MEDICAL GRAPHICS CORP /MN/, 10KSB, 1999-04-15

MEDICAL GRAPHICS CORP /MN/
10KSB, 1999-04-15
ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS

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U.S. 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 December 31, 1998.
/ / Transition report under Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from ________ to ________.

COMMISSION FILE NUMBER 0-9899

MEDICAL GRAPHICS CORPORATION
(Exact name of registrant as specified in its charter)

Minnesota 41-1316712
------------------------ ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

350 Oak Grove Parkway
Saint Paul Minnesota 55127
----------------------------------------------------
(Address of principal executive offices and Zip Code)

Issuer's telephone number: (651) 484-4874

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act: Common Stock,
Par Value $.05 Per Share (Title of Class)

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

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is 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. / /

State issuer's revenues for its most recent fiscal year: $20,449,000.

The aggregate market value of the common stock held by non-affiliates of the
registrant based on the closing sale price as reported on The Nasdaq SmallCap
Market on April 12, 1999 was $5,964,000.

As of April 12, 1999, 5,613,620 shares of the registrant's Common Stock, $.05
par value, and 444,445 shares of Class A Stock, $. 05 par value were
outstanding. Each share of Class A Stock is convertible into 3.375 shares of
Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company's definitive Proxy Statement for the Annual Meeting of
Shareholders, a definitive copy of which will be filed with the SEC within 120
days of December 31, 1998 are incorporated by reference into Items 9, 10, 11 and
12 of Part III.

Transitional Small Business Disclosure Formats (check one): Yes No X
--- ---

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TABLE OF CONTENTS

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PAGE NO.
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PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 1. Description of Business . . . . . . . . . . . . . . . . . . . . 1
Item 2. Description of Property . . . . . . . . . . . . . . . . . . . . 8
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . 8
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . 8

PART II. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10
Item 5. Market for Common Equity and Related Stockholder Matters. . . .10
Item 6. Management's Discussion and Analysis or Plan of Operation . . .11
Item 7. Financial Statements. . . . . . . . . . . . . . . . . . . . . .19
Item 8. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure . . . . . . . . . . . . . .35

PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35
Item 9. Directors, Executive Officers, Promoters and Control
Persons; Compliance with Section 16(a) of the Exchange Act. . .35
Item 10. Executive Compensation. . . . . . . . . . . . . . . . . . . . .35
Item 11. Security Ownership of Certain Beneficial Owners
and Management. . . . . . . . . . . . . . . . . . . . . . . . .35
Item 12. Certain Relationships and Related Transactions. . . . . . . . .35
Item 13. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . .36

INDEX TO EXHIBITS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36

SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39
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(ii)
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PART I

ITEM 1. DESCRIPTION OF BUSINESS

GENERAL OVERVIEW

Medical Graphics Corporation designs products and related software that
assist health care professions in the prevention, early detection and
cost-effective treatment of heart and lung disease and the evaluation of sleep
disorders. MedGraphics' pulmonary products consist of breath analysis
technology integrated with a computer and software. MedGraphics' sleep
diagnostic products consist of a recording system integrated with a computer and
software. The pulmonary systems are marketed worldwide while the sleep
diagnostic systems are marketed in the United States. More than 3,800
MedGraphics systems have been sold to customers for use in 45 countries.

PRIMARY PRODUCTS

PULMONARY FUNCTION TESTING SYSTEMS. Pulmonary function testing helps
health care professionals diagnose lung diseases, such as asthma and emphysema,
and manage treatment of their patients. Pulmonary function testing applications
include screening asthma patients, assessing pre-operative and post-operative
risk of heart and lung surgery patients, evaluating lung damage from
occupational exposures and documenting responses to therapy.

MedGraphics pulmonary function testing systems are operated with the
Company's proprietary BreezePF Windows 95 software, which is designed to operate
in a simple, easy-to-use manner. These pulmonary function testing systems are
sold under the Profiler name.

The MedGraphics pulmonary function products use a patented "expert system"
to assist physicians in the interpretation of patient test results. MedGraphics
pulmonary function products also use the preVent pneumotach, a patented
disposable mouthpiece/flow device that helps prevent the transmission of
infectious diseases. The preVent gives all MedGraphics products the capability
to perform spirometry, which measures the flow rates and pressures inside a
person's lungs.

Additional capabilities are available with the Profiler Series systems.

- The Profiler DL performs spirometry and also measures how efficiently
the lungs diffuse certain gases. The Profiler measures this lung function
by using a gas chromatograph which measures gas concentrations before the
patient breathes the gas in and after the patient breathes the gas out.
This is referred to as diffusion testing.

- The Profiler DX has all the abilities of the Profiler DL, plus the
ability to measure the volume of air the lungs breathe in and out. This is
done with a patented nitrogen analyzer that measures the amount of nitrogen
in a person's breath.

The Profiler Systems' compact design and mobility option attract a wide
variety of customers, including pulmonary laboratories in hospitals, office
based clinics, occupational medicine clinics, asthma centers and clinical
research centers.

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BODY PLETHYSMOGRAPH SYSTEMS. The Elite Series are MedGraphics' body
plethysmograph systems. A body plethysmograph is an enclosed metal and clear
acrylic chamber that offers the most sensitive method for measuring lung
function. The patient sits inside the chamber and undergoes diagnostic
pulmonary function tests.

- The Elite D performs spirometry and measures the total volume of air and
the resistance in a person's lungs.

- The Elite DL performs the same tests as the Elite D, and performs the
diffusion test the same way as the Profiler DL.

- The Elite DX performs all the tests as an Elite DL , and performs the
lung volume test the same way as the Profiler DX.

The Elite Series systems applications include diagnosing lung diseases and
managing their treatment, assessing the surgical risk of lung transplant and
lung reduction candidates and evaluating the impact of diseases, such as
neuromuscular disease, on breathing. The system's design optimizes patient
comfort with a clear-view acrylic enclosure and allows testing of a broad
population including pediatric patients and individuals in wheelchairs.

CARDIOPULMONARY EXERCISE TESTING SYSTEMS. The Company's cardiopulmonary
exercise testing systems measure fitness or conditioning levels as well as help
physicians diagnose heart and lung diseases. They do this by measuring the
concentrations of the oxygen and carbon dioxide in a person's lungs and how the
concentrations change as a person exercises on a bike or treadmill. They can
also measure the gas concentrations of a person at rest to determine nutritional
requirements of burned or critically ill patients. This measurement method is
called the nutrition or MAX option. The systems measure the gas concentrations
of every breath using a patented breath by breath methodology. The
cardiopulmonary systems use the same patented preVent pneumotach as the
pulmonary function testing systems and also include a patented oxygen analyzer
and a carbon dioxide analyzer.

The cardiopulmonary testing systems are sold in several different
configurations.

- The basic exercise testing system is a CPX/D which measures patient
fitness levels while exercising.

- The basic nutrition assessment system is a CCM/D which measures the
basic nutritional requirements of a patient at rest.

- A CPX/MAX/D is a CPX/D with the nutrition option added.

- A Cardio2 is a CPX/D with a 12-lead electrocardiogram stress option
added. The Electrocardiogram, which measures heart functions, is generally
referred to as an ECG.

- A Cardio2/MAX/D is a CPX/D with a 12-lead ECG and the Nutrition option.

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- A CPX Express is a smaller version of the CPX/D designed for use in a
physician's office. Like the CPX/D, it can be used with a nutrition option
and/or interfaced with a 12-lead ECG system.

The CPX/D and CPX Express can also be used in conjuction with other
manufacturer's stand-alone ECG systems.

Applications for the cardiopulmonary systems include distinguishing
between cardiovascular and pulmonary disease, screening for early signs of
cardiac and pulmonary dysfunction, establishing exercise prescriptions and
training programs and evaluating the efficacy of prescribed therapy.
MedGraphics holds several patents relating to data reporting, including two
expert system software packages for evaluating the information. Customers
include hospital cardiopulmonary laboratories, cardiology and pulmonary
office-based clinics, critical care units, cardiac rehabilitation units,
human performance laboratories and health clubs.

All the Company's cardiorespiratory and sleep diagnostic systems use an
IBM compatible computer with a Pentium processor, a full color monitor, a
printer and other peripherals

CYCLE ERGOMETERS. The Company offers several models of cycle ergometers
providing physicians and patients a tool for more successful outcomes in
clinical rehabilitation and athletic training. A cycle ergometer is a specially
designed stationary exercise bicycle that can operate at a broad spectrum of
resistance levels. The Company has two models of cycle ergometers that are used
in diagnostic, rehabilitation, training and sports medicine applications. The
ergometers are used and controlled by Medgraphics' cardiopulmonary exercise
testing systems. These ergometers are purchased through a third party.

SLEEP DIAGNOSTICS SYSTEMS. The clinical assessment of sleep disorders,
such as sleep apnea, restless leg syndrome and sleep seizures is performed with
polysomnography, which literally means making many recordings during sleep.
Although polysomnography is most commonly performed in a sleep lab, with
technologies such as the P-Series portable recorder, sold by MedGraphics, the
testing can now be performed in remote clinics or the home of the patient.

The all-night polysomnograph recording typically requires electrodes be
placed on the head to measure brain activity, eye movement and muscle tension in
the chin. The measurement of brain activity is called an Electroencephalogram,
often referred to as an EEG. Electrodes are also applied to monitor ECG. In
addition, respiration, leg movements and body position are monitored with
specially developed sensors. From the records of all these physiologic signals,
the clinician can determine the different stages of sleep, the number and
duration of any abnormal breathing events, and any other unusual activity that
the patient may experience during sleep.

The diagnostic sleep systems that are sold by Medical Graphics include
software and hardware technology to help the technician and clinician gather,
analyze and report the results from all-night recordings accurately and
efficiently.

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INDUSTRY

Early detection and prevention of heart and lung diseases is becoming more
commonplace as health care reform and cost containment efforts increase.
Physicians and health plan administrators are becoming more motivated to use
non-invasive diagnostic testing to detect early signs of disease and reverse the
disease process by therapeutic treatments, rather than relying on invasive and
expensive procedures to treat disease after it has already progressed. Thus,
the demand for therapeutic and diagnostic products, such as the MedGraphics',
is being affected by trends in the medical profession and its approach to the
treatment of illness as well as third party payment and reimbursement policies.

COMPETITION

The industry for companies selling cardiopulmonary diagnostic systems and
sleep disorders diagnostic systems is competitive. Our competitors include
large medical companies, some of which have greater financial and technical
resources and broader product lines than us. We believe that the principal
competitive factors in its markets are product features, price, quality,
customer service, performance, market reputation, breadth of product offerings
and effectiveness of sales and marketing efforts.

Our success depends on our ability to anticipate changes in technology and
industry standards, to develop and successfully introduce new and enhanced
products on a timely basis and to promote market acceptance of such products.
There are a number of companies that currently offer, or are in the process of
developing, products that compete with products offered by us. Some of these
competitors may have greater capital resources, research and development staffs
and experience in the medical device industry, including experience with respect
to regulatory compliance in the development, manufacturing and sale of medical
products similar to those offered by us. We believe the principal competitors
for our traditional products are SensorMedics Corporation, a subsidiary of
ThermoElectron Corporation and Erich Jaeger GmbH & Co.

We believe that our principal competitors in the sleep diagnostic market
are SensorMedics, Healthdyne Technologies, Inc. and Nellcor Puritan Bennett.
There can be no assurance that some of these competitors will not succeed in
developing technologies and products that are more effective than those
currently used or produced by us or that would render some products offered by
us obsolete or non-competitive.

Competition based on price is expected to become an increasingly important
factor in customer purchasing patterns as a result of cost containment pressures
on, and consolidation in, the health care industry. This competition has
exerted, and is likely to continue to exert, downward pressure on the prices we
are able to charge for our products. There can be no assurance that we will be
able to offset such downward price pressure through corresponding cost
reductions. Any failure to offset such pressure could have an adverse effect on
our business, results of operations or financial condition.

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MARKETING AND DISTRIBUTION

MedGraphics markets its products in the United States through a direct
sales force that targets customers located in hospitals, university-based
medical centers and office-based clinics. Each salesperson is responsible for a
specific geographic area and sells the Company's complete product line within
that area. Company salespersons are compensated with a base salary, expenses
and a revenue-based commission.

The Company markets its products outside the United States through sales
organizations that operate primarily as distributors. During 1998, MedGraphics
used approximately 33 international sales organizations to sell its products
into 45 countries. These organizations typically carry a limited inventory of
our products and sell our systems in specific geographic areas, generally on an
exclusive basis. International sales accounted for 13.1% and 18.4% of total
sales in 1998 and 1997, respectively. All of the Company's international sales
are made on a United States dollar-denominated basis.

Sales into foreign countries involves certain risks not ordinarily
associated with domestic business including fluctuations in exchange rates even
when products are denominated in dollars, reliance on distributors and
fluctuations in sales resulting from changes in local economies.

The Company believes that demonstration of its products' capabilities to
potential customers is one of the most significant factors in achieving sales.
Consequently, the main thrust of domestic and international promotional efforts
is product demonstrations at conventions and customer facilities. Other
promotional efforts include educational seminars, print advertisements, direct
mail campaigns and a MedGraphics web site (www.medgraph.com).

RESEARCH AND DEVELOPMENT

Research and development expenses for 1998 reflected extensive efforts to
convert our products to the Windows95/98 platform. Two new Windows95/98
pulmonary function software products were introduced during 1998. The gas
exchange product line is expected to be converted to the Windows95/98 platform
during 1999. In addition, MedGraphics is continuing to add product improvements
designed to enhance product reliability and improve margins. The Company is
also developing new products targeted for new growth markets. MedGraphics
believes ongoing research and development efforts have been and will remain
important to its continuing success. Research and development expenses were
$1,550,000 in 1998 compared to $1,867,000 in 1997.

MANUFACTURING

The Company currently manufactures and assembles all major analyzer
components of its pulmonary systems including a waveform analyzer, gas
chromatograph, nitrogen analyzer and oxygen analyzer. Sheet metal, electrical
components and some measurement devices are purchased from outside vendors and
are tested, assembled and packaged by Company personnel into fully integrated
systems. The Company also acquires general purpose computers, monitors and
printers from a variety of sources and integrates its proprietary transducer
modules into these systems. The Company acquires its cycle ergometers and the
hardware and software for its sleep diagnostic systems from third parties.
Although some of the Company's components are purchased from only one or a
limited number of suppliers, the Company believes that if it is unable to obtain
components from these suppliers, it would

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be able to obtain comparable components from other sources without significant
additional expense or interruption of business.

During 1997, the Company began to convert to a modified form of cellular
manufacturing, a process that has continued into 1999. Cellular manufacturing
utilizes an employee team to plan and schedule production, manufacture the
product and ensure the achievement of quality standards. This process
facilitates faster throughput of manufactured product and requires lower
inventory support levels. The Company has already benefitted from continually
improving manufacturing efficiencies.

GOVERNMENT REGULATION

Products manufactured by Medical Graphics Corporation are "devices" as
defined in the Federal Food, Drug and Cosmetic Act (the "Act") and are subject
to regulatory authority of the Food and Drug Administration ("FDA") which
regulates the manufacture, distribution, related record keeping, labeling and
advertising of such devices. The Medical Device Amendments of 1976 (the
"Amendments") amended the Act and substantially increased the regulatory
authority of the FDA over medical devices. Devices manufactured by the Company
must comply with the provisions of this law. Under the Amendments, the FDA must
determine the extent of control necessary to assure the safety and effectiveness
of devices, and must define these control levels by the promulgation of
regulations and standards.

The Company has filed notifications with the FDA of its intent to market
its systems pursuant to Section 510(k) of the Amendments. Under Section 510(k),
a medical device can be marketed if the FDA determines that the device is
substantially equivalent to similar devices marketed prior to May 28, 1976. The
FDA made such determinations for these systems, and the Company is marketing the
devices under Section 510(k).

The action of the FDA does not, however, constitute approval by the FDA of
the Company's products or pass upon their safety and effectiveness. The FDA has
increased the depth of its inspections for compliance with Good Manufacturing
Practices Regulations covering software documentation, as well as hardware
documentation. The Company successfully passed an FDA audit in 1998 with no
negative observations.

The Company's products are also subject to similar regulation in various
foreign countries. ISO 9001 certification provides assurance that MedGraphic's
development and manufacturing processes comply with standards for quality
assurance and manufacturing process control. ISO 9001 certification evidences
compliance with the requirements that enable a company to affix the CE Mark to
its products. The CE Mark denotes conformity with European standards for safety
and allows certified devices to be placed on the market in all European Union
("EU") countries. After June 1998, medical devices may not be sold in EU
countries unless they display the CE Mark. MedGraphics received ISO 9001
certification for its development and manufacturing processes in 1998.
MedGraphics achieved CE certification for its primary cardiopulmonary testing
products. The Company expects to achieve certification for the remainder of the
product line that it markets in Europe during 1999. There can be no assurance,
however, that the Company will be able to obtain regulatory approvals or
clearances for its products in foreign countries.

The Company must comply with various federal, state and local environmental
laws and

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regulations. The Company believes that it is currently in material compliance
with such applicable environmental laws and regulations.

PATENTS AND TRADEMARKS

MedGraphics relies on a combination of patent, trademark and trade secret
laws to establish proprietary rights in its products. The Company currently
owns 20 United States domestic patents that cover the basic aspects of the
Company's core technologies, including gas pressure, flow measurement,
breath-by-breath assessment of gas exchange and some expert systems. In
addition, the Company has a number of foreign patents with respect to
technologies covered by its United States patents. The United States patents
were issued during the period from 1984 through 1999. United States patents
issued prior to 1995 generally expire 17 years after issuance while patents
issued after 1994 generally expire 20 years after the date of initial patent
application. Foreign patents generally expire 20 years after the date of
original application, but vary from country to country. The Company intends to
aggressively enforce its intellectual property rights and has successfully done
so in the past. There can be no assurance, however, that these patents, or any
patents that may be issued as a result of existing or future application, will
offer any degree of protection from competitors.

The Company seeks to protect its trade secrets and proprietary know-how
through proprietary information agreements with employees, most consultants and
other parties. MedGraphics's proprietary information agreements generally
contain industry standard provisions requiring such individuals to assign to the
Company, without additional consideration, any inventions conceived or reduced
to practice while employed or retained by the Company, subject to customary
exceptions. MedGraphic's officers and other key employees also agree not to
compete with the Company for a period following termination. There can be no
assurance that proprietary information or non-compete agreements with employees,
consultants and others will not be breached, that MedGraphics would have
adequate remedies for any breach, or that third parties will not nonetheless
gain access to MedGraphic's technology.

The following United States registered trademarks appear in this Annual
Report on Form 10-KSB and are owned by the Company: MedGraphics and CPX EXPRESS.
In addition, the following Company trademarks appear in this Annual Report on
Form 10-KSB: PF/Dx, preVent, BREEZE, 1085 Series, CardiO2, CPX/D, CPX/MAX/D,
PS~Quest and PS~Tracker. Pentium is a trademark of Intel Corporation. Windows
is a trademark of Microsoft Corporation.

EMPLOYEES

The Company had 111 full-time and 3 part-time employees as of December 31,
1998. No employees are represented by labor organizations and there are no
collective bargaining agreements. Management believes that MedGraphic's
relations with its employees are good.

FORWARD-LOOKING STATEMENTS

Statements included in this Annual Report on Form 10-KSB that are not
historical or current facts are "forward-looking statements" made pursuant to
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995 and are subject to certain risks and uncertainties that could cause actual
results to differ materially. Various forward-looking statements have been made
in this Annual Report on Form 10-KSB and may also be made in the Company's other
reports filed under the

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Securities Exchange Act of 1934, in its press releases and in other documents.
In addition, from time to time, the Company through its management may make oral
forward-looking statements.

Forward-looking statements are subject to risks and uncertainties that
could cause actual results to differ materially from such statements. The words
"anticipate", "believe", "expect", "intend", "optimistic", "will" or similar
expressions are intended to identify forward-looking statements. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date on which they are made. The Company undertakes no
obligation to update publicly or revise any forward-looking statements.

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ITEM 2. DESCRIPTION OF PROPERTY

The Company currently leases a 52,250 square foot building for its office,
assembly and warehouse facilities located in suburban Saint Paul, Minnesota.
The lease expires June 30, 2002, at which time the Company has an option to
renew the lease for an additional four years. The Company has the option to
purchase the building at the end of each lease expiration period at the
building's fair market value. Annual rental costs will be approximately
$345,000 over the next four years. Rent expense for the years ended December
31, 1998 and 1997 was $344,000 and $348,000, respectively.

ITEM 3. LEGAL PROCEEDINGS

The Company has been named as a defendant in two product liability suits as
follows:

JOHN GEFROH V. TRINITY HOSPITAL AND MEDICAL GRAPHICS CORPORATION, North
Dakota District Court, Northwestern Judicial District, filed in March 1997,
Ward County civil no. 96-C-0327.

ROGER D. CROWE V. NORTHSHORE REGIONAL MEDICAL CENTER, NME HOSPITALS, INC.,
TENET HEALTHCARE CORPORATION, ASTRAND MANUFACTURING AND MEDICAL GRAPHICS
CORPORATION, 22d Judicial District Court for the Parish of St. Tammany,
State of Louisiana, Case No. JDC No. 95-14240-B, filed in November 1996.

The plaintiffs in both product liability suits are seeking compensatory
damages of an undisclosed amount resulting from injuries in connection with the
use our CardiO2 cycle ergometer. MedGraphics believes the injuries resulted
from the actions of one or more third parties and did not result from any
actions of MedGraphics. The Company carries insurance in an amount that it
believes is adequate to cover any liability it may be found to have arising from
the claims in both of these suits.

MedGraphics has also been named as a third-party defendant in COPELCO
CAPITAL, INC. V. MEMORIAL HOSPITAL, A DIVISION OF SISTERS OF CHARITY OF NAZARETH
HEALTH SYSTEMS, INC., Superior Court of New Jersey Law Division: Bergen County
Docket No. L2031-98. The plaintiff is seeking compensation for specific
performance of a lease provided by Copelco Capital to Memorial Hospital for
products purchased from MedGraphics. MedGraphics is of the opinion that
ultimate settlement of this matter will not have a material impact on its
financial statements.

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

Not Applicable

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PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

The Company's common stock trades on The Nasdaq SmallCap Market System
under the symbol MGCC. The following table shows the range of high and low
closing prices for the Company's common stock for the fiscal quarters indicated,
as reported by Nasdaq. Prices prior to June 6, 1998 have been adjusted to
reflect the Company's 3 for 2 stock dividend.

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<CAPTION>
CLOSING PRICES
High Low
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1998
First Quarter $ 2.33 $ 1.72
Second Quarter 3.75 1.72
Third Quarter 3.00 0.75
Fourth Quarter 1.19 0.63

1997
First Quarter $ 2.50 $ 1.11
Second Quarter 1.94 1.17
Third Quarter 2.61 1.67
Fourth Quarter 2.39 1.67
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APPROXIMATE NUMBER OF HOLDERS OF COMMON EQUITY

<TABLE>
<CAPTION>
Approximate Number of
Holders
Title of Class (as of April 12, 1999)
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<S> <C>
Common Stock, par value of $.05 1,400
Class A Stock, par value of $.05 1
</TABLE>

DIVIDENDS

MedGraphics has not paid any cash dividends on its common stock, and the
Board of Directors intends to retain earnings, if any, for the foreseeable
future for use in expansion of the Company's business. Under the terms of the
Company's credit agreement, the Company is prohibited from paying cash dividends
unless it is in compliance with certain covenants.

ISSUANCE OF UNREGISTERED SECURITIES

MedGraphics did not issue any unregistered securities during the quarter
ended December 31, 1998.

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

OVERVIEW

During 1996, the Company expanded its sales, marketing, and research and
development activities and retained new management personnel. This expansion,
in part, resulted in the Company reaching its borrowing base limit on its credit
line, entering into a forbearance agreement with its lender and becoming unable
to pay vendors' accounts payable when due, all of which occurred during the
fourth quarter of 1996. These events restricted the Company's ability to
produce products in the fourth quarter of 1996 and required management and the
Board of Directors to devote a significant amount of time to restructuring the
Company during the first quarter of 1997.

Subsequent to December 31, 1996, the Company retained Manchester Business
Services, Inc., to design and implement a restructuring plan. Under the
restructuring plan, the Company obtained a new line of credit, received
$1,500,000 of cash from the issuance of common stock, entered into agreements
with vendors which provided for payment of approximately $3,500,000 of accounts
payable in equal monthly installments for up to 36 months and reduced its work
force by approximately 25%. The Company obtained an additional $1,500,000 of
cash from the issuance of common stock on November 12, 1997 and $1,000,000 and
$500,000 from the issuance of common stock in January and February 1998,
respectively. Additional common stock was issued on September 30, 1998 for
$300,000 in cash and conversion of $250,000 of accounts payable owed to a
vendor. All issuances of common stock were recorded net of related issuance
costs.

During 1997, the Company withstood the initial challenge of its liquidity
crisis and the ensuing disruptions associated with important restructuring
decisions and numerous personnel changes to generate total revenue of
$19,173,000, only 5.5% lower than 1996. In addition, the Company improved gross
margins to 37.6% in 1997 from 29.4% in 1996 while also reducing total operating
expenses by 23.2% to $11,987,000 in 1997 from $15,617,000 in 1996.

During 1998, MedGraphics increased 1998 revenue by 6.7% to $20,449,000 on
the strength of domestic sales of the Company's new cardiorespiratory diagnostic
systems and market share growth in the sleep disorder diagnostic market. The
Company enjoyed a full year of selling its new sleep diagnostic systems after
first introducing them in September 1997. In addition, MedGraphics began
selling two new pulmonary function products and software enhancements for
existing products late in the third quarter of 1998. Gross margins continued to
improve to 39.2% in 1998 from 37.6% in 1997 while operating expenses decreased
23.8% to $9,130,000 in 1998.

The following discussion should be read in conjunction with the Company's
consolidated financial statements as of and for the years ended December 31,
1998 and 1997 included in Item 7 of this Form 10-KSB.

11
<PAGE>

RESULTS OF OPERATIONS

The following table presents statements of operations data as a percentage
of total revenues for the years ended December 31, 1998 and 1997 (As Restated).

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------

1998 1997
--------- ----------
<S> <C> <C>
Revenues 100.0% 100.0%
Cost of goods sold 60.8 62.4
--------- ----------

Gross margin 39.2 37.6
--------- ----------

Selling and marketing 27.6 32.8
General and administrative 9.4 11.6
Research and development 7.6 9.7
Non-recurring charges 8.4
--------- ----------
Total operating expenses 44.6 62.5
--------- ----------

Loss from operations (5.4) (24.9)
Interest expense (2.3) (1.8)
--------- ----------

Loss before income tax benefit (7.7) (26.7)
Income tax benefit 0.0 0.0
--------- ----------
Net loss (7.7)% (26.7)%
--------- ----------
--------- ----------
</TABLE>

REVENUE. Total revenue increased 6.7% to $20,449,000 in 1998 from
$19,173,000 in 1997. Domestic revenue increased 14.4% and service and supplies
increased 6.7% over 1997 to offset a 24.2% decline in revenue from international
sources. Revenue from domestic sales, international sources and service and
supplies represented 61.3%, 13.1% and 25.6% of 1998 revenue, respectively,
compared to 57.2%, 18.4% and 24.4%, respectively, for 1997.

The increase in domestic revenue was driven by both sales of pulmonary
diagnostics systems as well as strong sales of its new sleep diagnostic systems.
MedGraphics introduced updated models of its pulmonary function systems in
September 1998 and initial results reflected strong customer interest in these
new products. In addition, MedGraphics enjoyed revenue for all of 1998 from its
new diagnostics systems for sleep disorders that were introduced in late
September 1997.

International revenue for 1998 continued to be depressed from the closing
of the Company's German office at the end of 1996 as part of its overall cost
reduction strategy. In addition, international revenue has been impacted by
weaker economic conditions and a stronger dollar versus the local currencies.

GROSS MARGIN. The gross margin percentage increased to 39.2% of revenue in
1998 from 37.6% in 1997. This margin increase was achieved through
manufacturing efficiencies resulting from the 1997 adoption of a modified
version of cellular manufacturing under which major systems are produced in one

12
<PAGE>

continuous process over a shorter period of time rather than producing several
subassemblies requiring longer throughput times. These process revisions not
only reduce manufacturing costs but require significantly lower levels of
inventory.

SELLING. Selling and marketing expenses decreased 10.0% to $5,653,000 in
1998 from $6,282,000 in 1997. Selling expenses as a percent of revenue
decreased to 27.6% in 1998 compared to 32.8% in 1997. Increased commissions of
$245,000 on higher domestic revenue and increased expenses associated with
expanding MedGraphics domestic sales force were offset by savings related to the
following actions. The Company saved $348,000 due to its 1997 decision to sell
the asthma business unit and reduce focus on the sports medicine market.
Moreover, nearly $500,000 in savings resulted from reductions of marketing
costs, primarily personnel and related travel.

GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased
13.5% to $1,927,000 in 1998 from $2.228,000 in 1997. As a percent of revenue,
general and administrative expenses decreased to 9.4% in 1998 compared to 11.6%
in 1997. This decrease reflects lower consulting and bank refinancing expenses
associated with 1997 restructuring activities along with a $145,000 decrease in
the provision for doubtful accounts receivable.

RESEARCH AND DEVELOPMENT. Research and development expenses decreased
17.0% to $1,550,000 in 1998 from $1,867,000 in 1997 and as a percentage of
revenue decreased to 7.6% in 1998 from 9.7% in 1997. The Company has continued
to reduce its dependence on independent software contractors in favor of
in-house software engineers. Lower costs also reflect an increasing proficiency
of Company employees developing product software upgrades.

NON-RECURRING CHARGES. Non-recurring expenses of $1,610,000 for the year
ended December 31, 1997 included severance, legal, accounting and consulting
expenses associated with the cost reduction strategies implemented in the first
quarter of 1997.

NET INTEREST EXPENSE. The Company incurred net interest expense of
$454,000 in 1998 compared to $329,000 in 1997, which resulted from increased
interest payments associated with higher levels of borrowings.

INCOME TAX BENEFIT. The Company recognized no income tax benefit for
either 1998 or 1997 because the Company has established a valuation allowance
that completely offsets the benefit of any net operating loss carryforwards due
to uncertainty regarding the realization of future income tax benefits.

NEW ACCOUNTING STANDARDS

MedGraphics adopted the Financial Accounting Standards Board Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income",
effective January 1, 1998. SFAS No. 130 requires the disclosure of
comprehensive income and its components in the general-purpose financial
statements. The adoption by the Company of SFAS No. 130 did not have a material
effect on the Company's financial statements for 1998 or 1997. Total
comprehensive loss for the twelve months ended December 31, 1998 and 1997 was
$1,576,000 and $5,112,000, respectively.

The Company also adopted (SFAS) No. 131, "Disclosures about Segments of an
Enterprise and

13
<PAGE>

Related Information", effective January 1, 1998. SFAS No. 131 redefines how
operating segments are determined and requires disclosures of certain financial
and descriptive information about a Company's operating segments. This statement
does not have a material impact on results of operations or financial position.

INFLATION

The Company believes that inflation did not have a significant impact on
the Company's operations in 1998 or 1997.

YEAR 2000

The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Computer equipment,
software, devices and products with imbedded technology that are time-sensitive
may recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.

STATE OF READINESS

In late 1997, the Audit Committee of the Board of Directors of the Company
directed the Company's management to initiate a Year 2000 compliance plan. By
March 1998, management implemented a formal program to address the Company's
Year 2000 compliance by forming a Year 2000 staff consisting of personnel from
cross-functional areas of the Company, including information systems, marketing,
research and development, technical support, quality assurance and regulatory
affairs and administration (the "Y2K Project Team"). A Project Manager, who
reports to the Audit Committee of the Board, leads the Y2K Project Team to
ensure that it meets time deadlines, objectives and documents remedial action.

As part of its compliance plan, the Company's Y2K Project Team is taking
inventory of the Company's operations and dividing areas for assessment into
three categories:

- - VITAL - computer-controlled systems, programs, equipment and products that
the Company needs to function day-to-day;
- - CRITICAL - those systems which must be repaired or replaced prior to the
millennium but are not necessary for the Company's day-to-day operations;
and
- - MARGINAL - those systems for which repair and replacement are not material
to the Company's operations.

The Y2K Project Team has also identified five areas covering the entire
scope of the Company's business and has committed to completing an 8-step
program for each area.

14
<PAGE>

The diagram below identifies the five areas as well as the current and projected
schedule of the 8-step program for each area.

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------
Company OEM Products Internal Business Vendors &
Products Programming Information Suppliers
Systems
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Team Formation & Completed Completed Completed Completed Completed
Assignment
- ------------------------------------------------------------------------------------------------------------------------------
Inventory Completed Completed Completed Completed 80%
Assessment
- ------------------------------------------------------------------------------------------------------------------------------
Compliance Completed Completed Completed Completed 35%
Assessment
- ------------------------------------------------------------------------------------------------------------------------------
Risk Completed Completed Completed 90% 15%
Assessment
- ------------------------------------------------------------------------------------------------------------------------------
Resolution & Completed 80% Completed 90% 0%
Remediation
- ------------------------------------------------------------------------------------------------------------------------------
Validation Completed 80% Completed 90% 0%
- ------------------------------------------------------------------------------------------------------------------------------
Contingency
Plans Completed Completed Completed 80% 0%
- ------------------------------------------------------------------------------------------------------------------------------
Certification Completed 10% 10% 90% 10%
& Sign-off
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>

With respect to the Company's relationships with third parties, the Company
relies both domestically and internationally upon various vendors, governmental
agencies, utility companies, telecommunications service companies, delivery
service companies and other service providers. Although these service providers
are outside of the Company's control, the Company has mailed letters to those
with whom it believes its relationships are material and has verbally
communicated with some of its strategic business partners to determine the
extent to which electronic interfaces with such entities are vulnerable to Year
2000 issues and whether products and services purchased from or by such entities
are Year 2000 ready. As of February 1, 1999, the Company had received responses
from 10% of such third parties, and all of the companies that have responded
have provided written assurances indicating that their Year 2000 issues will be
addressed on a timely basis. The Company intends to complete follow-up
activities, including but not limited to phone surveys and mailings, with
significant vendors and service providers as part of completing validation of
these parties' compliance.

COSTS TO ADDRESS YEAR 2000 ISSUES

To date, the Company has not incurred any material expenditures in
connection with identifying or evaluating Year 2000 compliance issues. The
Company has incurred the majority of its costs from the recent installation of
updated internal computer systems as well as the labor cost and opportunity cost
of time spent by employees of the Company evaluating Year 2000 compliance
matters generally. Because the Company upgraded its internal computer systems
as part of its regularly planned software and hardware upgrade efforts, it does
not consider the costs related thereto to be charges for Year 2000

15
<PAGE>

compliance. The Company presently estimates the labor costs of its Year 2000
compliance efforts to date to be approximately $70,000. With respect to future
costs, the Company estimates it may spend approximately $175,000 for remediation
and validation of products and programs which the Company presently knows are
not compliant. The Company believes that these estimates are reasonable and
presently expects such to be within the Company's fiscal 1999 budget. At this
time, the Company has not completed an estimate of the overall potential
financial impact of Year 2000 compliance issues relating to its Year 2000
compliance program. Such impact, including the effect of a Year 2000 business
disruption, could have a material adverse impact on the Company's financial
condition and results of operations.

RISKS OF YEAR 2000 ISSUES

Since the Company has not yet completed its discovery and evaluation of
overall Year 2000 exposure, it cannot at this time state with certainty that the
Year 2000 issues will not have a material adverse impact on its financial
condition, results of operations and liquidity. Although the Company considers
them unlikely, the Company believes that the following several situations, not
in any particular order, make up the Company's "most reasonably likely worst
case Year 2000 scenarios:"

1. CUSTOMER LITIGATION.

The Company has developed a program to advise all customers of Year 2000
compliance of its products and has identified upgrade and replacement products
for its customers affected by Year 2000 compliance issues. These efforts
pertain not only to the Company's internally developed products but also to
externally acquired products. Although the Company believes that its efforts
will ensure no disruption in the business or operations of its customers, the
possibility exists that some customers may experience problems that may motivate
them to commence litigation against the Company for restitution and damages that
may be related to such problems.

2. DISRUPTION OF SUPPLY MATERIALS.

Several months ago, the Company began an ongoing process of surveying its
vendors with regard to their Year 2000 readiness and is now in the process of
assessing and cataloging the survey responses. The Company is pursuing
responses from critical and many non-critical vendors who had not responded by
January 31, 1999. The Company presently expects to work with vendors that show
a need for assistance or that provide inadequate responses, and in many cases
expects that survey results will be refined significantly by such work. Where
ultimate survey results show that the need arises, the Company will arrange for
back-up vendors before the changeover date.

3. DISRUPTION OF THE COMPANY'S INTERNAL COMPUTER SYSTEMS.

The Company has completed a scheduled upgrade of its current hardware and
software systems and such process has required Year 2000 compliance in all
areas. Year 2000 testing occurred as the upgrade process proceeded and, in
addition, will continue to occur prior to the changeover date. For this reason,
the Company considers that disruption of its internal computer systems is
unlikely.

16
<PAGE>

4. DISRUPTION OF THE COMPANY'S NON-COMPUTER SYSTEMS.

The Company is currently conducting a comprehensive assessment of all
non-computer systems, including utility, telecommunications, delivery and other
services. Although the Company intends to work with third party providers of
such services to ensure that there will be no disruption in the Company's
operations, the Company believes that if any disruptions do occur, such will be
dealt with promptly and will be no more severe with respect to correction or
impact than would be an unexpected breakdown of such services and related
equipment.

CONTINGENCY PLANS

While the Company recognizes the need for contingency planning, it has not
yet developed specific contingency plans for potential Year 2000 disruptions.
The aforementioned 8-step program, however, does include contingency planning by
the Y2K Project Team and such plans, as developed, will be carefully reviewed by
the Company. The Company believes that details of such plans will depend on the
Company's final assessment of the problem as well as the evaluation and success
of its remediation efforts. Future disclosures will include contingency plans
as they become available.

LIQUIDITY AND CAPITAL RESOURCES

MedGraphic's balance sheet reflected no cash as of December 31, 1998
because the normal amount of outstanding checks offset cash balances deposited
in the Company's bank accounts. All cash deposits are applied to the Company's
bank line of credit to maximize the use of cash and minimize the corresponding
cost of interest expense. The Company had $744,000 in cash available under its
line of credit and working capital of $1,212,000 at December 31, 1998.

MedGraphics used $3,309,000 of cash in operations during 1998. The
Company's net loss of $1,576,000 was partially offset with $511,000 of
depreciation and $357,000 in amortization. Cash from financing activities
was generated through a net increase of $1,037,000 in borrowings under the
line of credit and $1,773,000 in net proceeds received with the issuance of
common stock in private sales to investors. This cash was used to finance the
balance of MedGraphic's operating activities, including $321,000 used for
software production costs and $67,000 used for capital expenditures.

The Company has a working capital line of credit with a bank that provides
for total borrowings, based on available collateral, of up to $4,100,000, at the
discretion of the lender, which expires March 31, 2000. Total borrowings
outstanding under the credit agreement are secured by the Company's accounts
receivable and inventories. The credit agreement contains certain restrictive
covenants as well as limitations on capital expenditures and payment of
dividends. The credit line allows the Company to borrow up to 80% of eligible
domestic accounts receivable, 40% of eligible domestic inventory (not to exceed
$1,500,000), 90% of eligible foreign accounts receivable. MedGraphics did not
achieve technical compliance with all 1998 performance ratios stated in its
credit agreement. The bank has waived all violations and MedGraphics is in
compliance with its credit agreement at December 31, 1998.

As of December 31, 1997, the Company had cash of $387,000 and working
capital of $918,000. The Company financed part of its $5,112,000 net loss with
a $2,393,000 decrease in inventory and a

17
<PAGE>

$924,000 decrease in accounts receivable. Cash provided from financing
activities was generated through the issuance of common stock in private sales
to investors for net proceeds of $2,935,000. The cash provided from financing
activities was used to reduce net borrowings under the Company's line of credit
by $1,146,000 and for investing in capital expenditures of $215,000 and software
production costs of $417,000.

During 1997, the Company entered into financing arrangements with certain
vendors which provide for payment of outstanding balances in equal monthly
installments for up to 36 months. The balances which will be paid after
December 31, 1999, have been classified as long-term accounts payable financed
with vendors. The amounts due under the agreements are $769,000 and $48,000 for
1999 and 2000, respectively.

In November 1997, the Company entered into agreements to sell to private
investors up to 1,090,908 shares of common stock at a price of $2.75 per share.
These investors purchased 545,454 shares for $1,500,000 on November 12, 1997.
They also purchased 363,636 additional shares for $1,000,000 on January 30, 1998
and 181,818 additional shares for $500,000 on February 10, 1998.

On September 30, 1998, MedGraphics sold 550,000 shares of common stock at a
price of $1.00 per share to a private investor and Compumedics Sleep Pty, Ltd,
an Australian manufacturer of sleep diagnostic products and a supplier to the
Company. The private investor purchased 300,000 shares for cash and Compumedics
purchased 250,000 shares through conversion of $250,000 of accounts payable to
the Company.

The Company has no material commitments for 1999 capital expenditures. The
Company believes that its revenues from operations, together with cash and
borrowings available under its credit facility will be adequate to satisfy its
liquidity and capital resource needs through 1999.

18
<PAGE>

ITEM 7. FINANCIAL STATEMENTS

The following consolidated financial statements of the Company are included
herein:

Independent Auditors' Report
Consolidated Balance Sheets-December 31, 1998 and 1997
Consolidated Statements of Operations-Years ended December 31, 1998 and
1997
Consolidated Statements of Shareholders' Equity-Years ended December 31,
1998 and 1997
Consolidated Statements of Cash Flows-Years ended December 31, 1998 and
1997
Notes to Consolidated Financial Statements-Years ended December 31, 1998
and 1997

19
<PAGE>

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

On January 24, 1997, the Company filed a Report on Form 8-K reporting that
it had dismissed Ernst & Young LLP as its principal independent auditor and on
March 4, 1997 filed a Report on Form 8-K indicating that it had engaged Deloitte
& Touche LLP as its independent auditors for the year ended December 31, 1996.
The Reports on Form 8-K also indicated that there were no disagreements between
the Company and Ernst & Young LLP on any matter with respect to accounting
policies or practices.

PART III

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

The information contained under the headings "Election of Directors",
"Executive Officers of the Company", and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive proxy statement for its Annual
Meeting of Shareholders, a definitive copy of which will be filed within 120
days of December 31, 1998, is hereby incorporated by reference.

ITEM 10. EXECUTIVE COMPENSATION

The information contained under the heading "Executive Compensation" in the
Company's definitive proxy statement for its 1999 Annual Meeting of
Shareholders, is hereby incorporated by reference.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information contained under the heading "Security Ownership of Certain
Beneficial Owners and Management" in the Company's definitive proxy statement
for its 1999 Annual Meeting of Shareholders, is hereby incorporated by
reference.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information contained under the heading "Certain Transactions" in the
Company's definitive proxy statement for its 1999 Annual Meeting of
Shareholders, is hereby incorporated by reference.

20
<PAGE>

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS
INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION EXHIBIT METHOD OF FILING
- -------------- ----------- --------------------------------------
<S> <C> <C>
3.1 Restated Articles of Incorporation, Exhibit 3(a) to Report on Form 10-KSB
as amended for the year ended December 31, 1991,
file no. 0-9899

3.2 Amended bylaws Exhibit 3(b) to Report on Form 10-KSB
for the year ended December 31, 1992,
file no. 0-9899

4.1 Certificate of Rights and Preferences Exhibit 4.1 to Report on Form 10-KSB
of Class A Stock of the Company for the year ended December 31, 1996,
file no. 0-9899

10.1 Seventh Amendment to Lease for Exhibit 10(b) to Report on Form 10-KSB
350 Oak Grove Parkway, St. Paul, for the year ended December 31, 1994,
Minnesota file no. 0-9899

10.2 Credit Agreement dated March 31, 1997 Exhibit 10.2 to Report on Form 10-KSB
between the Company and Norwest Bank for the year ended December 31, 1996,
Minnesota, N.A. file no. 0-9899

10.2.1 First Amendment to Credit Agreement Exhibit 10.2.1 to Report on Form 10-KSB
dated November 12, 1997 for the year ended December 31, 1997,
file no. 0-9899

10.2.2 Second Amendment to Credit Agreement Exhibit 10.1 to Report on Form 10-QSB
dated March 30, 1998 for the quarter ended March 31, 1998,
file no. 0-9899

10.2.3 Third Amendment to Credit Agreement Filed electronically herewith
dated March 29, 1999

10.3 Credit and Security Agreement dated Exhibit 10.3 to Report on Form 10-KSB
March 31, 1997 between the Company for the year ended December 31, 1996,
and Norwest Business Credit, Inc. file no. 0-9899

10.3.1 First Amendment to Credit and Security Exhibit 10.3.1 to Report on Form 10-KSB
Agreement April 14, 1997 for the year ended December 31, 1996,
file no. 0-9899
</TABLE>

21
<PAGE>

<TABLE>
<S> <C> <C>
10.3.2 Second Amendment to Credit and Security Exhibit 10.3.2 to Report on Form 10-KSB
Agreement dated November 12, 1997 for the year ended December 31, 1997,
file no. 0-9899

10.3.3 Third Amendment to Credit and Security Exhibit 10.2 to Report on Form 10-QSB
Agreement dated March 26, 1998 for the quarter ended March 31, 1998,
file no. 0-9899

10.3.4 Fourth Amendment to Credit and Security Exhibit 10.1 to Report on Form 10-QSB
Agreement dated August 14, 1998 for the quarter ended September 30, 1998,
file no. 0-9899

10.3.5 Fifth Amendment to Credit and Security Exhibit 10.2 to Report on Form 10-QSB
Agreement dated September 10, 1998 for the quarter ended September 30, 1998,
file no. 0-9899

10.3.6 Sixth Amendment to Credit and Security Filed electronically herewith
Agreement dated March 29, 1999

10.4 Warrant between the Company Exhibit 10.4 to Report on Form 10-KSB
and Norwest Business Credit, Inc. for the year ended December 31, 1996,
dated March 27, 1997 file no. 0-9899

10.5* 1987 Stock Option Plan Exhibit 10(d) to Report on Form 10-KSB
for the year ended December, 31,
1992, file no. 0-9899

10.6 Sub-license Agreement between the Exhibit 10(e) to Report on Form 10-KSB
company and ErgometRx for the year ended December 31, 1992,
Corporation (formally Scientific file no. 0-9899
Exercise Prescriptions
Incorporated), dated February 11, 1993

10.7 Warrant Agreement between Exhibit 4.1 to Report on Form S-8
the Company and Catherine A. filed on May 16, 1997,
Anderson dated March 25, 1997 file no. 333-27251

10.8* Non-Employee Director Exhibit 4.1 to Report on Form S-8
Compensation Plan filed on December 8, 1997,
file no. 333-41725

10.9* Stock Option Agreement between Exhibit 10(h) to Report on Form 10-KSB
the Company and Donald C. for the year ended December 31, 1993,
Wegmiller file no. 0-9899
</TABLE>

22
<PAGE>

<TABLE>
<S> <C> <C>
10.10 Registration Rights Agreement between Exhibit 10.11 to Report on Form 10-KSB
the Company and FAMCO II LLC for the year ended December 31, 1996,
file no. 0-9899

10.11 Registration Rights Agreement between Exhibit 4 to Schedule 13D/A filed on
the Company and FAMCO II LLC, November 21, 1997 with respect to FAMCO
Special Situations Fund III, L.P., II LLC and Family Financial Strategies, Inc.
Special Situations Private Equity Fund
L.P.(4), Special Situations Cayman Fund
L.P.(4)

10.1.1 Eighth Amendment to Lease for Exhibit 10.12 to Report on Form 10-KSB
350 Oak Grove Parkway, St. Paul, for the year ended December 31, 1997,
Minnesota. file no. 0-9899

10.13* Employment Agreement dated August 3, Filed electronically herewith
1998 between the Company and
Richard E. Jahnke

10.14* Stock Option Agreement between the Filed electronically herewith
Company and Mark W, Sheffert
dated January 9, 1999

21.1 The Company has one wholly-owned subsidiary, Medical Graphics Corporation GmbH,
located in Germany.

23.1 Independent Auditors' Consent of Filed electronically herewith
Deloitte & Touche LLP

27.1 Financial Data Schedule Filed electronically herewith

- -----------------------------
</TABLE>

*Indicates compensatory contract or arrangement.

(b) REPORTS ON FORM 8-K

No reports on Form 8-K were filed during the three months ended December
31, 1998.

23
<PAGE>

SIGNATURES

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

MEDICAL GRAPHICS CORPORATION

April 15, 1999 /s/ Richard E. Jahnke
---------------------------------------------
Richard E. Jahnke, President
and Chief Executive Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Richard E. Jahnke and Dale H.
Johnson and each of them acting individually, as his or her attorney-in-fact,
each with full power of substitution, for him or her in any and all capacities,
to sigh any and all amendments to this Annual Report on Form 10-KSB and to file
the same, with exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission, hereby ratifying and confirming our
signatures as they may be signed by our said attorney to any and all amendment
to said Annual Report on Form 10-KSB.

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 and
in the capacities on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<S> <C> <C>
/s/ Mark W. Sheffert Chairman of the Board April 15, 1999
- ----------------------------
Mark W. Sheffert and Director

/s/ Richard E. Jahnke President, Chief Executive April 15, 1999
- ----------------------------
Richard E. Jahnke Officer and Director (Principal
Executive Officer)

/s/ Dale H. Johnson Chief Financial Officer April 15, 1999
- ----------------------------
Dale H. Johnson (Principal Financial and
Accounting Officer)
</TABLE>

24
<PAGE>

<TABLE>
<S> <C> <C>
/s/ Anthony J. Adducci Director April 15, 1999
- ----------------------------
Anthony J. Adducci

/s/ Gerald T. Knight Director April 15, 1999
- ----------------------------
Gerald T. Knight

/s/ W. Edward McConaghay Director April 15, 1999
- ----------------------------
W. Edward McConaghay

/s/ Donald C. Wegmiller Director April 15, 1999
- ----------------------------
Donald C. Wegmiller

/s/ John C. Penn Director April 15, 1999
- ----------------------------
John C. Penn

/s/ John D. Wunsch Director April 15, 1999
- ----------------------------
John D. Wunsch
</TABLE>

<PAGE>

Exhibit Number 10.2.3

THIRD AMENDMENT TO CREDIT AGREEMENT
(EXIMBANK GUARANTEED LOAN NO. AP072067XX)

This Amendment, dated as of March 29, 1999, is made by and
between MEDICAL GRAPHICS CORPORATION, a Minnesota corporation ("the Borrower")
and NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION, a national banking association
(the "Lender").

Recitals

The Borrower and the Lender have entered into a Credit
Agreement dated as of March 31, 1997 as amended by a First Amendment to Credit
Agreement dated as of November 12, 1997 and a Second Amendment to Credit
Agreement dated as of March 30, 1998 (as so amended, the "Credit Agreement").
Capitalized terms used in these recitals have the meanings given to them in the
Credit Agreement unless otherwise specified.

The Borrower has requested that the Lender extend the Maturity
Date by one year and make other amendments to the Credit Agreement. The Lender
is willing to grant the Borrower's request pursuant to the terms and conditions
set forth herein.

NOW, THEREFORE, in consideration of the premises and of the
mutual covenants and agreements herein contained, it is agreed as follows:

1. DEFINED TERMS. Capitalized terms used in this Amendment
which are defined in the Credit Agreement shall have the same meanings as
defined therein, unless otherwise defined herein. In addition, Section 1.1 of
the Credit Agreement is amended by adding or amending, as the case may be, the
following definitions:

"'Maturity Date' means March 28, 2000."

2. NO OTHER CHANGES. Except as explicitly amended by this
Amendment, all of the terms and conditions of the Credit Agreement shall remain
in full force and effect and shall apply to any advance or letter of credit
thereunder.

3. FEES.

(a) APPLICATION FEE. The Borrower shall reimburse the Lender
for the $100 application fee payable to Eximbank in connection with the
renewal application.

(a) FACILITY FEE. The Borrower shall pay the Lender a fully
earned and non-refundable facility fee of $4,375, due and payable upon
the date of this Amendment.

<PAGE>

4. CONDITIONS PRECEDENT. This Amendment shall be effective
when the Lender shall have received an executed original hereof, together with
each of the following, each in substance and form acceptable to the Lender in
its sole discretion:

(a) A Certificate of the Secretary of the Borrower certifying
as to (i) the resolutions of the board of directors of the Borrower
approving the execution and delivery of this Amendment, (ii) the fact
that the articles of incorporation and bylaws of the Borrower, which
were certified and delivered to the Lender pursuant to its Certificate
of Authority dated as of March 31, 1997 continue in full force and
effect and have not been amended or otherwise modified except as set
forth in the Certificate to be delivered, and (iii) certifying that the
officers and agents of the Borrower who have been certified to the
Lender, pursuant to the Certificate of Authority dated as of March 31,
1997, as being authorized to sign and to act on behalf of the Borrower
continue to be so authorized or setting forth the sample signatures of
each of the officers and agents of the Borrower authorized to execute
and deliver this Amendment and all other documents, agreements and
certificates on behalf of the Borrower.

(b) The SBA/Eximbank Joint Application, properly completed and
executed by the Borrower.

(d) Payment of the fee described in Paragraph 3.

(e) Receipt by the Lender of the executed Loan Authorization
Notice.

(f) Such other matters as the Lender may require.

5. REPRESENTATIONS AND WARRANTIES. The Borrower hereby
represents and warrants to the Lender as follows:

(a) The Borrower has all requisite power and authority to
execute this Amendment and to perform all of its obligations hereunder,
and this Amendment has been duly executed and delivered by the Borrower
and constitutes the legal, valid and binding obligation of the
Borrower, enforceable in accordance with its terms.

(b) The execution, delivery and performance by the Borrower of
this Amendment have been duly authorized by all necessary corporate
action and do not (i) require any authorization, consent or approval by
any governmental department, commission, board, bureau, agency or
instrumentality, domestic or foreign, (ii) violate any provision of any
law, rule or regulation or of any order, writ, injunction or decree
presently in effect, having applicability to the Borrower, or the
articles of incorporation or by-laws of the Borrower, or (iii) result
in a breach of or constitute a default under any indenture or loan or
credit agreement or any other

<PAGE>

agreement, lease or instrument to which the Borrower is a party or by
which it or its properties may be bound or affected.

(c) All of the representations and warranties contained in
Article V of the Credit Agreement are correct on and as of the date
hereof as though made on and as of such date, except to the extent that
such representations and warranties relate solely to an earlier date.

6. REFERENCES. All references in the Credit Agreement to "this
Agreement" shall be deemed to refer to the Credit Agreement as amended hereby;
and any and all references in the Security Documents to the Credit Agreement
shall be deemed to refer to the Credit Agreement as amended hereby.

7. NO WAIVER. The execution of this Amendment and acceptance
of any documents related hereto shall not be deemed to be a waiver of any
Default or Event of Default under the Credit Agreement or breach, default or
event of default under any Security Document or other document held by the
Lender, whether or not known to the Lender and whether or not existing on the
date of this Amendment.

8. RELEASE. The Borrower, hereby absolutely and
unconditionally releases and forever discharges the Lender, and any and all
participants, parent corporations, subsidiary corporations, affiliated
corporations, insurers, indemnitors, successors and assigns thereof, together
with all of the present and former directors, officers, agents and employees of
any of the foregoing, from any and all claims, demands or causes of action of
any kind, nature or description, whether arising in law or equity or upon
contract or tort or under any state or federal law or otherwise, which the
Borrower has had, now has or has made claim to have against any such person for
or by reason of any act, omission, matter, cause or thing whatsoever arising
from the beginning of time to and including the date of this Amendment, whether
such claims, demands and causes of action are matured or unmatured or known or
unknown.

9. COSTS AND EXPENSES. The Borrower hereby reaffirms its
agreement under the Credit Agreement to pay or reimburse the Lender on demand
for all costs and expenses incurred by the Lender in connection with the Credit
Agreement, the Security Documents and all other documents contemplated thereby,
including without limitation all reasonable fees and disbursements of legal
counsel. Without limiting the generality of the foregoing, the Borrower
specifically agrees to pay all fees and disbursements of counsel to the Lender
for the services performed by such counsel in connection with the preparation of
this Amendment and the documents and instruments incidental hereto. The Borrower
hereby agrees that the Lender may, at any time or from time to time in its sole
discretion and without further authorization by the Borrower, make an Advance
under the Credit Agreement, or apply the proceeds of any Advance, for the
purpose of paying any such fees, disbursements, costs and expenses and the fee
required under paragraph 3 hereof.

<PAGE>

10. MISCELLANEOUS. This Amendment may be executed in any
number of counterparts, each of which when so executed and delivered shall be
deemed an original and all of which counterparts, taken together, shall
constitute one and the same instrument.

IN WITNESS WHEREOF, the parties hereto have caused this
Amendment to be duly executed as of the date first written above.

NORWEST BANK MINNESOTA, NATIONAL ASSOCIATION MEDICAL GRAPHICS, INC.

/s/ Brett A. Beugen /s/ Richard Jahnke
- ------------------------ ------------------------
Brett A. Beugen Richard Jahnke
Its Officer Its President

<PAGE>

Exhibit Number 10.3.6

SIXTH AMENDMENT TO CREDIT AND SECURITY AGREEMENT

This Amendment, dated as of March 29, 1999, is made by and
between MEDICAL GRAPHICS CORPORATION, a Minnesota corporation (the "Borrower")
and NORWEST BUSINESS CREDIT, INC., a Minnesota corporation (the "Lender").

Recitals

The Borrower and the Lender have entered into a Credit and
Security Agreement dated as of March 31, 1997 as amended by First Amendment to
Credit and Security Agreement dated as of July 10, 1997, Second Amendment to
Credit and Security Agreement dated as of November 12, 1997, Third Amendment to
Credit and Security Agreement dated as of March 26, 1998, Fourth Amendment to
Credit and Security Agreement dated as of August 14, 1998 and Fifth Amendment to
Credit and Security Agreement dated as of September 10, 1998 (as so amended, the
"Credit Agreement"). Capitalized terms used in these recitals have the meanings
given to them in the Credit Agreement unless otherwise specified.

The Borrower has requested that certain amendments be made to
the Credit Agreement, which the Lender is willing to make pursuant to the terms
and conditions set forth herein.

NOW, THEREFORE, in consideration of the premises and of the
mutual covenants and agreements herein contained, it is agreed as follows:

"Overadvance Component' means from March 1, 1999 through May
31, 1999, the lesser of 5% of Eligible Inventory or $125,000 and (e)
thereafter, $0."

2. ACCOMMODATION FEE. Section 2.6 of the Credit Agreement is
hereby amended by adding the following new subsection (e):

"(e) ACCOMMODATION FEE. If a default occurs under Sections
6.12, 6.14 or 6.15 before June 30, 1999, then beginning on July 31,
1999, the Borrower shall pay a monthly accommodation fee of $8,500, due
and payable on the last day of each month."

3. FINANCIAL COVENANTS. Sections 6.12, 6.14 and 6.15 of the
Credit Agreement are hereby amended in their entirety and replaced with the
following new sections:

<PAGE>

"Section 6.12 MINIMUM BOOK NET WORTH. The Borrower will
maintain its Book Net Worth, determined as of each date below, at an
amount not less than the amount set forth opposite the applicable date:
<TABLE>
<CAPTION>

DATE MINIMUM BOOK NET WORTH
---- ----------------------
<S> <C>
March 31, 1999 $1,895,000
June 30, 1999 $1,970,000
September 30, 1999 $2,070,000
December 31, 1999 $2,670,000

</TABLE>

"Section 6.14 MINIMUM NET INCOME. The Borrower will achieve as
of each fiscal quarter end listed below, year-to-date Net Income of not
less than the amount set forth opposite such date:

DATE MINIMUM YEAR-TO-DATE NET INCOME
---- -------------------------------
<S> <C>
March 31, 1999 ($125,000)
June 30, 1999 ($50,000)
September 30, 1999 $50,000
December 31, 1999 $350,000

</TABLE>

In addition, for each month listed below, the Borrower must
achieve Net Income of not less than the amount set forth opposite such
month, and for each two-month period listed below, the Borrower must
achieve a cumulative Net Income of not less than the amount set forth
opposite such period:

MONTHS MINIMUM NET INCOME
------ ------------------
<S> <C>
April, 1999 & May, 1999 ($500,000)
July, 1999 & August, 1999 ($550,000)
October, 1999 & September, 1999 ($300,000)

</TABLE>

-2-
<PAGE>

"Section 6.15 MINIMUM DEBT SERVICE COVERAGE RATIO. The
Borrower will achieve a Debt Service Coverage Ratio at or above 1.00 to
1.00 as of each fiscal year end."

4. NEW COVENANTS. Section 6.17 of the Credit Agreement is
hereby amended in its entirety and replaced with the following new section:

Section 6.17 NEW COVENANTS. On or before March 31 of each
year, the Borrower and the Lender shall agree on new covenant levels
for Sections 6.12, 6.14, 6.15 and 7.10 for periods after such date. The
new covenant levels will be based on the Borrower's projections for
such periods and shall be no less stringent than the present levels.

5. NO OTHER CHANGES. Except as explicitly amended by this
Amendment, all of the terms and conditions of the Credit Agreement shall remain
in full force and effect and shall apply to any advance or letter of credit
thereunder.

6. WAIVER OF DEFAULTS. The Borrower is in default of the
following provisions of the Credit Agreement (collectively, the "Defaults"):

SECTION/COVENANT PERIOD REQUIRED ACTUAL
---------------- ------ -------- ------
<S> <C> <C> <C>
6.14 Minimum Net Income 10/31/98 not less than ($1,600,000) ($1,696,000)
11/30/98 not less than ($1,600,000) ($2,045,000)
12/31/98 not less than ($900,000) ($1,251,000)
6.15 Debt Service Coverage Ratio FYE 12/31/98 not less than 0.25 to 1.00 -0.43 to 1.00

</TABLE>

Upon the terms and subject to the conditions set forth in this
Sixth Amendment, the Lender hereby waives the Defaults. This waiver shall be
effective only in this specific instance and for the specific purpose for which
it is given, and this waiver shall not entitle the Borrower to any other or
further waiver in any similar or other circumstances.

7. DEFAULT WAIVER FEE. The Borrower shall pay the Lender a
fully earned, non-refundable fee in the amount of $50,500 in consideration of
the Lender's execution of this Amendment and the waiver granted in Paragraph 6.
The first $25,000 of such fee is payable as of the date hereof and the remainder
is payable in three equal monthly installments, the first installment due on
April 30, 1999 and each subsequent installment due on the last day of each month
thereafter.

-3-
<PAGE>

8. CONDITIONS PRECEDENT. This Amendment shall be effective
when the Lender shall have received an executed original hereof, together with
each of the following, each in substance and form acceptable to the Lender in
its sole discretion:

(a) Payment of the first $25,000 of the default waiver fee set
forth in Paragraph 7. If the remainder of the default waiver fee set
forth in Paragraph 7 hereof is not paid in full when due, the waiver
set forth in Paragraph 6 shall be null and void.

(b) Such other matters as the Lender may require.

9. REPRESENTATIONS AND WARRANTIES. The Borrower hereby
represents and warrants to the Lender as follows:

10. REFERENCES. All references in the Credit Agreement to
"this Agreement" shall be deemed to refer to the Credit Agreement as amended
hereby; and any and all references in the Security Documents to the Credit
Agreement shall be deemed to refer to the Credit Agreement as amended hereby.

11. NO OTHER WAIVER. Except as set forth in Paragraph 6, the
execution of this Amendment and acceptance of any documents related hereto shall
not be deemed to be a waiver of any Default or Event of Default under the Credit
Agreement or breach, default or event of default under any Security Document or
other document held by the Lender,

-4-
<PAGE>

whether or not known to the Lender and whether or not existing on the date of
this Amendment.

12. RELEASE. The Borrower hereby absolutely and
unconditionally releases and forever discharges the Lender, and any and all
participants, parent corporations, subsidiary corporations, affiliated
corporations, insurers, indemnitors, successors and assigns thereof, together
with all of the present and former directors, officers, agents and employees of
any of the foregoing, from any and all claims, demands or causes of action of
any kind, nature or description, whether arising in law or equity or upon
contract or tort or under any state or federal law or otherwise, which the
Borrower has had, now has or has made claim to have against any such person for
or by reason of any act, omission, matter, cause or thing whatsoever arising
from the beginning of time to and including the date of this Amendment, whether
such claims, demands and causes of action are matured or unmatured or known or
unknown.

13. COSTS AND EXPENSES. The Borrower hereby reaffirms its
agreement under the Credit Agreement to pay or reimburse the Lender on demand
for all costs and expenses incurred by the Lender in connection with the Credit
Agreement, the Security Documents and all other documents contemplated thereby,
including without limitation all reasonable fees and disbursements of legal
counsel. Without limiting the generality of the foregoing, the Borrower
specifically agrees to pay all fees and disbursements of counsel to the Lender
for the services performed by such counsel in connection with the preparation of
this Amendment and the documents and instruments incidental hereto. The Borrower
hereby agrees that the Lender may, at any time or from time to time in its sole
discretion and without further authorization by the Borrower, make a loan to the
Borrower under the Credit Agreement, or apply the proceeds of any loan, for the
purpose of paying any such fees, disbursements, costs and expenses.

14. MISCELLANEOUS. This Amendment may be executed in any
number of counterparts, each of which when so executed and delivered shall be
deemed an original and all of which counterparts, taken together, shall
constitute one and the same instrument.

-5-
<PAGE>

IN WITNESS WHEREOF, the parties hereto have caused this
Amendment to be duly executed as of the date first written above.

NORWEST BANK MINNESOTA MEDICAL GRAPHICS CORPORATION

/s/ Brett A. Beugen /S/ Dale H. Johnson
- ------------------------ --------------------------
Brett A. Beugen Dale H. Johnson
Its Officer Its Chief Financial Officer

-6-

<PAGE>

Exhibit 10.13

August 3, 1998

Mr. Richard Jahnke
25 Neptune Street
Mahtomedi, MN 55115

Dear Mr. Jahnke

We write to set forth our agreement with respect to your employment as the
President and Chief Executive Officer of Medical Graphics, Inc. (the "Company"),
commencing August 3, 1998 (the "Employment Date"). This agreement is intended to
be effective as of August 3, 1998, except for the Company's agreement in Section
3, which is effective as of December 16, 1998.

1. EMPLOYMENT. The Company hereby agrees to employ you, and you agree to be
employed by the Company, during the term stated in Section 6, and on the terms
and conditions hereinafter set forth. You will serve as the President and Chief
Executive Officer of the Company and, at no additional compensation, be elected
as a member of the Board of Directors, and in such other directorships, Board
committee memberships and offices of the Company and its subsidiaries to which
you may from time to time be elected or appointed by the Chairman of the Board.
You agree to serve the Company faithfully and, to the best of your ability, to
promote the Company's interest, and to devote your full working time, energy and
skill to the Company's business. You may attend to personal business and
investments, engage in charitable activities and community affairs, and serve on
a reasonable number of corporate, educational and civic boards, so long as those
activities do not interfere with your duties under this Agreement and provided
that service on any corporate boards on which you did not serve as of the date
hereof shall be subject to prior approval by the Board of Directors.

You will have such authority, powers, functions, duties, and
responsibilities as are normally accorded chief executive officers. You will
discharge your duties at all times in accordance with any and all policies
established by the Board of Directors and will report to, and be subject to the
direction of, the Board of Directors.

2. BASE SALARY.

As partial compensation for all of your services (including services as
director, Board committee member or officer of the Company and its subsidiaries)
during your term of employment hereunder, you will receive a base salary at an
annual rate of Two Hundred Forty Thousand Dollars ($240,000), payable in
biweekly installments. Such base salary shall be reviewed annually at the
discretion of the Board.

3. BONUS; STOCK OPTIONS.

(a) As additional compensation for your services, you shall be eligible
to earn bonus compensation for each fiscal year of the Company, commencing with
the fiscal year ending December 31, 1999, during your term of employment
hereunder in accordance with an incentive compensation plan

<PAGE>

Mr.Richard Jahnke
August 3, 1998
Page 2

to be mutually agreed to in advance of each such fiscal year by you and the
Company's Board of Directors.

(b) You shall receive, subject to shareholder approval as necessary,
options to purchase 400,000 shares of the Company's Common Stock at an exercise
price per share as listed below under the terms and conditions of the Company's
1987 Stock Option Plan. The option agreements shall be substantially in the form
of Exhibit A and Exhibit B attached hereto and shall have the following terms:

(i) A ten-year option to purchase 200,000 shares at a price of
$1.25 per share, which shall vest 25% on the date of grant which shall
be December 16, 1998, and an additional 25% per year on August 3, 1999,
2000, and 2001, subject to earlier vesting upon a Change in Control as
defined below.
This option will be an incentive stock option to the extent possible.

(ii) A ten-year option to purchase 200,000 shares at a price
of $2.25 per share, which shall vest on the date that is nine years and
eleven months from August 3, 1998, subject to earlier vesting upon the
achievement of reasonable performance goals as set forth on the exhibit
attached to the option or upon a Change in Control as defined below.

4. FRINGE BENEFITS.

(a) You will be eligible to participate in any and all Company
sponsored insurance (including medical, dental, life and disability insurance),
retirement, and other fringe benefit programs that it maintains for its
executive officers, subject to and on a basis consistent with the terms of each
such plan or program.

(b) You will be entitled to four weeks of paid vacation annually.

(c) The Company will pay or reimburse you $600 per month for all costs
associated with a private automobile selected by you, including, but not limited
to, lease costs, gas, repairs, general maintenance and insurance.

5. EXPENSES. During the term of your employment, the Company will reimburse you
for your reasonable travel and other expenses incident to your rendering of
services in conformity with its regular policies regarding reimbursement of
expenses as in effect from time to time. Payments to you under this paragraph
will be made upon presentation of expense vouchers in such detail as the Company
may from time to time reasonably require.

6. TERM AND TERMINATION.

(a) TERM. The term of this Agreement will begin on August 3, 1998 and
will continue for a period of two (2) years thereafter, unless and until
terminated in accordance with the terms of this Agreement (the "Original Term").
Upon the expiration of the Original Term of this Agreement, and on each
successive anniversary thereafter, the term of your employment under this
Agreement will be automatically extended for one (1) additional year, unless at
least 120 days prior to any such anniversary, either you or the Company delivers
to the other written notice of the notifying party's desire not to

<PAGE>

Mr.Richard Jahnke
August 3, 1998
Page 3

extend the term of your employment. Notice by the Company to not extend the term
of this Agreement shall not constitute termination without Cause under this
Agreement.

(b) TERMINATION. This Agreement and your employment may be
terminated prior to the end of the Term provided in Section
6(a):

(i) By your resignation upon 30 days prior written notice to
the Company;

(ii) By the Company for Cause (as defined in this Agreement)
immediately upon written notice to you.

(iii) By the Company for any reason and at any time upon 30
days prior written notice to you.

(iv) By the Company at any time in the event of your
Disability (as defined in this Agreement.)

(v) After a Change in Control, by you for Good Reason (as
defined in this Agreement) upon 30 days prior written notice to the
Company.

In the event of your termination of employment for any of the foregoing reasons,
you shall immediately resign as a director of the Company and any of its
subsidiaries.

7. CONSEQUENCES OF TERMINATION.

(a) TERMINATION FOR CAUSE; RESIGNATION WITHOUT GOOD REASON. If
your employment is terminated by the Company for Cause or by
you without Good Reason, then you will be paid your base
salary to the date of termination and the unpaid portion of
any bonus or incentive amount earned by you for the fiscal
year ending prior to the termination of your employment which
you are entitled to receive under the terms of the annual
incentive plan. You will not be entitled to receive any base
salary or fringe benefits for any period after the date of
termination, except for the right to receive benefits which
have become vested under any benefit plan or to which you are
entitled as a matter of law.

(b) TERMINATION WITHOUT CAUSE PRIOR TO A CHANGE IN CONTROL. If the
Company terminates your employment without Cause prior to a
Change in Control, then for a period of 12 months after the
effective date of the termination of your employment :

(i) The Company will continue to pay your then current
base salary in accordance with the Company's normal
payroll practice; and

(ii) The Company will pay the unpaid portion of any bonus
or incentive amount earned by you for the fiscal year
ending prior to the termination of your employment
which you are entitled to receive under the terms of
the applicable incentive plan; and

<PAGE>

Mr.Richard Jahnke
August 3, 1998
Page 4

(iii) You will be entitled to continued participation in
the health care coverage, and life insurance benefit
plans of the Company, as in effect on the date of
your termination as permitted by law. The Company
will continue to pay its share of the health care and
life insurance premiums for this coverage for a
period of up to 12 months, and you shall pay your
share of the cost associated with that coverage as if
you were still actively employed by the Company. If
you cannot be covered under any of the Company's
group plans or policies, the Company will reimburse
you for your full cost of obtaining comparable
alternative or individual coverage elsewhere, less
any contribution that you would have been required to
make under the Company's group plans or policies. If,
during the aforesaid 12-month period, you are
employed by a third party and become eligible for any
health care and/or life insurance coverage provided
by that third party, the Company will not,
thereafter, be obligated to provide you with the
insurance benefits described in this paragraph
(b)(iii). This 12-month coverage shall run
concurrently with COBRA and thereafter you shall be
responsible for the full cost of any such coverage
for which you may be entitled by law for the
remainder of the COBRA continuation period.

(c) TERMINATION IN THE EVENT OF DEATH OR DISABILITY. If your
employment terminates due to your death or if the Company
terminates your employment due to a Disability, then

(i) The Company will continue to pay your base salary to
your estate or to you for the remainder of the month
in which your death occurs or in which your
employment is terminated due to Disability, together
with the unpaid portion of any bonus or incentive
amount earned by you for the fiscal year ending prior
to the termination of your employment which you are
entitled to receive under the terms of the applicable
incentive plan; and in the event of termination due
to Disability, you will continue to receive, during
that month, all of the fringe benefits then being
paid or provided to you;

(ii) You will be entitled to receive all Disability and
other benefits, such as continued health coverage or
life insurance proceeds, provided in accordance with
the terms and condition of the health care coverage,
life insurance, disability, or other employee benefit
plans of the Company and applicable law; and .

(d) CHANGE IN CONTROL; TERMINATION WITHOUT CAUSE; RESIGNATION FOR
GOOD REASON. If, after a Change in Control, the Company
terminates your employment without Cause or you resign your
employment for Good Reason, then:

(i) For a period of 24 months after the effective date of
the termination of your employment:

(A) The Company will continue to pay your then
current base salary in accordance with the
Company's normal payroll practice; and

<PAGE>

Mr.Richard Jahnke
August 3, 1998
Page 5

(B) The Company will pay the unpaid portion of
any bonus or incentive amount earned by you
for the fiscal year ending prior to the
termination of your employment which you are
entitled to receive under the terms of the
applicable incentive plan; and

(C) You will be entitled to continued
participation in the health care coverage,
and life insurance benefit plans of the
Company, as in effect on the date of your
termination, for a period of up to 24
months. The Company will continue to pay its
share of the health care and life insurance
premiums for this coverage, and you shall
pay your share of the cost associated with
that coverage as if you were still actively
employed by the Company. If you cannot be
covered under any of the Company's group
plans or policies, the Company will
reimburse you for your full cost of
obtaining comparable alternative or
individual coverage elsewhere, less any
contribution that you would have been
required to make under the Company's group
plans or policies. If, during the aforesaid
24-month period, you are employed by a third
party and become eligible for any health
care coverage provided by that third party,
the Company will not, thereafter, be
obligated to provide you with the insurance
benefits described in this clause (C). This
24-month coverage shall run concurrently
with COBRA.

(ii) The Company will pay a reasonable amount for
out-placement and job search services for you by a
nationally recognized out-placement firm selected by
you and reasonably acceptable to the Company.

(d) The benefits provided you under this Section 7 are in lieu of
any benefits that would otherwise be provided to you under any
severance pay or other policies of the Company.

8. EFFECT OF TERMINATION ON STOCK OPTIONS.

(a) In the event of (i) the termination of your employment by the Company
other than for Cause, or (ii) your termination of your employment prior
to a Change in Control and other than by reason of death or Disability,
any vested stock options granted to you under Section 3, to the extent
unexercised, shall terminate ninety (90) days after termination and be
without further force or effect.

(b) In the event you are terminated for Cause as defined herein or you
violate any of your obligations under Section 10 following termination
of your employment and during such period as such provisions remain in
effect any vested stock options granted to you under Section 3, to the
extent unexercised, shall terminate 30 days after termination of
employment at which time the options shall be without further force or
effect.

(3) In the event of the termination of your employment by reason
of death or Disability, all options shall vest immediately and
shall remain exercisable for a period of one year (or such
earlier time as the option by their terms otherwise expire) at
which time the options shall be without further force or
effect.

<PAGE>

Mr.Richard Jahnke
August 3, 1998
Page 6

9. NO MITIGATION. Following termination of your employment for any reason, you
will be under no obligation to mitigate your damages by seeking other
employment, and there will be no offset against the amounts due you under
Section 7, except as specifically provided in Section 7(b)(iii) or for any
claims which the Company may have against you.

10. PROPERTY RIGHTS, CONFIDENTIALITY, NON-SOLICIT AND NON-COMPETE
PROVISIONS

(a) COMPANY'S PROPERTY.

(i) You shall promptly disclose to the Company in writing all
inventions, discoveries, and works of authorship, whether or not
patentable or copyrightable, which are conceived, made, discovered,
written, or created by you alone or jointly with another person, group,
or entity, whether during the normal hours of employment at the Company
or on your own time, during the term of this Agreement. You agree to
assign all rights to all such inventions and works of authorship to the
Company. You further agree to give the Company any of the assistance it
reasonably requires in order for the Company to perfect, protect and
use its rights to inventions and works of authorship.

This provision shall not apply to an invention, discovery, or work of
authorship for which no equipment, supplies, facility, or trade secret
information of the Company was used and which was developed entirely on
your own time and which does not relate to the business of the Company,
to the Company's anticipated research or development, or does not
result from any work performed by you for the Company.

(ii) You shall not remove any records, documents, or any other
tangible items (excluding your personal property) from the premises of
the Company in either original or duplicate form, except as is needed
in the ordinary course of conducting business for the Company.

(iii) You shall immediately deliver to the Company, upon
termination of employment with the Company, or at any other time upon
the Company's request, any property, records, documents, and other
tangible items (excluding your personal property) in your possession or
control, including data incorporated in word processing, computer, and
other data storage media, and all copies of such records, documents,
and information, including all Confidential Information, as defined
below.

(b) CONFIDENTIAL INFORMATION. During the course of your employment you
will develop, become aware of, and accumulate expertise, knowledge, and
information regarding the Company's organization strategies, business, and
operations and the Company's past, current, or potential customers, and
suppliers. Company considers such expertise, knowledge, and information to be
valuable, confidential, and proprietary, and it shall be considered Confidential
Information for purposes of this Agreement. During this Agreement and at all
times thereafter you agree not to use such Confidential Information or disclose
it to other persons or entities except as is necessary for the performance of
your duties for the Company or as has been expressly permitted in writing by the
Company. Provided, however, that the foregoing covenant shall not apply to any
information possessed by you prior to your employment by the Company, or to any
information which is in or has entered the public domain or has

<PAGE>

Mr.Richard Jahnke
August 3, 1998
Page 7

been disclosed with any industry segment in which the Company or any subsidiary
or affiliated company of the Company operates by or pursuant to the authority of
the Company or any subsidiary or affiliated company of the Company.

(c) NON-SOLICITATION. During (i) the term of this Agreement, and (ii)
the greater of (A) any period for which you are receiving payments under Section
7 of this Agreement, or (B) one year after the termination of this Agreement or
the date on which you are no longer employed by the Company in any capacity,
whichever shall last occur, you shall not directly or indirectly attempt to hire
away any then-current employee of the Company or a subsidiary of the Company or
to persuade any such employee to leave employment with the Company.

(d) NON-COMPETITION. During (i) the term of this Agreement and (ii) the
greater of (A) any period for which you are receiving payments under Section 7
of this Agreement, or (B) one year after termination of this Agreement or the
date on which you are no longer employed by the Company in any capacity,
whichever shall last occur, you shall not engage or participate, either
individually or as an employee, consultant, or principal, partner, agent,
trustee, officer, or director of a corporation, partnership, or other business
entity, in any business in which the Company, including any subsidiary or
affiliated company in which the Company has a more than 20 percent equity
interest, was engaged prior to the termination of this Agreement. Provided,
however, that mere ownership of not more than 5% of the outstanding common stock
of a company the securities however, which are publicly traded shall not
constitute competition for purposes of this Section 10(d).

The provisions of this Section 10 shall survive the termination of this
Agreement.

11. ARBITRATION. Any disputes arising under or in connection with this Agreement
(including without limitation the making of this Agreement) shall be resolved by
final and binding arbitration to be held in Minneapolis, Minnesota in accordance
with the rules and procedures of the American Arbitration Association. The
parties shall select a mutually acceptable single arbitrator to resolve the
dispute or if they fail or are unable to do so, each side shall within the
following ten (10) business days select a single arbitrator and the two so
selected shall select a third arbitrator within the following ten (10) business
days. The arbitration award or other resolution may be entered as a judgment at
the request of the prevailing party by any court of competent jurisdiction in
Minnesota or elsewhere. The arbitrator shall have no power to award any punitive
or exemplary damages. The arbitrator may construe or interpret, but shall not
ignore or vary the terms of this Agreement, and shall be bound by controlling
law. You acknowledge that your failure to comply with the terms of the Agreement
regarding Confidential Information, Inventions, and Non-Competition could cause
immediate and irreparable injury to the Company and that therefore, the
arbitrators, or a court of competent jurisdiction, if an arbitration panel
cannot immediately be convened, will be empowered to provide injunctive relief,
including temporary or preliminary relief, to restrain any such failure to
comply. Each party shall bear its own costs and attorneys' fees in connection
with the arbitration.

<PAGE>

Mr.Richard Jahnke
August 3, 1998
Page 8

12. DEFINITIONS. For purposes of this Agreement, the following terms
will have meanings set forth below:

(a) CAUSE. "Cause" means that you have (A) committed an act of
dishonesty or fraud or involving a breach of trust; (B) committed any act or
omission that is a substantial cause for a regulatory body with jurisdiction
over the Company or any of its affiliates to request or recommend adverse action
against you, the Company, or any of its affiliates; (C) been indicted for or
convicted of any felony including moral turpitude; (D) failed to follow any
reasonable and material policy of the Company or reasonable and material
instructions of the Company's Board of Directors; (E) engaged in any gross
misconduct or gross negligence in the performance of your duties; (F) failed to
make substantial progress toward one or more of the performance goals
established between you and the Company's Board of Directors as established in
the budget approved by the Board of Directors; or (G) have otherwise materially
breached this Agreement. In the case of conduct described in clauses (D), (E),
(F) and (G), the Company must give you written notice of that failure or breach
and you will have 30 days to correct the same. You will be entitled to a hearing
before the Board of Directors of the Company before any termination for Cause
described in clauses (D), (E) and (F) becomes effective.

(b) CHANGE IN CONTROL. A "Change in Control" means a change in control
of the Company of a nature that would be required to be reported (assuming such
event has not been previously reported) in response to Item 1(a) of the Current
Report on Form 8-K, as in effect on the date hereof, pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934 (the "Exchange Act"); provided,
that, without limiting the foregoing, a "Change in Control" shall be deemed to
have occurred at such time as (i) any person (that is not currently a 35%
beneficial owner) is or becomes a "beneficial owner" (as defined in Rule 13d-3
under the Exchange Act), directly or indirectly, of 35 percent or more of the
combined voting power of the Company's outstanding securities ordinarily
possessing the right to vote for the election of directors; (ii) there ceases to
be a majority of the Board of Directors comprised of the individuals described
in the next sentence, or (iii) the Company disposes of all or substantially all
of its assets. For purposes of this paragraph, "Board of Directors" shall mean:
individuals who on the date hereof constituted the Board of Directors and any
new director who subsequently was elected or nominated for election by a
majority of the directors who held such office immediately prior to the Change
in Control.

(c) DISABILITY. "Disability" means that you are deemed to be disabled
under the terms of the Company's long term disability plan and have satisfied
the qualifying period for entitlement to benefits under such plan.

(d) GOOD REASON. "Good Reason" means, after a Change in Control, the
Company, without your express written consent, (A) materially reduces your
principal duties, responsibilities, or authority as President and Chief
Executive Officer; (B) reduces your annual base compensation as described in
Section 2 (including any increases given under Section 2(b)) or your target
bonus as described in Section 3, or reduces the benefits provided you under any
fringe benefit plan; provided, however, that the Company may alter, amend or
terminate any benefit plan so long as any such change applies to executive
officers generally; (C) relocates the Company's corporate headquarters or your
principal place of work outside the Minneapolis-Saint Paul metropolitan area; or
(D) materially breaches this Agreement. The occurrence of an event described in
this Section 12 (d) will not constitute Good Reason unless, within 60 days
thereof, you give the Company written notice stating that an event of Good
Reason has occurred

<PAGE>

Mr.Richard Jahnke
August 3, 1998
Page 9

and describing that event, and the Company does not correct the same, if the
same is correctable, within 30 days.

13. GENERAL PROVISIONS.

(a) This Agreement may not be amended or modified except by a
written agreement signed by both of us.

(b) In the event that any provision or portion of this agreement
are determined to be invalid or unenforceable for any reason,
the remaining provisions of this Agreement will remain in full
force and effect to the fullest extent permitted by law.

(c) This Agreement shall bind and benefit the parties hereto and
their respective successors and assigns, but none of your
rights or obligations hereunder may be assigned by either
party hereto without the written consent of the other, except
by operation of law upon your death.

(d) This Agreement has been made in and shall be governed and
construed in accordance with the laws of the State of
Minnesota without giving effect to the principles of conflict
of laws of any jurisdiction.

(e) No failure on the part of either party to exercise, and no
delay in exercising, any right or remedy under this Agreement
will operate as a waiver; nor will any single or partial
exercise of any right or remedy preclude any other or further
exercise of any right or remedy.

(f) Any notice or other communication under this Agreement must be
in writing and will be deemed given when delivered in person,
by overnight courier (with receipt confirmed), by facsimile
transmission (with receipt confirmed by telephone or by
automatic transmission report), or upon receipt if sent by
certified mail, return receipt requested, as follows (or to
such other persons and/or addresses as may be specified by
written notice to the other party):

If to Medical Graphics, Inc.:

Medical Graphics, Inc.
Attention: Chairman of the Board of Directors
350 Oak Grove Parkway
St. Paul, MN 55127

With a copy to:

Lindquist & Vennum, PLLP
4200 IDS Center
Minneapolis, MN 55402
Attn: Thomas G. Lovett

If to Richard Jahnke:

<PAGE>

Mr.Richard Jahnke
August 3, 1998
Page 10

Richard Jahnke
25 Neptune Street
Mahtomedi, MN 55115

(g) This Agreement, and the option agreements ancillary hereto
contains our entire understanding and agreement with respect
to these matters and supersedes all previous agreements,
discussions, or understandings, whether written or oral,
between us on the same subjects.

(h) In the event any provision of this Agreement is held
unenforceable, that provision will be severed and shall not
affect the validity or enforceability of the remaining
provisions. In the event any provision is held to be
overbroad, that provision shall be deemed amended to narrow
its application to the extent necessary to render the
provision enforceable according to applicable law.

(i) All terms of this Agreement intended to be observed and
performed after the termination of this Agreement will survive
such termination and will continue in full force and effect
thereafter, including without limitation, Sections 7, 8, 9, 10
and 11.

(j) The headings contained in this Agreement are for convenience
only and shall in no way restrict or otherwise affect the
construction of the provisions hereof. Unless otherwise
specified herein, references in this Agreement to Sections and
Exhibits are to the sections of and exhibits to this
Agreement. This Agreement may be executed in multiple
counterparts, each of which shall be an original and all of
which together shall constitute one and the same instrument.

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

If the foregoing correctly sets forth your understanding of our agreement,
please so indicate by signing and returning to us a copy of this letter.

Very truly yours,

MEDICAL GRAPHICS CORPORATION

/s/ Mark W. Sheffert
------------------------------------
Its Chairman

Accepted and agreed to:

/s/ Richard E. Jahnke
- -------------------------
Richard Jahnke

<PAGE>

Exhibit 10.14

MEDICAL GRAPHICS CORPORATION
STOCK OPTION AGREEMENT

THIS AGREEMENT, made as of the 9th day of January, 1999 by and between
MEDICAL GRAPHICS CORPORATION, a Minnesota corporation (the "Company"), and Mark
W. Sheffert (the "Optionee");

W I T N E S S E T H:

WHEREAS, the Optionee on the date hereof is a non-employee director of
the Company or a Subsidiary of the Company; and

WHEREAS, the Company's Board of Directors believes it is appropriate to
grant Mr. Sheffert additional compensation in light of all the work he has done
for the Company in his capacity as Chairman, in particular, Mr. Sheffert's
efforts as Chairman in raising (i) $1.5 million in financing in March and April
1997; (ii) $3.0 million in financing in November 1997 and January and February
1998 and (iii) $550,000 in September 1998.

WHEREAS, the Company's Board of Directors has adopted a stock option
plan providing for the grant of non-qualified stock options known as the
"Medical Graphics Corporation 1994 Non-Employee Director Compensation Plan"
(hereinafter referred to as the "Plan"); and

WHEREAS, as of the date hereof, the Company's Board of Directors (or,
if so appointed and empowered by the Board, the Board's Stock Option Committee)
authorized the grant of this non-qualified stock option to the Optionee,
including the immediate vesting provisions of Section 4.

NOW, THEREFORE, in consideration of the premises and the mutual
covenants herein contained, the Company and the Optionee hereby agree as
follows:

1. GRANT OF OPTION. The Company hereby grants to the Optionee, as of
the date of this Agreement, the option to purchase 150,000 shares of Common
Stock of the Company (the "Option Stock") subject to the terms and conditions
herein contained, and subject only to adjustment in such number of shares as
provided in Section 12 of the Plan.

<PAGE>

2. OPTION PRICE. During the term of this option, the purchase price for
the shares of Option Stock granted herein is $1.25 per share, subject only to
adjustment of such price as provided in Section 12 of the Plan.

3. TERM OF OPTION. The term of this Option shall be for a period of
five (5) years from January 9, 1999 (the "Option Date").

4. EXERCISE OF OPTION. This Option shall be exercisable in full as of
the date of this grant.

5. PERSONAL EXERCISE BY OPTIONEE. This option shall, during the
lifetime of the Optionee, be exercisable only by said Optionee and shall not be
transferable by the Optionee, in whole or in part, other than by will or by the
laws of descent and distribution.

6. MANNER OF EXERCISE OF OPTION. This option is to be exercised by the
Optionee (or by the Optionee's successor or successors) by giving written notice
to the Company of an election to exercise such option. Such notice shall specify
the number of shares to be purchased hereunder and shall specify a date (not
more than 30 calendar days and not less than 10 calendar days from the date of
delivery of the notice to the Company on which the Optionee shall deliver
payment of the full purchase price for the shares being purchased and the
Company shall deliver certificates to the Optionee representing the shares so
purchased. Such notice shall be delivered to the Company at its principal place
of business. An option shall be considered exercised at the time the Company
receives such notice. Upon receipt of such notice and subject to the provision
of Paragraph 9 below, the Company shall, on the date specified in such notice
and against payment by the Optionee of the required purchase price, deliver to
the Optionee certificates for the shares so purchased. Payment for shares of
Option Stock may be made in the form of cash, check, bank draft, or money order.
All requisite original issue or transfer documentary stamp taxes shall be paid
by the Company.

7. RIGHTS AS A SHAREHOLDER. The Optionee or a transferee of this option
shall have no rights as a shareholder with respect to any shares covered by this
option until the date of the issuance of a stock certificate for such shares. No
adjustment shall be made for dividends (ordinary or extraordinary, whether in
cash, securities or other property), distributions or other rights for which the
record date is prior to the date such stock certificate is issued, except as
provided in Section 12 of the Plan.

8. STOCK OPTION PLAN. The option evidenced by this Agreement is granted
pursuant to the Plan, a copy of which Plan is attached hereto or has been made
available to the Optionee and is hereby made a part of this Agreement. This
Agreement is subject to and in all respects limited and conditioned as provided
in the Plan. The Plan governs this option and the Optionee, and in the event of
any question as to the construction of this Agreement or of a conflict between

<PAGE>

the Plan and this Agreement or of a conflict between the Plan and this
Agreement, the Plan shall govern, except as the Plan otherwise provides.

9. WITHHOLDING TAXES. In order to permit the Company to receive a tax
deduction in connection with the exercise of this option, the Optionee agrees
that as a condition to any exercise of this option, the Optionee will also pay
to the Company, or make arrangements satisfactory to the Company regarding
payment of, any federal, state, local or other taxes required by law to be
withheld with respect to the option's exercise.

10. INVESTMENT PURPOSE. The Company requires as a condition to the
grant and exercise of this option that any stock acquired pursuant to this
option be acquired for only investment if, in the opinion of counsel for the
Company, such is required or deemed advisable under securities laws or any other
applicable law, regulation or rule or any government or governmental agency. In
this regard, if requested by the Company, the Optionee, prior to the acquisition
of any shares pursuant to this option, shall execute an investment letter to the
effect that the Optionee is acquiring shares pursuant to the option for
investment purposes only and not with the intention of making any distribution
of such shares and will not dispose of the shares in violation of the applicable
federal and state securities laws.

11. TERMINATION OF DIRECTORSHIP. If the Optionee ceases to be a
director of the Company or any Subsidiary for any reason, or because of the
sale, merger, consolidation or liquidation of the Company (which is covered by
the provisions of Section 12 of the Plan), this option shall nevertheless
terminate on the option's originally stated expiration date.

12. RECAPITALIZATIONS, SALES, MERGERS, EXCHANGES, CONSOLIDATIONS,
LIQUIDATION. In the event of a stock dividend or stock split, the number of
shares of Option Stock and option exercise price shall be adjusted as provided
in Section 12 of the Plan. Similarly, in the event of a sale, merger, exchange,
consolidation or liquidation of the Company, this option shall be adjusted as
provided in Section 12 of the Plan.

13. SCOPE OF AGREEMENT. This Agreement shall bind and inure to the
benefit of the Company and its successors and assigns and the Optionee and any
successor or successors of the Optionee permitted by Paragraph 5 above.

IN WITNESS WHEREOF, the Company and the Optionee have executed this
Agreement in the manner appropriate to each, as of the day and year first above
written.

3
<PAGE>

MEDICAL GRAPHICS CORPORATION

/s/ Richard E. Jahnke
--------------------------------------
Its President and Director

Mark W. Sheffert

/s/ Mark W. Sheffert
--------------------------------------
Optionee

4
<PAGE>

<PAGE>

MEDICAL GRAPHICS CORPORATION

CONSOLIDATED FINANCIAL STATEMENTS FOR THE
YEARS ENDED DECEMBER 31, 1998 AND 1997
AND INDEPENDENT AUDITORS' REPORT

<PAGE>

INDEPENDENT AUDITORS' REPORT

Shareholders and Board of Directors
Medical Graphics Corporation

We have audited the accompanying consolidated balance sheets of Medical Graphics
Corporation and Subsidiary (the Company) as of December 31, 1998 and 1997 and
the related consolidated statements of operations, shareholders' equity, and
cash flows for the years then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated 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 audits to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements present fairly, in all
material respects, the financial position of Medical Graphics Corporation and
Subsidiary at December 31, 1998 and 1997 and the results of their operations and
cash flows for the years then ended, in conformity with generally accepted
accounting principles.

April 14, 1999
Minneapolis, Minnesota

<PAGE>

MEDICAL GRAPHICS CORPORATION

CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
1998 1997

ASSETS
<S> <C> <C>
Current Assets:
Cash $ 387
Accounts receivable, less allowance for doubtful accounts of $118 and $164, respectively $ 5,263 3,890
Inventories (Notes 1 and 2) 4,917 4,800
Prepaid expenses and other current assets 155 272
------------ ------------
Total current assets 10,335 9,349

Equipment and Fixtures (Notes 1 and 3) 4,092 4,072
Less accumulated depreciation 3,574 3,110
------------ ------------
Equipment and fixtures, net 518 962

Software Production Costs, less accumulated amortization of $1,212
and $855, respectively (Note 1) 566 602

Other Assets 7 13
------------ ------------
$ 11,426 $ 10,926
------------ ------------
------------ ------------

LIABILITIES AND SHAREHOLDERS' EQUITY

Current Liabilities:
Accounts payable $ 2,975 $ 2,261
Accounts payable financed with vendors - current (Note 1) 769 1,145
Note payable (Note 8) 3,291 2,254
Employee compensation 517 786
Deferred service contract revenue 870 896
Warranty reserve 374 414
Other liabilities and accrued expenses 327 675
------------ ------------
Total current liabilities 9,123 8,431

Long-Term Accounts Payable Financed with Vendors (Note 1) 48 807

Commitments and Contingencies (Notes 7 and 12)

Shareholders' Equity (Notes 1, 9, and 10):
Class A convertible common stock, par value $.05 per share;
500,000 shares authorized, liquidation preference of $3.38 per share,
444,000 issued and outstanding, convertible into 1,500,000 shares
of common stock 22 22
Common stock, par value $.05 per share; authorized 9,500,000 shares; issued
and outstanding 5,608,000 and 4,453,000, respectively 280 223
Additional paid-in capital 15,738 13,652
Retained deficit (13,785) (12,209)
------------ ------------
Total shareholders' equity 2,255 1,688
------------ ------------
$ 11,426 $ 10,926
------------ ------------
------------ ------------
</TABLE>

See notes to consolidated financial statements.

2
<PAGE>

MEDICAL GRAPHICS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Revenues (Note 4):
Equipment sales $ 15,216 $ 14,492
Service and supplies revenue 5,233 4,681
------------ ------------
Total revenues 20,449 19,173

Cost of Goods Sold:
Cost of equipment sales 9,293 9,460
Cost of service and supplies revenues 3,148 2,509
------------ ------------
Total cost of goods sold 12,441 11,969
------------ ------------

Gross Margin 8,008 7,204

Operating Expenses:
Selling and marketing 5,653 6,282
General and administrative 1,927 2,228
Research and development 1,550 1,867
Non-recurring charges (Note 5) 1,610
------------ ------------
Total operating expenses 9,130 11,987
------------ ------------

Loss from Operations (1,122) (4,783)

Other Expense -
Interest expense (454) (329)
------------ ------------

Loss Before Income Tax Benefit (1,576) (5,112)

Income Tax Benefit (Note 6) - -
------------ ------------

Net Loss $ (1,576) $ (5,112)
------------ ------------
------------ ------------

Basic and Dilutive Net Loss per Share of Common Stock (Note 1) $ (0.26) $ (1.15)
------------ ------------
------------ ------------

Weighted Average Common Shares Outstanding 6,015 4,449
------------ ------------
</TABLE>

See notes to consolidated financial statements.

3
<PAGE>

MEDICAL GRAPHICS CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
CLASS A STOCK COMMON STOCK ADDITIONAL RETAINED
---------------- ---------------- PAID-IN EARNINGS
SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) TOTAL
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 3,839 $ 192 $ 10,160 $ (7,097) $ 3,255

Net loss (5,112) (5,112)
Class A stock issued in a private sale,
net of issuance costs 444 $ 22 1,434 1,456
Common stock issued to Chairman of
Board of Directors 45 2 100 102
Common stock issued in a private sale,
net of issuance costs 545 28 1,384 1,412
Common stock issued under Employee
Stock Purchase Plan 24 1 66 67
Warrants issued in conjunction with
development and implementation of
cost reduction plan (Note 5) 508 508
------ ------- --------- ------- ---------- --------- ---------

Balance at December 31, 1997 444 22 4,453 223 13,652 (12,209) 1,688

Net loss (1,576) (1576)
Common stock issued under Employee
Stock Purchase Plan 20 1 44 45
Common stock issued in private sales,
net of issuance costs (Note 9) 1,096 54 1,916 1,970
Common stock issued to a former employee 15 1 44 45
Common stock issued upon exercise of
stock options 3 8 8
Common stock issued to directors 21 1 74 75
------ ------- --------- ------- ---------- --------- ---------

Balance at December 31, 1998 444 $ 22 5,608 $ 280 $ 15,738 $ (13,785) $ 2,255
------ ------- --------- ------- ---------- --------- ---------
------ ------- --------- ------- ---------- --------- ---------
</TABLE>

See notes to consolidated financial statements.

4
<PAGE>

MEDICAL GRAPHICS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998 AND 1997 (IN THOUSANDS)
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss $(1,576) $(5,112)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation 511 579
Amortization, principally software production costs 357 287
Common stock issued to directors and former officers in lieu of compensation 120
Common stock and warrants issued in conjunction with the development
and implementation of a cost reduction plan (Note 5) 610
Changes in operating assets and liabilities:
Accounts receivable (1,373) 924
Inventory (117) 2,393
Prepaid expenses and other assets 123 (72)
Accounts payable (671) (186)
Employee compensation, other liabilities, and accrued expenses (617) (497)
Warranty reserve (40) (149)
Deferred service contract revenue (26) (92)
-------- -------
Net cash used in operating activities (3,309) (1,315)

Cash Flows from Investing Activities:
Capital expenditures (67) (215)
Software production costs (321) (417)
-------- -------
Net cash used in investing activities (388) (632)

Cash Flows from Financing Activities:
Borrowings under line of credit agreement 22,483 18,682
Repayments under line of credit agreement (21,446) (19,828)
Net proceeds from issuance of common stock 1,773 2,935
------- -------
Net cash provided by financing activities 2,810 1,789
------- -------

Decrease in Cash (387) (158)

Cash at Beginning of Year 387 545
------- -------

Cash at End of Year $ - $ 387
------- -------
------- -------
</TABLE>

See notes to consolidated financial statements.

5
<PAGE>

MEDICAL GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------

1. DESCRIPTION OF BUSINESS, LIQUIDITY, AND SIGNIFICANT ACCOUNTING POLICIES

BUSINESS - Medical Graphics Corporation (the Company) designs and produces
innovative noninvasive diagnostic systems for the prevention, early
detection, and cost-effective treatment of heart and lung disease. In
addition, the Company purchases noninvasive sleep diagnostic systems from
a third-party.

LIQUIDITY - The Company's working capital requirements for 1998 were met
principally through amounts borrowed on the Company's line of credit (see
Note 8), the issuance of common stock under private sales to investors
(see Note 9), and credit arrangements made with the Company's vendors
during the first quarter 1997. This vendor credit consisted of the Company
entering into financing arrangements with certain vendors that provided
for payment of outstanding balances in equal monthly installments for up
to 36 months. The remaining amounts due under these vendor agreements are
payable in the amount of $769,000 and $48,000 in 1999 and 2000,
respectively. The balances outstanding at December 31, 1998 that will be
paid after December 31, 1999 have been classified as long-term accounts
payable financed with vendors.

In addition, the Company incurred net losses of $1,576,000 and $5,112,000
for the years ended December 31, 1998 and 1997, respectively. Management
plans to generate profitable operations by increasing revenues, improving
gross margins, and controlling expenses. There can be no assurance the
Company will be able to generate profitable operations in the future.

CONSOLIDATION - The financial statements include the accounts of the
Company and its wholly owned subsidiary, Medical Graphics Corporation,
GmbH (MGCG). All intercompany transactions have been eliminated. The
operations of MGCG were terminated early in 1997 in accordance with an
exit plan adopted in the fourth quarter of 1996 (see Note 5).

INVENTORIES - Inventories are valued at the lower of cost or market
determined by the first-in, first-out method.

EQUIPMENT AND FIXTURES - Equipment and fixtures are stated at cost. The
Company provides for depreciation using straight-line and accelerated
methods at rates designed to amortize the cost of equipment and fixtures
over their estimated useful lives.

SOFTWARE PRODUCTION COSTS - Software production costs are capitalized once
technological feasibility has been established and all research and
development activities for other components of the product are completed.
Capitalized software production costs are amortized over three years using
the straight-line method.

REVENUE RECOGNITION - Sales are recorded by the Company when products are
shipped or services are provided to the customer.

DEFERRED SERVICE CONTRACTS - Amounts billed to customers under service
contracts are deferred and recognized as income over the term of the
agreement, and costs are recognized as incurred.

6
<PAGE>

INCOME TAXES - Income taxes are recorded under the liability method.
Deferred income taxes are recorded to reflect the tax consequences in
future years of differences between the basis of assets and liabilities
for income tax and for financial reporting purposes using enacted tax
rates in effect during the year in which the differences are expected to
reverse. Deferred tax asset valuation allowances are recorded to reduce
deferred tax assets to the amount expected to be realized.

BASIC AND DILUTIVE NET LOSS PER SHARE - In 1997, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 128, EARNINGS PER
SHARE. Basic net loss per share of common stock is computed by dividing
net loss by the weighted average number of common shares outstanding
during each year. For purposes of this calculation, the convertible Class
A common shares are assumed to have been converted. Common equivalent
shares from stock options and warrants to purchase 1,697,000 and 1,342,000
shares of common stock at a range of $1.00 to $8.67 and $1.92 to $10.00
were outstanding during 1998 and 1997, respectively, but are excluded from
the computation of dilutive net loss per share as their effect is
antidilutive. Therefore, basic and dilutive net loss per share amounts are
equal for each of the periods presented.

SALES AND SEGMENT INFORMATION - The Company manufactures and sells its
products to customers in the medical field and operates in only one
business segment. The Company grants its customers credit in connection
with sales of its products. It performs periodic credit evaluations of its
customers' financial condition and generally does not require collateral.
The Company requires irrevocable letters of credit on sales to certain
foreign customers. Receivables generally are due within 30 days for
domestic customers. Credit losses relating to customers have consistently
been within management's expectations. Export sales to foreign countries,
primarily in Europe and the Pacific Rim, accounted for 13% and 18% of
total sales in 1998 and 1997, respectively.

USE OF ESTIMATES - The preparation of the consolidated financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes.
Actual results could differ from the estimates.

IMPAIRMENT OF LONG-LIVED ASSETS - The Company records losses on long-lived
assets used in operations when indicators of impairment are present and
the undiscounted cash flows estimated to be generated by those assets are
less than the carrying amount. To the extent long-lived assets are
considered impaired, such assets are adjusted to their estimated fair
values with fair value determined by the present value of discounted
future cash flows or, to the extent such long-lived assets are held for
sale, the estimated sales proceeds less costs of disposal.

ACCOUNTING PRONOUNCEMENT - In June 1997, the Financial Accounting
Standards Board issued SFAS No. 131, DISCLOSURE ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION, which changes the way public companies
report information about operating segments. SFAS No. 131, which is based
on the management approach to segment reporting, establishes requirements
to report selected segment information quarterly and to report entitywide
disclosures about products and services, major customers, and material
countries in which the entity holds assets and reports revenue. The
Company adopted SFAS No. 131 as of December 31, 1998. The Company operates
within a single operating segment.

COMPREHENSIVE EARNINGS(LOSS) - Comprehensive earnings (loss) is a measure
of all nonowner changes in shareholders' equity and includes such items as
net earnings, certain foreign currency translation items, minimum pension
liability adjustments, and changes in the value of available-

7
<PAGE>

for-sale securities. In 1998 and 1997, comprehensive earnings (loss) for
the Company was the same as net earnings (loss) as reported.

RECLASSIFICATIONS - Certain reclassifications have been made to the 1997
financial statements to conform to the classifications used in 1998. These
reclassifications had no effect on previously reported net loss or
shareholders' equity.

2. INVENTORIES

At December 31, the Company's inventories consisted of the following
components (in thousands):

<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Purchased components and work-in-process $ 2,941 $ 3,164
Finished goods 1,976 1,636
------- -------
$ 4,917 $ 4,800
------- -------
------- -------
</TABLE>

3. EQUIPMENT AND FIXTURES

At December 31, the Company's equipment and fixtures consisted of the
following (in thousands):

<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Building improvements $ 742 $ 733
Computer equipment 1,548 1,491
Manufacturing equipment 933 933
Furniture and fixtures 869 915
------- -------
Total equipment and fixtures, at cost 4,092 4,072
Less accumulated depreciation 3,574 3,110
------- -------
$ 518 $ 962
------- -------
------- -------
</TABLE>

4. GEOGRAPHIC INFORMATION

The Company manages its business on the basis of one reportable segment.
See Note 1 for a brief description of the Company's business. As of
December 31, 1998, the Company had operations established in various
countries throughout the world. The Company is exposed to the risk of
changes in social, political, and economic conditions inherent in foreign
operations, and the Company's results of operations are affected by
fluctuations in foreign currency exchange rates. In no single country
outside the United States did operations account for more than 10% of the
Company's net sales for 1998 and 1997. Net sales by geographic area are
presented by attributing revenues from external customers on the basis of
where the products are sold.

8
<PAGE>

Net sales by geographic area:

<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
United States $ 17,770 $ 15,637
International 2,679 3,536
---------- ----------
$ 20,449 $ 19,173
---------- ----------
---------- ----------
</TABLE>

5. NON-RECURRING CHARGES

During December 1996, the Board of Directors approved closing the
Company's sales and marketing subsidiary in Germany and authorized
implementation of a restructuring plan. The Company recorded a $550,000
charge to operations in the fourth quarter of 1996 related to expected
exit costs of the German office. Of this total, $250,000 was recorded as
cost of goods sold and $100,000 was recorded in general and administrative
expenses, and the remainder as a non-recurring charge. During 1997, the
Company recorded an additional $150,000 charge for employee severance
related to the subsidiary in Germany and implemented certain cost
reduction strategies that included the termination of certain
additional employees and the sale of a products line. Non-recurring
charges of $1,610,000, substantially all of which were paid during 1997,
included employee severance, legal, consulting, and accounting expenses.

In connection with the 1997 cost reduction efforts, the Company granted
the former chairman of the Company a warrant to purchase 195,000 shares of
common stock at a price of $2.67 per share in exchange for certain
consulting services to the Company. The warrant expires on March 31, 2000.
The Company also issued 45,000 shares of common stock and granted a
warrant to purchase 225,000 shares of common stock at a price of $2.25 per
share to an individual for services provided in connection with the
development and implementation of the cost reduction plan. This individual
also was elected the Chairman of the Board of Directors. The warrant
expires on March 31, 2002. Non-recurring charges in 1997 included
$537,000 relating to the issuance of stock and warrants.

6. INCOME TAXES

Significant components of the income tax benefit are as follows:

<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Current:
Federal $ - $ -
State - -
Deferred - -
------- -------
Income tax benefit $ - $ -
------- -------
------- -------
</TABLE>

9
<PAGE>

Significant components of the Company's deferred tax assets and
liabilities at December 31 are as follows (in thousands):

<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Allowance for bad debts $ 42 $ 58
Inventory reserve 69 69
Warranty reserve 133 147
Other reserve 63
Vacation accrual 36 48
Deferred service contract revenue 58 60
Valuation allowance (338) (445)
-------- --------
Total current - -

Inventory capitalization 15 3
Capitalized software and patents (201) (214)
Net operating loss and tax credit carryforwards 4,635 3,806
Valuation allowance (4,449) (3,595)
-------- --------
Total noncurrent - -
-------- --------

Net deferred tax assets $ - $ -
-------- --------
-------- --------
</TABLE>

Reconciliations of the Company's expected income tax benefits computed at
the U.S. federal statutory tax rate to the income tax benefits recorded
are as follows (in thousands):

<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Income tax benefit at statutory rate $ (552) $ (1,789)
Increase of deferred tax asset valuation allowance 747 1,139
Utilization of net operating loss carryforward related
to IRS audit adjustments for 1994 and 1993 613
Other (195) 37
-------- --------
$ - $ -
-------- --------
-------- --------
</TABLE>

As of December 31, 1998, the Company had federal net operating loss
carryforwards of $12,290,000 that expire from 2002 through 2012. The
Internal Revenue Service has examined the Company's income tax returns
through December 31, 1995. Total income taxes paid were $6,000 and $24,000
in 1998 and 1997, respectively.

7. LEASES

The Company leases office and manufacturing facilities, automobiles, and
various office accessories. The building lease expires in 2002, at which
time the Company has an option to renew the lease for an additional four
years. The Company has the option to purchase the building at the end of
each lease expiration period at the building's fair market value.

10
<PAGE>

Future minimum lease payments under noncancelable operating leases with
remaining terms of one year or more consisted of the following at December
31, 1998 (in thousands):

<TABLE>
<CAPTION>
Year ending December 31:
<S> <C>
1999 $ 397
2000 367
2001 357
2002 172
-------
$ 1,293
-------
-------
</TABLE>

Rent expense for the years ended December 31, 1998 and 1997 was $420,000
and $490,000, respectively.

8. NOTE PAYABLE TO BANK

In March 1997, the Company obtained a new credit agreement with Norwest
Business Credit, Inc. (Norwest) that provides for total borrowings, based
on available collateral as defined, of up to $4,100,000, at the discretion
of Norwest, and expires March 31, 2000. The credit line allows the Company
to borrow up to 80% of eligible domestic accounts receivable, 40% of
eligible domestic inventory (not to exceed $1,500), and 90% of eligible
foreign accounts receivable. The Company's accounts receivable and
inventories secure total borrowings outstanding under the credit
agreement. The credit agreement contains certain restrictive covenants,
including maintenance of minimum net worth (as defined), earnings
requirements, and debt service requirements as well as limitations on
capital expenditures and payment of dividends.

Borrowings under the line of credit bear interest at the Norwest "base"
rate plus 4.0% (11.75% at December 31, 1998). The "base" rate is equal to
the interest rate publicly announced by Norwest Bank Minnesota, National
Association from time to time as its "base" rate. The line of credit
contains a minimum monthly interest charge of $15,000. In addition, the
Company granted to Norwest a three-year warrant to purchase 93,750 shares
of the Company's common stock at an exercise price of $2.25 per share. The
value of this warrant ($73,000) is being amortized to interest expense
over the term of the line of credit. The warrant contained antidilution
provisions and as a result of the Company's September 1998 issuance of
common stock, the warrant exercise price decreased to $1.00 per share and
the shares issuable under the warrant increased to 210,937 shares.

The Company had outstanding borrowings of $3,291,000 and $2,254,000 at
December 31, 1998 and 1997, respectively, and at December 31, 1998 had
additional borrowing availiability of $744,000. Total cash paid for
interest was $454,000 and $329,000 for the years ended December 31, 1998
and 1997, respectively. The Company amended its line of credit agreement
in June and November 1997 as well as March, August, and September 1998. As
of December 31, 1998, the Company was in technical default of its minimum
net income and minimum debt service coverage ratio covenants. These
technical defaults were waived through an amendment to the line of credit
agreement on March 29, 1999.

9. CAPITAL STOCK

In June 1998, the Company distributed a three-for-two stock split effected
in the form of a stock dividend. All share and per share data have been
adjusted to reflect this stock split.

11
<PAGE>

In March 1997, the Company's Board of Directors authorized 500,000 shares
of a new class of convertible stock (Class A stock). The Class A stock has
voting rights. Each share was originally convertible into 1.5 share of
common stock. The Company issued 444,000 shares of the new class of stock
receiving net proceeds of $1,456,000.

In October 1997, the Company's Board of Directors authorized the issuance
of additional common stock in a private sale to investors. On November 10,
1997 the Company agreed to sell up to 1,091,000 shares of the Company's
common stock at a price of $2.75 per share. The investors purchased
545,000 shares for $1,500,000 (less costs of issuance of $88,000) on
November 10, 1997 and 545,000 shares for $1,500,000 (less costs of
issuance of $31,000) in January and February of 1998.

In September 1998, the Company's Board of Directors authorized the
issuance of additional common stock in a private sale to investors. On
September 30, 1998 the investors purchased 550,000 shares for $550,000
(less costs of issuance of $49,000).

The Company's Class A stock contained antidilution provisions. As a result
of the September 1998 offering, 444,000 shares of class A stock are now
convertible into 1,500,000 shares of common stock.

10. STOCK OPTION PLANS, EMPLOYEE STOCK PURCHASE PLAN, AND 401(k) PLAN

The Company has an Employee Incentive Stock Option Plan under which a
total of 1,350,000 shares have been reserved for issuance, with 276,000
shares remaining reserved and unissued at December 31, 1998. Options are
generally issued at prices not less than the fair market value at the date
of grant and become exercisable over a one- to five-year period. Also,
under the option plan, nonqualified options have been issued to an officer
and certain nonemployees. These options become exercisable over a one- to
ten-year period following the date of grant.

The Company also has a Nonemployee Director Compensation Plan, which
provides for the granting of nonqualified options for up to 675,000 shares
of common stock to nonemployee members of the Board of Directors as well
as the Chairman of the Board. Under the plan, an option to purchase 15,000
shares of common stock will be granted automatically when an eligible
director is first elected to the Board of Directors of the Company. An
option to purchase 2,250 shares (4,500 shares for the Chairman of the
Board) will be granted automatically following each Board Meeting
personally attended by each director, not to exceed 13,500 shares (27,000
shares for the Chairman of the Board) per director annually. An option to
purchase 750 shares will be granted automatically following each Board
Committee meeting personally attended by each director, not to exceed
2,250 shares per director annually. The option exercise price per share
will not be less than the fair market value of the common stock on the
date of grant. All options granted under the plan become exercisable one
year after the date of grant.

12
<PAGE>

A summary of option activity is as follows (in thousands):

<TABLE>
<CAPTION>
Employee Weighted Weighted
Incentive Average Nonqualified Average
Stock Options Exercise Stock Options Exercise
Outstanding Price Outstanding Price
<S> <C> <C> <C> <C>
Balance at December 31, 1996 324 $ 4.09 591 $ 4.48

Granted 400 2.46 312 2.43
Canceled or expired (246) 4.19 (554) 4.45
----- -----

Balance at December 31, 1997 478 2.68 349 2.69

Granted 263 1.20 294 2.34
Exercised (3) 2.87
Canceled or expired (238) 2.38 (14) 4.84
----- -----

Balance at December 31, 1998 500 $ 1.96 629 $ 2.43
----- ------ ----- ------
----- ------ ----- ------

Exercisable at December 31, 1997 124 $ 3.17 214 $ 2.71
----- ------ ----- ------
----- ------ ----- ------

Exercisable at December 31, 1998 200 $ 2.53 333 $ 2.51
----- ------ ----- ------
----- ------ ----- ------
</TABLE>

The Company's Employee Stock Purchase Plan (the ESP Plan), a qualified
plan pursuant to Internal Revenue Code Section 423, became effective in
May 1993. The ESP Plan gives eligible employees an opportunity to purchase
the Company's common stock, through payroll deductions not exceeding 15%
of eligible compensation, at a per share price of 85% of the lesser of the
fair value on the first day or the last day of each six-month purchase
period. The six-month purchase periods begin on July 1 and January 1 of
each year. Participating employees may purchase a maximum of 5,000 shares
during each purchase period and no more than $25,000 of fair value of
stock in each calendar year. A total of 300,000 shares has been authorized
for issuance under the ESP Plan. Shares issued under the ESP Plan in 1998
and 1997 were 20,000 and 24,000 shares, respectively. The ESP Plan will
terminate on January 1, 2003, unless extended by the Board of Directors.

In 1996, the Company adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION. The Company has elected to continue following the accounting
guidance of Accounting Principles Board Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, for measurement and recognition of stock-based
transactions with employees. No compensation cost has been recognized for
options issued under the stock option plans, because the exercise price of
all options granted was at least equal to the fair value of the common
stock on the date of the grant. Had compensation costs for the stock
options issued to certain directors and employees and common stock issued
under the ESP Plan been determined at the grant date, based on the fair
value provisions of SFAS No. 123, the Company's 1998 and 1997 pro forma
net loss would have been $2,058 and $5,535, respectively, and basic and
dilutive net loss per share would have been $.34 and $1.24, respectively.

The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted
average assumptions: dividend yield of 0%; a

13
<PAGE>

risk-free interest rate of 4.7% and 6.5% in 1998 and 1997, respectively;
an expected life of 5 and 7 years in 1998 and 1997, respectively; and
expected volatility of 47% and 54% in 1998 and 1997, respectively. The
weighted average fair value of options issued in 1998 and 1997 was $.80
and $1.66, respectively.

Substantially all employees of the Company may participate in a defined
contribution plan established under the provisions of Section 401(k) of
the Internal Revenue Code. The plan generally provides for a contribution
by the employee of up to 15% of their gross earnings with a 25% matching
contribution by the Company on the first 6% of gross earnings. The Company
did not contribute to the plan in 1998 and expensed contributions to the
plan of approximately $12,000 in 1997.

11. RELATED-PARTY TRANSACTIONS

An former officer and director of the Company is the president of
ErgometRx Corporation. ErgometRx Corporation possesses certain proprietary
information and prototype hardware relating to an exercise bike used for
stress testing and physical exercise. The Company has obtained an
exclusive license to manufacture and sell products utilizing this
proprietary information in certain markets under a five-year royalty
agreement. Under this agreement, the Company paid no royalties for 1998 or
1997.

The current Chairman of the Board of Directors is the president of
Manchester Companies. As part of the cost reduction plan in 1997, the
Board of Directors engaged Manchester Companies to provide investment
banking and management consulting services to the Company. Fees
aggregating $120,000 and $265,000 for 1998 and 1997, respectively, were
paid to Manchester Companies for those services. In addition, the Company
was paid $10,000 for administrative services that were provided to
Manchester Companies.

12. LITIGATION

The Company is a defendant in various claims and litigation which are
incidental to its business. Management is of the opinion that certain of
these matters are covered by insurance and that ultimate settlement of
these matters will not have a material impact on its consolidated
financial statements.

<PAGE>

EXHIBIT 21.1

SUBSIDIARIES OF THE COMPANY

<TABLE>
<CAPTION>
Jurisdiction or
Name of Direct Subsidiaries Organization
---------------
<S> <C>
Medical Graphics Corporation GmbH Germany
</TABLE>

Name of Indirect Subsidiaries

None

<PAGE>

EXHIBIT 23.1

INDEPENDENT AUDITORS' CONSENT OF
DELOITTE & TOUCHE LLP

We consent to the incorporation by reference in Registration Statements No.
33-15765, No. 33-47993, No. 33-64430, No. 33-64432, No. 33-80596, No.
33-80386, No. 33-14295, No. 33-27251, No. 33-32465, No. 33-32469, No.
33-41725 and No. 33-57353 of Medical Graphics Corporation on Form S-8 and in
Registration Statements No. 33-32467 and No. 33-41721 of Medical Graphics
Corporation on Form S-3 and our report dated February 22, 1999 appearing in
this Annual Report on Form 10-KSB of Medical Graphics Corporation for the
year ended December 31, 1998.

April 14, 1999 /s/ Deloitte & Touche LLP
Minneapolis, Minnesota

<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED DECEMBER 31,
1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 5,381
<ALLOWANCES> (118)
<INVENTORY> 4,917
<CURRENT-ASSETS> 10,335
<PP&E> 4,092
<DEPRECIATION> (3,574)
<TOTAL-ASSETS> 11,426
<CURRENT-LIABILITIES> 9,123
<BONDS> 0
0
0
<COMMON> 218
<OTHER-SE> 2,037
<TOTAL-LIABILITY-AND-EQUITY> 11,426
<SALES> 20,449
<TOTAL-REVENUES> 20,449
<CGS> 12,441
<TOTAL-COSTS> 21,571
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 454
<INCOME-PRETAX> (1,576)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,576)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,576)
<EPS-PRIMARY> (0.26)
<EPS-DILUTED> (0.26)

</TABLE>