------------
John C. Landon, Ph.D.

/s/ J. Thomas August             Director                           8/28/97
---------------------
J. Thomas August M.D.

/s/ Charles C. Francisco         Director                           8/28/97
------------------------
Charles C. Francisco

/s/ Charles F. Gauvin            Director                           8/28/97
---------------------
Charles F. Gauvin

/s/ Michael P. O'Flaherty        Chief Operating Officer
-------------------------        and Secretary                      8/28/97
Michael P. O'Flaherty

/s/ David A. Newcomer            Chief Financial Officer            8/28/97
---------------------
David A. Newcomer

                                      -26-


<PAGE>




                      DIAGNON CORPORATION AND SUBSIDIARIES
                      ------------------------------------

                   TABLE OF CONTENTS TO FINANCIAL STATEMENTS
                   -----------------------------------------

Independent Auditors' Report.....................................  28

Financial Statements:
     Consolidated Balance Sheets, May 31, 1997 and 1996..........  29

     Statements of Consolidated Operations for each of the
     years in the three year period ended May 31, 1997...........  30

     Statements of Consolidated Cash Flows for each of the years
     in the three year period ended May 31, 1997.................  31

     Statements of Consolidated Stockholders' Equity for each
     of the years in the three year period ended May 31, 1997 ...  32

     Notes to Financial Statements...............................  33

Other financial statement schedules are omitted because they are not applicable
or required.

                                      -27-


<PAGE>




DELOITTE & TOUCHE LLP
2 Hopkins Plaza
Baltimore, Maryland 21201-2983
Telephone: (410) 576-6700
Facsimile: (410) 837-0510
ITT Telex: 4995614

INDEPENDENT AUDITORS' REPORT

Diagnon Corporation:

We have audited the accompanying consolidated balance sheets of Diagnon
Corporation and Subsidiaries as of May 31, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the years in the three year period ended May 31, 1997. These financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Diagnon Corporation and
Subsidiaries at May 31, 1997 and 1996, and the results of their operations and
their cash flows for each of the years in the three year period ended May 31,
1997 in conformity with generally accepted accounting principles.

/s/  Deloitte & Touche LLP
Deloitte & Touche LLP
July 30, 1997

                                      -28-


<PAGE>



DIAGNON CORPORATION AND SUBSIDIARIES
------------------------------------
CONSOLIDATED BALANCE SHEETS, MAY 31, 1997 AND MAY 31, 1996
----------------------------------------------------------

<TABLE>
<CAPTION>

ASSETS                                                                             1997                            1996
------                                                                        --------------                  --------------
<S><C>
CURRENT ASSETS:
Cash and cash equivalents                                                     $       62,638                  $      218,543
Accounts receivable:
  Trade                                                                            1,245,292                         930,598
  Unbilled                                                                           598,922                         622,245
  Other                                                                               49,999                          27,425
Prepaid expenses                                                                      76,444                          71,432
Inventories                                                                           44,961                          52,755
Deferred income taxes - current                                                       50,000                          49,000
                                                                              --------------                  --------------
Total current assets                                                               2,128,256                       1,971,998
                                                                              --------------                  --------------
LOANS TO OFFICERS                                                                     90,000                          90,000
                                                                              --------------                  --------------
FIXED ASSETS:
Leasehold improvements                                                               670,899                         543,735
Furniture, fixtures and equipment                                                  2,985,508                       2,647,531
                                                                              --------------                  --------------
Total                                                                              3,656,407                       3,191,266
Less accumulated depreciation
  and amortization                                                                 2,182,091                       1,920,873
                                                                              --------------                  --------------
Fixed assets, net                                                                  1,474,316                       1,270,393
                                                                              --------------                  --------------
DEFERRED INCOME TAXES - NONCURRENT                                                   797,400                         796,500
OTHER NONCURRENT ASSETS                                                              204,549                         102,093
                                                                              --------------                  --------------
TOTAL                                                                         $    4,694,521                  $    4,230,984
                                                                              ==============                  ==============

LIABILITIES
-----------
CURRENT LIABILITIES:
Borrowings under line of credit                                               $      536,120
Current maturities of long-term debt                                                 124,153                  $      113,918
Accounts payable                                                                     250,767                         234,270
Accrued compensation and related costs                                               292,956                         275,794
Accrued income taxes                                                                   5,543                           3,560
Other accrued liabilities                                                             12,641                          11,503
                                                                              --------------                  --------------
Total current liabilities                                                          1,222,180                         639,045
LONG-TERM DEBT                                                                       164,192                         288,345
                                                                              --------------                  --------------
Total liabilities                                                                  1,386,372                         927,390
                                                                              --------------                  --------------

STOCKHOLDERS' EQUITY
Convertible preferred stock - par value of $1.00 per
share, 325,000 shares authorized; no shares issued
and outstanding
Common stock - par value of $.01 per share;
25,000,000 shares authorized; 9,602,452 shares
issued; 5,398,244 shares outstanding                                                  96,024                          96,024
Additional paid-in capital                                                         7,395,015                       7,395,015
Accumulated deficit                                                               (3,555,533)                     (3,560,088)
                                                                              --------------                  --------------
Total                                                                              3,935,506                       3,930,951
Less - treasury stock 4,204,208 shares, at cost                                     (627,357)                       (627,357)
                                                                              --------------                  --------------
Total stockholders' equity                                                         3,308,149                       3,303,594
                                                                              --------------                  --------------
TOTAL                                                                         $    4,694,521                  $    4,230,984
                                                                              ==============                  ==============
</TABLE>

See notes to financial statements.

                                      -29-


<PAGE>



DIAGNON CORPORATION AND SUBSIDIARIES
------------------------------------
STATEMENTS OF CONSOLIDATED OPERATIONS FOR EACH OF THE YEARS
-----------------------------------------------------------
IN THE THREE YEAR PERIOD ENDED MAY 31, 1997
-------------------------------------------

<TABLE>
<CAPTION>
                                                                  1997                       1996                       1995
                                                               ----------                 ----------                 ----------
<S><C>
REVENUES AND SALES:
  Contract revenues                                            $8,919,294                 $8,812,776                 $9,459,667
  Product sales                                                    19,916                      7,189                      1,392
                                                               ----------                 ----------                 ----------
  Total Revenues and Sales                                      8,939,210                  8,819,965                  9,461,059
                                                               ----------                 ----------                 ----------

OPERATING EXPENSES:
  Contract                                                      6,886,440                  6,777,791                  7,288,220
  Cost of goods sold                                               18,941                      6,846
  Research and development                                        349,199                    235,071                     18,809
  General and administrative                                    1,610,012                  1,642,875                  1,789,357
                                                               ----------                 ----------                 ----------
  Total Operating Expenses                                      8,864,592                  8,662,583                  9,096,386
                                                               ----------                 ----------                 ----------

OPERATING INCOME                                                   74,618                    157,382                    364,673

INTEREST INCOME                                                    10,157                      9,718                      7,743
INTEREST EXPENSE                                                  (49,320)                   (49,602)                   (49,086)
                                                               ----------                 ----------                 ----------

INCOME BEFORE INCOME TAX                                           35,455                    117,498                    323,330

PROVISION FOR INCOME TAX                                          (30,900)                   (25,300)                  (201,900)
                                                               ----------                 ----------                 ----------

NET INCOME                                                     $    4,555                 $   92,198                 $  121,430
                                                               ==========                 ==========                 ==========

INCOME PER SHARE                                               $     0.00                 $     0.02                 $     0.02
                                                               ==========                 ==========                 ==========

WEIGHTED AVERAGE NUMBER OF
  SHARES OUTSTANDING                                            5,398,244                  5,398,244                  5,398,244
                                                               ==========                 ==========                 ==========
</TABLE>

See notes to financial statements.

                                      -30-


<PAGE>



DIAGNON CORPORATION AND SUBSIDIARIES
------------------------------------
STATEMENTS OF CONSOLIDATED CASH FLOWS FOR EACH OF THE YEARS
-----------------------------------------------------------
IN THE THREE YEAR PERIOD ENDED MAY 31, 1997
-------------------------------------------

<TABLE>
<CAPTION>
                                                                           1997                 1996                1995
                                                                        ----------           ----------          ----------
<S><C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net Income                                                             $    4,555           $  92,198           $  121,430
                                                                        ----------           ---------           ----------
  Adjustments to reconcile net income to net cash
    (used for) provided by operating activities:
    Depreciation and amortization                                          261,218             271,763              328,254
    Deferred income taxes                                                   (1,900)             (2,300)             181,900
    (Increase) decrease in accounts receivable                            (313,945)             45,196               65,908
    Increase in prepaid expenses                                            (5,012)               (919)             (12,257)
    Decrease (increase) in inventories                                       7,794             (52,755)
    (Increase) decrease in other assets                                   (102,456)             28,677              (90,386)
    Decrease in accounts payable and accrued expenses                       34,797              20,583                3,546
    Increase (decrease) in income taxes payable                              1,983               3,258              (10,940)
    Decrease in deferred income                                                                                     (86,579)
                                                                        ----------           ---------           ----------
      Total Adjustments                                                   (117,521)            313,503              379,446
                                                                        ----------           ---------           ----------

 NET CASH (USED FOR) PROVIDED BY OPERATING ACTIVITIES                     (112,966)            405,701              500,876
                                                                        ----------           ---------           ----------
CASH FLOWS USED FOR INVESTING ACTIVITIES:
 Capital expenditures                                                     (465,141)           (284,777)            (126,263)
 Decrease in loans to officers                                                                                       10,000
                                                                        ----------           ---------           ----------
 NET CASH USED FOR INVESTING ACTIVITIES                                   (465,141)           (284,777)            (116,263)
                                                                        ----------           ---------           ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
 Net proceeds (payments) under line-of-credit agreement                    536,120                                 (154,967)
 Principal payments under capital lease obligations                       (113,918)           (113,268)             (75,715)
 Other                                                                                                                 (350)
                                                                        ----------           ---------           ----------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES                       422,202            (113,268)            (231,032)
                                                                        ----------           ---------           ----------
NET DECREASE IN CASH AND CASH EQUIVALENTS                                 (155,905)              7,656              153,581
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                           218,543             210,887               57,306
                                                                        ----------           ---------           ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD                              $   62,638           $ 218,543           $  210,887
                                                                        ==========           =========           ==========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

 Cash paid during the period for:
  Interest                                                              $   46,988           $  50,496           $   49,415
                                                                        ==========           =========           ==========
  Income taxes                                                          $   25,600           $  24,470           $   30,954
                                                                        ==========           =========           ==========

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:

  The Company issued:
   Long-term debt issued in connection with capital
    leases                                                                                   $ 289,644           $  202,108
</TABLE>

See notes to financial statements.

                                      -31-


<PAGE>




DIAGNON CORPORATION AND SUBSIDIARIES
------------------------------------
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY FOR EACH OF THE YEARS
---------------------------------------------------------------------
IN THE THREE YEAR PERIOD ENDED MAY 31, 1997
-------------------------------------------

<TABLE>
<CAPTION>
                               COMMON STOCK                                                                 TREASURY STOCK
                         -------------------------                                                  ------------------------------
                                                             ADDITIONAL
                           NUMBER OF          PAR             PAID-IN          ACCUMULATED          NUMBER OF              AT
                            SHARES           VALUE            CAPITAL            DEFICIT             SHARES               COST
                           ---------         -----           ----------        -----------          ---------             ----
<S><C>
BALANCE, JUNE 1, 1994      9,602,452        $ 96,024        $ 7,395,015        $(3,773,716)         (4,204,208)        $ (627,357)

NET INCOME                                                                         121,430
                           ---------        --------        -----------        -----------          ----------         ----------

BALANCE, MAY 31, 1995      9,602,452          96,024          7,395,015         (3,652,286)         (4,204,208)          (627,357)

NET INCOME                                                                          92,198
                           ---------        --------        -----------        -----------          ----------         ----------

BALANCE, MAY 31, 1996      9,602,452          96,024          7,395,015         (3,560,088)         (4,204,208)          (627,357)

NET INCOME                                                                           4,555
                           ---------        --------        -----------        -----------          ----------         ----------
BALANCE, MAY 31, 1997      9,602,452        $ 96,024        $ 7,395,015        $(3,555,533)         (4,204,208)        $ (627,357)
                           =========        ========        ===========        ===========          ==========         ==========
</TABLE>

See notes to financial statements.

                                      -32-


<PAGE>



DIAGNON CORPORATION AND SUBSIDIARIES
------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Consolidation
-------------

The accompanying consolidated financial statements include the accounts of
Diagnon Corporation (the "Company") its wholly-owned subsidiaries, BIOQUAL, Inc.
and Enhanced Therapeutics, Inc.  All significant intercompany transactions and
balances are eliminated in consolidation.

Segment Information
-------------------

The Company's principal business consists of the government contract research
operations.

Use of Estimates
----------------

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities 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.

Fixed Assets and Depreciation
-----------------------------

Fixed assets are stated at cost. Depreciation is provided for financial
reporting purposes using the straight-line method over the estimated useful
lives of the assets (generally three to ten years). Tax depreciation is provided
on the straight-line method. Leasehold improvements are amortized over the lease
period or the estimated useful life of the improvements, whichever is shorter.

Inventories
-----------

Inventories are stated at the lower of cost or market.

Research and Development
------------------------

All costs incurred in connection with any research and development activities
are expensed as incurred.

Government contracts
--------------------

Substantially all of the Company's revenue is from U.S. Government contracts.
The indirect rates used in CPFF contracts are subject to final negotiated
settlements at the end of each fiscal year.

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

Contract research revenue is generally earned based on cost-plus-fixed-fee
("CPFF") arrangements and is recognized as costs are incurred.

                                      -33-


<PAGE>



Earnings Per Share
------------------

The Company is required to adopt SFAS No. 128 "Earnings Per Share" effective
June 1, 1998. The standard specifies the computation, presentation and
disclosure requirements for earnings per share. The Company does not believe
this statement will have a material effect on earnings per share.

Earnings per share is computed based on the weighted average number of common
shares outstanding during each period. In 1997, 1996 and 1995, common stock
options were not included in the calculation of earnings per share because they
had an immaterial effect (less than 3%).

Cash and Cash Equivalents
-------------------------

The Company considers cash equivalents to include short-term investments which
have a maturity of 90 days or less at the date of purchase.

2.  CAPITAL STOCK

Stock Options
-------------

The Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for the 1988 Stock Option Plan, accordingly, no
compensation has been recognized for the plan. Had compensation costs for the
plan been determined based on fair value at the grant date forward under the
plan consistent with Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," the Company's net income and income
per share would not have been materially affected on a pro forma basis for the
years ended May 31, 1997 and 1996.

The Company has reserved 408,000 shares of its Common Stock to cover the
exercise of options granted under its 1988 stock option plan. With the exception
of the CEO's option which expires January 19, 1999, options expire ten years
from date of grant under the plan, or upon the optionee's separation from the
Company and were granted at the average of the closing bid and ask price of the
Company's Common Stock at the date of grant. The Company has reserved an
additional 30,000 shares of its Common Stock to cover the exercise of options
granted outside its 1988 stock option plan. Option transactions were as follows:

<TABLE>
<CAPTION>
                                                                        Number of
                                                                         Shares                      Option
                                                                       Under Option                  Price
                                                                       ------------                  ------
<S><C>
Outstanding, June 1, 1994                                                304,000                 $ .08  to .4469
  Granted                                                                    -0-
  Cancelled                                                                  -0-
                                                                         -------

Outstanding, May 31, 1995                                                304,000                   .08  to .4469
  Granted                                                                 40,000                   .375 to .5625
  Cancelled                                                                  -0-
                                                                         -------

Outstanding, May 31, 1996                                                344,000                   .08  to .5625
  Granted                                                                 97,000                   .34375 to .42
  Cancelled                                                               (3,000)                  .5625
                                                                         -------

Outstanding, May 31, 1997                                                438,000                   .08  to .5625
                                                                         =======
</TABLE>

                                      -34-


<PAGE>



The number of options exercisable at May 31 were as follows:

                    1997    438,000
                    1996    344,000
                    1995    304,000

3.  LINE OF CREDIT

The Company has a line of credit of $1,000,000 with a bank to meet periodic cash
flow needs. As of May 31, 1997, there were $536,120 of borrowings under this
line of credit, the maximum amount borrowed during the fiscal year was $934,561,
the average balance outstanding was $204,281, and the average interest rate was
8.83% during 1997. The line is guaranteed by the Company's subsidiary, BIOQUAL,
and bears interest at the prime rate plus .25% and is collateralized by trade
accounts receivable. The line is subject to renewal on or before October 29,
1997.

4.  LONG-TERM DEBT

                                                1997                      1996
                                                ----                      ----

Capitalized Lease Obligations                 $288,345                  $402,263

Less Current Maturities                        124,153                   113,918
                                              --------                  --------

Long-Term                                     $164,192                  $288,345
                                              ========                  ========

Future annual minimum payments under the capital leases as of May 31, 1997,
were:

        1998                                         $144,543
        1999                                          124,502
        2000                                           41,264
        2001                                           10,591
                                                     --------
                                                      320,900
        Less:  Amount representing interest            32,555
                                                     --------
        Present value of minimum lease payments      $288,345
                                                     ========

The Company leases equipment under various capital leases which expire in fiscal
years 1999, 2000 and 2001. Property held under the capital leases at May 31,
1997 and 1996 consisted of the following:

                                               1997                  1996
                                               ----                  ----

        Equipment                            $479,362              $479,362
        Less:  Accumulated amortization        96,644                48,708
                                             --------              --------
                                             $382,718              $430,654
                                             ========              ========

The equipment is amortized on a straight-line basis over the estimated useful
life of the equipment. Amortization expense amounted to $54,975, $33,516 and
$66,700 in 1997, 1996 and 1995, respectively, and is included with depreciation
expense in the financial statements.

The fair value of long-term debt is estimated to approximate its carrying value
at May 31, 1997 based on borrowing rates currently available with similar terms
and maturity.

                                      -35-


<PAGE>



5.  INCOME TAXES

Income taxes are accounted for using Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" (SFAS No. 109), which requires an asset
and liability approach to financial accounting and reporting for income taxes.
Under SFAS No. 109, deferred tax assets and liabilities are provided for
differences between the financial statement and tax bases of assets and
liabilities that will result in future taxable or deductible amounts. The
deferred tax assets and liabilities are measured using the enacted tax laws and
rates applicable to the periods in which the differences are expected to affect
taxable income. Income tax expense is computed as the tax payable or refundable
for the period plus or minus the change during the period in deferred tax assets
and liabilities.

The components of income tax expense are as follows:

<TABLE>
<CAPTION>
                                                                      1997                  1996                 1995
                                                                      ----                  ----                 ----
<S><C>
        Current tax expense                                         $ 32,800              $ 27,600            $ 20,000
        Deferred tax (benefit) expense                                (1,900)               (2,300)            181,900
                                                                    --------              --------            --------
                                                                    $ 30,900              $ 25,300            $201,900
                                                                    ========              ========            ========

A reconciliation of actual income tax expense to that which would have resulted
from applying the federal statutory tax rates is as follows:


</TABLE>
<TABLE>
<CAPTION>
                                                           1997             1996            1995
                                                           ----             ----            ----
<S><C>
Federal taxes at statutory
  rate                                                   $ 12,055         $ 39,949         $111,258
State taxes at statutory rate                              32,800           27,600           20,000
Executive life insurance
  premiums                                                  2,034            8,997            4,187
Decrease (increase) in
  previously recognized tax
  loss carryforwards                                      (11,126)         (46,000)          69,649
Other, net                                                 (4,863)          (5,246)          (3,194)
                                                         --------         --------         --------
                                                         $ 30,900         $ 25,300         $201,900
                                                         ========         ========         ========
</TABLE>

The components of deferred income taxes are as follows:

<TABLE>
<CAPTION>
                                                                  May 31,      May 31,       May 31,
                                                                   1997         1996          1995
                                                                  -------      -------       -------
<S><C>
Financial statement accruals                                    $   40,904   $   39,646    $   41,056
Different useful lives for
  depreciation of fixed assets
    for tax purposes                                               (58,300)      10,691        61,358
Tax loss carryforward                                            1,598,000    1,518,000     1,564,000
Less: valuation allowance                                         (733,204)    (722,837)     (823,214)
                                                                ----------   ----------    ----------
Total deferred income taxes                                     $  847,400   $  845,500    $  843,200
                                                                ==========   ==========    ==========
</TABLE>

As of May 31, 1997, the Company has cumulative tax operating loss carryforwards
of approximately $4,700,000 available to reduce future federal taxable income.
The operating loss carryforwards expire in fiscal years 2000 to 2003. Management
believes that it is more likely than not that the Company will generate future
taxable income sufficient to realize a portion of the remaining tax loss
carryforward and that the valuation allowance is appropriate given the current
estimates of future taxable income.

                                      -36-


<PAGE>



6.  COMMITMENTS AND CONTINGENCIES

Leases
------

The Company is a lessee under various noncancelable operating leases, covering
the facilities in which its operations are conducted and certain equipment and
vehicles. During 1997, 1996 and 1995, the Company subleased a part of its
premises. As of May 31, 1997, there are no material sublease agreements. The
rental income earned has been offset against the Company's rental expense in the
period. The aggregate minimum annual rental commitments under these various
leases are as follows:

              Rental
            Commitment
            ----------

1998          1,340,000
1999          1,373,000
2000          1,256,000
2001          1,287,000
2002             64,000

Facilities leases contain options for five-year extensions.

Rental expense was approximately $1,322,000, net of $11,000 of sublease income,
$1,388,000, net of $10,000 of sublease income, and $1,355,000, net of $9,000 of
sublease income, for the years ended May 31, 1997, 1996 and 1995, respectively.

7.  RELATED PARTIES

The following schedule presents information regarding loans to officers for the
three year period ended May 31, 1997.

<TABLE>
<CAPTION>
                                                  Balance at                                                             Balance
                                                  Beginning of                                                          at End of
Name of Person                                       Period                 Additions            Repayments               Period
--------------                                    ------------              ---------            ----------             ---------
<S><C>
Year Ended May 31, 1997:

President                                           $ 90,000                  $   -0-              $   -0-              $ 90,000

Year Ended May 31, 1996:

President                                           $ 90,000                  $   -0-              $   -0-              $ 90,000

Year Ended May 31, 1995:

President                                           $ 90,000                  $   -0-              $   -0-              $ 90,000
Executive Vice President                              10,000                      -0-               10,000                   -0-
</TABLE>

The loan to the President bears interest at the six month certificate of deposit
rate. On October 11, 1995, the Company's shareholders affirmatively voted to
approve the purchase of common stock of the Company held by Dr. Landon at fair
market value in an amount sufficient to fund the payment of the $45,000
installment payment, plus accrued interest, due after fiscal year 1995 and in a
similar manner to purchase common stock of the Company held by Dr. Landon at
fair market value in an amount sufficient to fund the payment of the final
$45,000 installment payment, plus accrued interest, due after fiscal year 1996.
The 1996 payment would be made within six weeks after the end of fiscal year
1996. On October 16, 1996, the Board of Directors affirmatively voted to extend

                                      -37-


<PAGE>



the due date of the loan, maintaining all other terms and conditions, until
October 31, 1998. As of July 30, 1997, neither the stock purchase or the loan
repayment transaction have occurred.

The President had an employment agreement with the Company which expired May
1996, subsequently the Board of Directors extended the agreement until May 31,
1997 at the same terms and conditions. The agreement continued to provide a base
compensation and additional incentive compensation dependent upon annual
operations. Currently, the Compensation Committee of the Board of Directors is
negotiating a new employment agreement with Dr. Landon.

The loan to the Executive Vice President bore interest at the six month
certificate of deposit rate plus one percent as quoted by Signet Bank/MD. The
loan was paid in full during March 1995.

                                      -38-


<PAGE>








                                    EXHIBITS









                                      -39-


<PAGE>





                  (21)  List of Subsidiaries

                        1.  BIOQUAL, Inc.
                            9600 Medical Center Dr.
                            Rockville, Maryland  20850-3336
                            Incorporated in Delaware

                        2.  Enhanced Therapeutics, Inc.
                            9600 Medical Center Dr.
                            Rockville, Maryland  20850-3336
                            Incorporated in Delaware

                                      -40-