DENTAL MEDICAL DIAGNOSTIC SYSTEMS INC, 10KSB/A, 1999-04-22

DENTAL MEDICAL DIAGNOSTIC SYSTEMS INC
10KSB/A, 1999-04-22
DENTAL EQUIPMENT & SUPPLIES

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------

Amendment No. 1 To
FORM 10-KSB
----------------

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
COMMISSION FILE NO. 0-12850
----------------

DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC.
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)

DELAWARE 13-3152648
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

200 N. WESTLAKE BOULEVARD, SUITE 202
WESTLAKE VILLAGE, CALIFORNIA 91362
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE: (805) 381-2700

SECURITIES REGISTERED PURSUANT TO SECTION
12(B) OF THE EXCHANGE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION
12(G) OF THE EXCHANGE ACT:

REDEEMABLE COMMON STOCK PURCHASE WARRANTS, AND
COMMON STOCK, $0.01 PAR VALUE
(TITLE OF CLASS)

Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange 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 disclosure of delinquent filers in response to Item 405 of
regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]

The issuer's revenues for the fiscal year ended December 31, 1998 were
$19,227,798.

At March 18, 1999, the issuer had 5,405,694 shares of Common Stock, $0.01
par value, issued and outstanding.

The aggregate market value of the outstanding voting and non-voting common
equity held by non-affiliates of the issuer computed by reference to the average
bid and asked price of such common equity as of December 23, 1998 was
$22,068,118.

DOCUMENTS INCORPORATED BY REFERENCE

Items 9-12 of Part III of this Report incorporate by reference portions of
the Registrant's definitive Proxy Statement with respect to its 1999 Annual
Meeting of Stockholders.

Transitional Small Business Disclosure format: Yes [ ] No [X]
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This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the Exchange Act and Section
27A of the Securities Act. The words "expect", "estimate", "anticipate",
"predict", "believe" and similar expressions and variations thereof are intended
to identify forward-looking statements. Such statements appear in a number of
places in this filing and include statements regarding the intent, belief or
current expectations of Dental/Medical Diagnostic Systems, its directors or
officers with respect to, among other things (a) trends affecting the financial
condition or results of operations of Dental/Medical Diagnostic Systems and (b)
the business and growth strategies of Dental/Medical Diagnostic Systems. The
stockholders of Dental/Medical Diagnostic Systems are cautioned not to put undue
reliance on such forward looking statements. Such forward-looking statements are
not guarantees of future performance and involve risks and uncertainties, and
that actual results may differ materially from those projected in this Report,
for the reasons, among others, discussed in the Sections - "Management's
Discussion and Analysis of Financial Condition and Results of Operations", and
"Risk Factors". Dental/Medical Diagnostic Systems undertakes no obligation to
publicly revise these forward-looking statements to reflect events or
circumstances that arise after the date hereof.

PART I

Item 1. Description of Business
- -------------------------------

GENERAL

Dental/Medical Diagnostic Systems, Inc. ("Company") designs, develops,
assembles and markets high technology dental equipment and related consumables.
The Company's best selling product during 1998 was the tooth curing and
whitening device known as the "Apollo 95E." The Company also markets and sells a
line of whitening gels known as "Apollo Secret" for use with the Apollo 95E, and
in the second quarter of 1999 intends to introduce a line of composite resin
materials known as "ASAP - Accelerated Solutions for Aesthetic Procedures," also
for use with the Apollo 95E. In addition, the Company manufactures and sells
intraoral camera systems, known as the "TeliCam II System," and "TeliCam Elite,"
and a multi-operatory intraoral camera system, known as the "InTELInet," for use
in connection with the TeliCam II System and TeliCam Elite.

The Company's customers are dentists in the domestic and international
marketplace. In the domestic market, the United Kingdom and Germany, the Company
sells directly to dentists. In the international market, with the exception of
the United Kingdom and Germany, the Company sells its products through
independent dealers and distributors. The Company's products are not available
through traditional retail channels.

The Company was organized in New York in 1981 under the name Edudata
Corporation and reincorporated in Delaware in 1983. On February 2, 1998, the
Company formed "DMDS, Ltd.," a wholly owned subsidiary created under the laws of
the United Kingdom. The Company markets its products internationally through
DMDS, Ltd.

BUSINESS STRATEGY

The Company's goal is to be a leading manufacturer and distributor of both
high technology dental devices and related consumables. The Company believes
that its focus on the following business strategies will help it to achieve this
goal:

DELIVERY OF INNOVATIVE, VALUE-ORIENTED PRODUCTS. The Company seeks to
provide innovative products that offer a strong price-value relationship to
its customers. The Company endeavors to deliver products that offer, or will
offer, greater or differentiated operating features, such as the Company's
Apollo 95E (described below) which can cure composite materials in just
three seconds, as compared with the 10-60 seconds it takes other competing
brands of curing lamps, and is able to whiten teeth in under 40 minutes. The
Company also plans on introducing new products incorporating innovative
digital x-ray technology into the worldwide marketplace during the third
quarter of 1999. See "Risk Factors - In order to maintain our exclusive
rights to the digital x-ray technology developed by Suni we must make
certain minimum royalty payments to Suni" and "Risk Factors - The Government
extensively regulates our products."

COMMITMENT TO PRODUCT DEVELOPMENT. The Company is continually seeking
out innovative technology to incorporate into its dental products. From
inception (October 23, 1995) through December 31, 1998, the Company has
devoted approximately $2.65 million to product development activities,
including approximately $549,000 in fiscal 1998. The dental market is highly

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competitive and the Company believes that its focus on new and improved
technologies is essential if the Company is to continue to grow and to
maintain a competitive position in the marketplace.

GROWTH THROUGH ACQUISITIONS AND LICENSING AGREEMENTS. The Company
anticipates that it will complement its internal growth, both in number of
products and sales, through acquisitions and licensing agreements and a
focus on developing and marketing new technologies for the dental practice.
The Company believes that acquisitions and licensing agreements present an
effective means of obtaining technical personnel and obtaining or expanding
technologies, products and markets. The Company continually evaluates
opportunities for acquisitions and licensing agreements.

EXPANSION OF DOMESTIC AND INTERNATIONAL SALES. Although both the
domestic and international dental supply markets are highly competitive, the
Company believes that the size of these markets provides an opportunity for
growth. The Company increased its sales in the current year through the
introduction of new products, namely the composite curing and tooth
whitening device (Apollo 95E) and the related whitening consumable, Apollo
Secret. See "Current Products." The Company plans on introducing a composite
curing consumable for use with the Apollo 95E during the second quarter of
1999 and new products incorporating digital x-ray technology into the
worldwide marketplace during the third quarter of 1999. Also, in an effort
to expand international sales of its current and future products, the
Company has altered its marketing strategy in the two biggest markets in
Europe, Germany and the United Kingdom, by acquiring the assets of the third
party distributorships the Company had agreements with to distribute the
Company's products in those respective countries. The Company believes that
by duplicating its domestic marketing strategy in Germany and the United
Kingdom of selling directly to dentists, the Company has increased its
opportunity for growth because of the increased direct access to customers.
The Company intends to capitalize on its experienced management and sales
team to increase its domestic and international sales. See "Risk Factors -
In order to maintain our exclusive rights to the digital x-ray technology
developed by Suni we must make certain minimum royalty payments to Suni."

CURRENT PRODUCTS

The Apollo 95E (Tm)
-------------------

On October 2, 1997, the Company purchased the assets of S.E.D. Gerant
("S.E.D."), a company organized under the laws of France. Among the acquired
assets was a patent for S.E.D.'s "Biotron" curing and whitening device products.
From this technology, the Company developed the "Apollo 95E" a unique,
visible-light curing instrument which is designed for two different
applications: the hardening of tooth-colored dental composite materials in three
seconds or less and for single appointment, in-office tooth whitening in less
than forty minutes. This safe plasma-arc lamp uses a high-frequency electrical
field to generate plasma energy, which is ideal for the fast-curing (hardening)
of photosensitive composites. The Apollo 95E also produces light and heat which,
when used in conjunction with the Apollo Secret whitening materials, activates
the whitening chemicals in the Apollo Secret. The result of this activation is
dramatic whitening of stained teeth. The rapid performance of the Apollo 95E in
both hardening composite materials and whitening teeth enables an average dental
practice to save about 5 to 8 hours per month of a dentists time.

CURING COMPOSITES: Tooth-colored composite materials are one of the
most requested methods of tooth restoration (bonding) in use today.
They are delivered to the tooth in syringe-shaped tubes and then
shaped into the proper tooth contours with dental instruments. In
order to cure (harden) these paste-like materials, a visible light
curing lamp (Apollo 95E) is used to initiate the proper chemical
reaction. The hand-piece to the Apollo 95E, which delivers the actual
lightsouce to the mouth, is a cylindrical shaped instrument
approximately the size of a large pen with a curved end designed to
make it easy for a dentist to be able to restore or whiten hard to
reach surface areas of teeth. The lamp is located at the tip of the
instrument.

The Apollo 95E cures these filling materials in just three seconds or
less compared with the 10-60 seconds it takes other competing brands of
curing lamps. Most restorations require the dentist to place multiple
layers of composite material into/onto a tooth, curing each layer
separately. With the curing lamps that are still used in most dental
offices today, total curing time per tooth averages 2 to 4 minutes. The
Apollo 95E shortens the curing time to under 3 seconds with the same
results. Composite curing is an essential aspect for the practice of
dentistry in all countries, making curing lamps a practical device for
all dental offices.

WHITENING: "Power bleaching" or "Light-assissted Bleaching" is fast
becoming a sought-after dental protocol which allows the patient to
leave the dental office, in under 40 minutes, with a dramatically
whitened smile. The only alternative tooth-whitening method to the
Apollo 95E currently available requires the patient to wear an
uncomfortable custom-fitted tray

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filled with unpleasant tasting whitening gels. In order to achieve

dramatic whitening results, the trays would have to be worn overnight
or for several hours a day for two to three weeks. In addition,
patients often find themselves in pain from soft-tissue contact with
the caustic gel.

With the Apollo 95E, the process is much quicker. The Apollo Secret gel
is simply applied to the patient's teeth without any tissue protection,
as the gel's special neutralizing component virtually eliminates any
tooth or tissue sensitivity. The dentist or dental assistant holds the
Apollo 95E against the gel and then applies the light to each tooth for
only 3 seconds. Several passes are made around all of the teeth being
bleached and 40 minutes later the patient leaves the office with
whitened teeth.

Because the Apollo 95E is not a laser device, in-office tooth whitening
in less than forty minutes can be done by a dental assistant in a
majority of states in the United States. This allows the dentist to
concentrate on more complex procedures, while offering dentists an
additional source of revenue that can be generated by a dental
hygienist/assistant.

In March 1998, the Company introduced this proprietary, non-laser technology
to markets outside of the US and Canada. After receiving FDA 510(k) approval in
August 1998, the Company began shipping the Apollo 95E in the U.S. and Canada.
The Company's facility in Irvine, CA handles the manufacturing and shipping of
this product line for North America, South America, Australia, New Zealand and
for the Pacific Rim countries. For the overseas markets, including Europe and
the Middle East, the Apollo 95E is manufactured and shipped from the Company's
facility in France.

The Apollo 95E has received acceptance in both domestic and international
dental markets, and sales have increased every quarter since its introduction.
The Company believes that the Apollo 95E non-laser lamp produces faster
composite curing and in-office tooth whitening results than any other known
like-product available today, including dental lasers designed for curing.

On October 2, 1998, the Company entered into an agreement with Chrysalis
Dental, Inc. ("CDI") which grants to the Company the exclusive worldwide license
to make or have made, use, or sell patent pending tooth whitening products
created by CDI. Under this license, the Company has begun marketing its own line
of tooth whitening gels (Apollo Secret), intended for use with the Apollo 95E
and competing lamps. See "Risk Factors -- As a result of the decline in sales of
the TeliCam, our future depends on our ability to develop and introduce new
products."

In the second quarter of 1999, the Company plans to introduce a new line of
restorative composite materials (ASAP), as with Apollo Secret, ASAP is intended
for use with the Apollo 95E and competing lamps. See "Risk Factors -- As a
result of the decline in sales of the TeliCam, our future depends on our ability
to develop and introduce new products."

Since the introduction of the Apollo 95E in March 1998, and through December
31, 1998, the Company has sold 2,907 units internationally, accounting for
approximately $6.6 million in revenues, and 1,479 units domestically, accounting
for approximately $5.5 million in revenues.

The TeliCam, Intraoral Cameras
------------------------------

The Company's best selling product from 1996 through mid-1998 was its line
of intraoral cameras beginning with the "TeliCam I," which was introduced into
the market in February 1996. In the second quarter of 1997, the Company began
marketing the "TeliCam II System," which was developed to allow the video
interfacing of multiple examination rooms via the Company's networking system
known as "InTELInet" (described below). Currently, the Company's primary
intraoral camera is the "TeliCam Elite," which was introduced into the market
during the second quarter of 1998. The distinguishing feature that sets the
TeliCam apart from competing intraoral dental cameras is the proprietary "Teli"
CCU processor. This "frame grabber computer chip" allows the camera to capture
and "freeze" multiple video images and display them simultaneously without an
additional external capture device such as a computer, video recorder, or video
color printer. In addition, the Teli CCU processor incorporates an automatic
light intensity control which substantially eliminates reflection and glare from
the intraoral illumination providing clearer video images. The Company has
exclusive worldwide rights to market the Teli CCU processor to the dental
market. DMD cameras also have the capability to focus as closely as two (2)
millimeters and have magnification capabilities of up to 120 times the actual
image without requiring a lens change. These TeliCam images assist dentists in
displaying dental health and hygiene problems to patients and, as a result, can
assist to promote patient acceptance of treatment plans. Through December 31,
1998, the Company had sold an aggregate of 6,039 TeliCam I, TeliCam II and
TeliCam Elite Systems to dentists throughout the United States, as well as to
several dental schools, and an aggregate of 2,842 TeliCam I, TeliCam II and
TeliCam Elite Systems internationally.

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As a result of price erosion and decreasing margins caused by increased
competition from new manufacturers entering the marketplace, the Company
believes that the market for intraoral cameras has become both saturated and
less profitable, resulting in a decline in revenues from the Company's intraoral
camera products. The Company is currently researching new technological
advancements and clinical uses for its line of intraoral cameras. See "Risk
Factors -- One of our primary products has had a significant decline in sales."

InTELInet
---------

In November 1996, the Company introduced its InTELInet Video Monitoring
System ("InTELInet") which creates a video-electronic information link between
the different examination rooms within the same dental office. The System
includes a minimum of two intraoral video cameras, a video monitor with built-in
VCR, cable installation and a single video printer. The InTELInet System allows
dentists and their auxiliaries the ability to conduct multiple patient video
examinations at the same time because the "TeliCam" has its own built-in video
microprocessor capture device. This proprietary design allows for the use of
just one central video printer to interface with multiple operatories using
cameras simultaneously. This creates a cost savings and functional benefit when
compared to competing dental inter-operatory video networking systems that
require expensive computers, video printers, or capture devices for each
operatory.

Due to the general absence of multiple operatory practices outside of the
United States, the InTELInet is only being marketed domestically by the Company.
The InTELInet network is only compatible with DMD intraoral dental cameras. In
addition, the Company has designed the InTELInet system to be compatible with
the digital x-ray technology the Company is currently developing with Suni
Imaging Microsystems, Inc. See "Product Development." From the time of its first
introduction in late November 1996, through December 31, 1998, an aggregate of
599 InTELInet multiple operatory networking systems have been sold by the
Company.

PRODUCT DEVELOPMENT.

The Company intends to pursue growth through new product development and
introduction and by improving and updating its current products to respond to
competitive pressures.

The Company has entered into an agreement with Suni Imaging Microsystems,
Inc. ("Suni") to develop digital x-ray technology for incorporation into a
digital x-ray system for the dental market. The Company has obtained exclusive
rights to market products to the dental market incorporating certain digital
x-ray technology developed by Suni. Suni will retain the rights to developed
microchip technology underlying the x-ray system it develops for the Company.
Digital x-ray systems, including those currently on the market, reduce radiation
exposure compared to conventional x-ray systems and allow dentists to view x-ray
images in real-time without the time-consuming process of film development while
eliminating the need to use and dispose of chemicals required to develop
conventional x-ray film. The Company believes that this technology will provide
improved image quality and a more comfortable sensor for the patient at a lower
price point than competitive systems. This technology also is designed to allow
database storage and recall of images for comparison purposes. The development
of the technology has been, and will continue to be, performed by Suni and
funded by the Company. No assurance can be given that the Company will be able
to commercially exploit the digital x-ray technology. Additionally, the Company
filed for 510(k) notification on January 5, 1999 and is currently waiting for
such notification, and therefore, the timing of the domestic introduction of the
product is uncertain. See "Description of Business -- Government Regulation" and
"Risk Factors -- The government extensively regulates our products."

The Company expended approximately $549,000, $1.2 million and $322,000 for
research and development of its products for the fiscal years ended December 31,
1998 and 1997, and for the ten month period ended December 31, 1996,
respectively.

MANUFACTURING AND COMPONENT PARTS

The Company assembles and tests the Apollo 95E curing and whitening lamps,
the TeliCam Elite video camera system and the TeliCam II video camera system
sold to North America, South America, Australia, New Zealand and the Pacific Rim
countries, at its facility located in Irvine, California. For the overseas
markets, including Europe and the Middle East, the TeliCam products are
assembled and tested at the Company's facility in Irvine, while the Apollo 95E
is assembled and tested at its facility in France. With the exception of the
TeliCam's CCU processor, the Company believes that there are multiple sources
from which it may purchase the components for the Apollo 95E and the TeliCam
Systems. The Company anticipates that the single source that it obtains the CCU

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processor component of the TeliCam System from is capable of meeting projected
demand for the foreseeable future. Although the Company believes that, if
necessary, it will be able to negotiate satisfactory alternative supply
arrangements, failure to do so may have a material adverse effect on the
Company. Furthermore, there can be no assurance that suppliers will dedicate
sufficient production capacity to satisfy the Company's requirements within
scheduled delivery times or at all. Failure or delay by the Company's suppliers
in fulfilling its anticipated needs may adversely affect the Company's ability
to market the Apollo 95E and the TeliCam Systems.

Effective October 1, 1996, the Company amended its distribution agreement
("BMC Distribution Agreement") with Boston Marketing, a licensed distributor of
the Teli manufactured CCD chip which includes the Teli CCU processor. Pursuant
to the BMC Distribution Agreement, the Company has the exclusive right (i) to
market certain Teli manufactured CCD chip assemblies with CCU processors (model
numbers CS6110 S/B with Frame Grabber, CS6110 P S/B with Frame Grabber and the
CS6110 S/B without Frame Grabber (each a "Teli Unit" and collectively the "Teli
Units")) to the dental market, and (ii) to use the "TeliCam" trademark. The Teli
Units are key components of the Company's intraoral digital cameras. The BMC
Distribution Agreement has a five-year initial term. The Company has agreed to
purchase a minimum of 2,500 Teli Units per year for each of the five years, at
an initial price of $750 per Teli Unit. The Boston Marketing Distribution
Agreement is terminable by Boston Marketing if the Company fails to meet its
annual minimum purchase obligation. While the term of the BMC Distribution
Agreement expires on December 31, 2000, it may be extended by mutual agreement
of the Company and Boston Marketing for an additional five-year term. As of the
date hereof, the Company has not made a determination as to whether it will
attempt to renew this agreement. Management believes that, if necessary, other
CCD chips, CCU processors and frame grabbers could be obtained from third-party
suppliers on comparable terms, although a disruption in supplies of components
could extend for up to six months, which would materially adversely affect the
Company's operating results.

On March 17, 1999, the Company entered into a manufacturing agreement with
Suni under which Suni will assemble, test and package the Company's digital
x-ray system incorporating the digital x-ray technology developed by Suni for
the Company. The Company is currently working with Suni to produce a digital
x-ray system that meets the Company's specifications. While the Company believes
that an acceptable device will be manufactured, no assurance can be given that
Suni will be able to produce a product which will meet the Company's
specifications. Under the agreement, which has a three year term, the Company
has guaranteed payment in full for at least 3,000 units per year and has agreed
to place orders for at least 750 units per quarter. The Company has also agreed
to fulfill all of its requirements for the x-ray product from Suni during the
term of the agreement. The Company cannot begin shipping products under this
agreement to the market until it receives 510(k) notification. If, and when,
510(k) notification is received, the Company intends to begin introducing the
digital x-ray system for sale worldwide. See "Risk Factors - We substantially
depend upon third parties for several critical elements of our business,
including the development and licensing for distribution of our products - The
government extensively regulates our products."

BACKLOG

The Company generally does not operate with significant order backlog and a
substantial portion of its revenues in any quarter is derived from orders booked
in that quarter.

MARKETING AND SALES

US SALES AND DISTRIBUTION. The Company's domestic sales are made by eight
full-time employees who are based at corporate headquarters, and a national
field force of fourteen independent sales representatives under the supervision
of twenty independent Regional Managers. The Company's full time sales employees
are generally experienced in the business of marketing and distribution of
dental products, inclusive of the TeliCam II, the TeliCam Elite intraoral
cameras, the Apollo 95E high intensity composite curing and in-office whitening
system and related consumables. The Company markets its products through direct
mail solicitations, professional publications advertising, and attendance at
dental conferences. Since March 1996 the Company has run advertisements in
various publications for the dental industry on a monthly basis, and has
attended in excess of 127, 75, and 70 dental conferences and trade shows during
1998, 1997 and 1996, respectively. In addition to an increase in the number of
dental conferences and trade shows attended, during fiscal 1998 the Company
expanded its marketing efforts by engaging in a more comprehensive mailing
campaign and increasing publications advertising. The Company has also sold
equipment and consumables to a number of dental schools including the University
of Chicago, Tufts University and the University of Louisville. The Company
believes that these and anticipated future dental school sales will generate
additional interest in, as well as familiarity with, the Company's products at
the initial stages of a dental professional's career.

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INTERNATIONAL SALES AND DISTRIBUTION. In the international market, with the
exception of the United Kingdom and Germany, the Company sells the Apollo 95E
and the TeliCam System through independent dealers and distributors, pursuant to
oral distribution agreements. Presently, the Company has approximately fifty
independent distributors and dealers, which cover key international markets
including, the Middle East, the Far East, Europe, Australia and Canada. On
September 17, 1997 the Company repurchased distribution rights for its products
in the European market from an independent distributor for 50,000 shares of its
Common Stock. The Company's international distributors provide important
support, including customer support and product service, to customers in each of
their respective countries. The Company had an agreement with Hiroki Umezaki, a
former officer, director and principal stockholder of the Company, pursuant to
which he was to receive a 15% commission on all sales made by the Company in
Asia, except Japan, in which his commission was to be 12%. This agreement has
been amended to provide that Mr. Umezaki shall receive a 12% commission on sales
made in Japan only. The Company markets the Apollo 95E through its wholly owned
subsidiary, DMDS, Ltd. and through its existing network of international
distributors with all products being shipped from the Company's facility in
France.

On March 1, 1999, DMDS, Ltd. purchased the assets of DMD Germany, an
independent company organized under the laws of Germany, for a purchase price
consisting of 100,000 shares of the Common Stock of the Company. DMD Germany's
sole business was the sale and distribution of the Company's products in
Germany. The assets that DMDS, Ltd. purchased include the business (as a going
concern), customer lists, goodwill, the benefit of the lease and other contracts
with third parties and all other items of whatever nature owned by DMD Germany
and used in the conduct of the business of DMD Germany. The Company also entered
into an employment agreement with Ralf Muller, the General Manager of DMD
Germany. The Company intends to continue the business of DMD Germany as
currently operated. The Company purchased the assets of DMD Germany for the
purpose of increasing its revenues and the margins on products sold in Germany.

On March 1, 1999, DMDS, Ltd. purchased the assets of Midas, Ltd., an
independent company organized under the laws of the United Kingdom, for a
purchase price consisting of 50,000 shares of the Common Stock of the Company.
Midas, Ltd.'s primary business was the sale and distribution of the Company's
products in the United Kingdom. The assets that DMDS, Ltd. purchased include the
business (as a going concern), customer lists, goodwill, the benefit of the
lease and other contracts with third parties and all other items of whatever
nature owned by Midas, Ltd. and used in the conduct of the business of Midas,
Ltd. The Company also entered into a non-compete agreement with Sostre NV, the
entity that has distributed the Company's products for Midas, Ltd. The Company
intends to continue the business of Midas, Ltd. substantially as currently
operated. The Company purchased the assets of Midas, Ltd. for the purpose of
increasing its revenues and the margins on products sold in the UK.

TRAINING, CUSTOMER SUPPORT AND PRODUCT SERVICE

Management believes that operating the Company's Products requires very
little training. As part of the Company's customer service program, the sales
representative or international distributor responsible for the sale of the
TeliCam, the Telicam Elite and the Apollo 95E schedules an installation and
training appointment when the system is delivered. In addition, the Company
provides a systems operating manual to its customers which provides answers to
frequently asked questions about the product's operations. The Company's
technical support personnel, and internationally, the support personnel of the
Company's distributors, are also available to answer customers telephone
inquiries during normal business hours. All DMD Systems come with a one-year
complete parts and labor warranty and extended warranties are also available.
InTELInet installation and maintenance is provided through independent
installers retained by the Company. The Company is currently developing a
program for training, customer support and service for the products it plans to
introduce in 1999.

PATENTS AND PROPRIETARY RIGHTS

The Company's subsidiary, DMDS, Ltd., holds a patent in France and is
currently seeking worldwide patent protection for the Apollo 95E system. There
can be no assurance (i) that patents outside of France will be granted for the
Apollo 95E system, and (ii) if granted, the patents will provide adequate
protection for the Company's technologies. Protection is being sought in all of
the countries of the world in which this technology can be marketed. The Company
has an exclusive worldwide license to distribute the whitening system technology
used in Apollo Secret, which is the subject of a pending application for patent
in the US. The Company has established rights in the trademarks under which it
sells its lamps and consumable products and has sought to register these
trademarks with the United States Patent and Trademark Office.

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The intellectual property rights to the TeliCam System are owned by third
parties. Pursuant to an agreement with Boston Marketing Company, Ltd. ("Boston
Marketing") the Company has the exclusive right to market TeliCam's CCD
processor unit ("Teli Units") to the dental market ("Boston Marketing
Distribution Agreement"). Also pursuant to this agreement, the Company has the
rights to use the "TeliCam" trademark.

The Company's success and ability to compete is dependent in part upon its
proprietary technology for which domestic and international patent protection is
pending. The Company's proprietary technology for the TeliCam is not protected
by any patents. Consequently, the Company relies primarily on trademark, trade
secret and copyright laws to protect this technology. Also, the Company has
implemented a policy that all employees and third-party developers sign
nondisclosure agreements. However, there can be no assurance that such
precautions will provide meaningful protection from competition or that
competitors will not be able to develop similar or superior technology
independently. Also, the Company has no license agreements with the end users of
its products so it may be possible for unauthorized third parties to copy the
Company's products or to reverse engineer or otherwise obtain and use
information that the Company regards as proprietary. If litigation is necessary
in the future to enforce the Company's intellectual property rights, to protect
the Company's trade secrets or to determine the validity and scope of the
proprietary rights of others, such litigation could result in substantial costs
and diversion of resources and could have a material adverse effect on the
Company's business, operating results and financial condition. Ultimately, the
Company may be unable, for financial or other reasons, to enforce its rights
under intellectual property laws. In addition, the laws of certain countries in
which the Company's products are or may be distributed may not protect the
Company's products and intellectual property rights to the same extent as the
laws of the United States. See "Risk Factors -- None of our products are
protected by patents."

The Company believes that its products do not infringe upon any valid
existing proprietary rights of third parties. There can be no assurance that
third parties will not assert infringement claims in the future. Any such third
party claims, whether or not meritorious, may be covered by present insurance
policies but could, nevertheless, result in costly litigation or require the
Company to enter into royalty or licensing agreements. There can be no assurance
that the Company would prevail in any such litigation or that any such licenses
would be available on acceptable terms, if at all. If the Company were found to
have infringed upon the proprietary rights of third parties, it could be
required to pay damages, cease sales of the infringing products and redesign or
discontinue such products, any of which alternatives, individually or
collectively could have a material adverse effect on the Company's business,
operating results and financial condition.

GOVERNMENT REGULATION

The Company sells products which are legally defined to be medical devices,
therefore, the Company is considered to be a medical device manufacturer and as
such is subject to the regulations of, among other governmental entities, the
United States Food and Drug Administration and the corresponding agencies of the
states and foreign countries in which the Company sells its products. These
regulations govern the introduction of new medical devices, the observance of
certain standards with respect to the manufacture and labeling of medical
devices, the maintenance of certain records and the reporting of potential
product problems and other matters. A failure to comply with such regulations
could have material adverse effects on the Company.

The Federal Food, Drug and Cosmetic Act ("FDC Act") regulates medical
devices in the United States by classifying them into one of three classes based
on the extent of regulation believed necessary to ensure safety and
effectiveness. Class I devices are those devices for which safety and
effectiveness can reasonably be ensured through general controls, such as device
listing, adequate labeling, premarket notification and adherence to the Quality
System Regulation ("QSR") as well as medical device reporting ("MDR"), labeling
and other regulatory requirements. Some Class I medical devices are exempt from
the requirement of pre-market approval or clearance. Class II devices are those
devices for which safety and effectiveness can reasonably be ensured through the
use of special controls, such as performance standards, post-market surveillance
and patient registries, as well as adherence to the general controls provisions
applicable to Class I devices. Class III devices are devices that generally must
receive premarket approval by the FDA pursuant to a premarket approval ("PMA")
application to ensure their safety and effectiveness. Generally, Class III
devices are limited to life sustaining, life supporting or implantable devices;
however, this classification can also apply to novel technology or new intended
uses or applications for existing devices.

Before they can be marketed, most medical devices introduced to the United
States market are required by the FDA to secure either clearance of a pre-market
notification pursuant to Section 510(k) of the FDC Act (a "510(k) Clearance") or
approval of a PMA. Obtaining approval of a PMA application can take several
years. In contrast, the process of obtaining 510(k) Clearance generally requires
a submission of substantially less data and generally involves a shorter review
period. Most Class I and Class II devices enter

Page 8
<PAGE>

the market via the 510(k) Clearance procedure, while new Class III devices
ordinarily enter the market via the more rigorous PMA procedure. In general,
approval of a 510(k) Clearance may be obtained if a manufacturer or seller of
medical devices can establish that a new device is "substantially equivalent" to
a predicate device other than one that has an approved PMA. The claim for
substantial equivalence may have to be supported by various types of
information, including clinical data, indicating that the device is as safe and
effective for its intended use as its legally marketed equivalent device. The
510(k) Clearance is required to be filed and cleared by the FDA prior to
introducing a device into commercial distribution. Market clearance for a 510(k)
Notification submission may take 3 to 12 months or longer. If the FDA finds that
the device is not substantially equivalent to a predicate device, the device is
deemed a Class III device, and a manufacturer or seller is required to file a
PMA application. Approval of a PMA application for a new medical device usually
requires, among other things, extensive clinical data on the safety and
effectiveness of the device. PMA applications may take years to be approved
after they are filed. In addition to requiring clearance or approval for new
medical devices, FDA rules also require a new 510(k) filing and review period,
prior to marketing a changed or modified version of an existing legally marketed
device, if such changes or modifications could significantly affect the safety
or effectiveness of that device. FDA prohibits the advertisement or promotion of
any approved or cleared device for uses other than those that are stated in the
device's approved or cleared application.

The Company has already received FDA 510(k) notification allowing marketing
of the Telicam Intraoral Camera and the Apollo 95E. In addition, in preparation
for the anticipated third quarter 1999 introduction of its Digital X-ray medical
device, the Company has submitted an application for premarket notification
("510(k)") to the FDA. There can be no assurance that 510(k) Clearance for the
digital x-ray device will be received.

Pursuant to FDC Act requirements, the Company has registered its
manufacturing facility with the FDA as a medical device manufacturer, and listed
the medical devices it manufactures. The Company also is subject to inspection
on a routine basis for compliance with FDA regulations. These regulations
include those covering the QSR, which, unless the device is a Class I exempt
device, require that the Company manufacture its products and maintain its
documents in a prescribed manner with respect to issues such as design controls,
manufacturing, testing and validation activities. Further, the Company is
required to comply with other FDA requirements with respect to labeling, and the
MDR regulations which require that the Company provide information to the FDA on
deaths or serious injuries alleged to have been associated with the use of its
products, as well as product malfunctions that are likely to cause or contribute
to death or serious injury if the malfunction were to recur. The Company
believes that it is currently in material compliance with all relevant QSR and
MDR requirements.

In addition, the Company's facility is required to have a California
Medical Device Manufacturing License. The license is not transferable and must
be renewed annually. Approval of the license requires that the Company be in
compliance with the FDA's QSR, labeling and MDR regulations. The Company filed a
timely application for a license to cover its manufacturing activities, and in
early March 1999 the California Department of Health Services (DHS) conducted an
inspection of the Company's facilities and found no "reportable observations."
The Company received a list of adjustments and clarifications recommended by the
DHS. The Company filed a response to this list on March 19, 1999 and expects to
receive the license from the California DHS in early April. The Company can not
guarantee that the California DHS will grant or renew the Company's license. See
"Risk Factors - We do not have California licensing."

Generally, if the Company is in compliance with FDA and California
regulations, it may market its medical devices throughout the United States.
International sales of medical devices are also subject to the regulatory
requirements of each country. In Europe, the regulations of the European Union
require that a device have a CE mark before it can be sold in that market. The
Company has obtained a CE mark for its Apollo 95E device and is seeking approval
from the European Union to market the new digital x-ray product. The regulatory
international review process varies from country to country. The Company, in
general, will rely upon its distributors and sales representatives in the
foreign countries in which it markets its products to ensure that the Company
compiles with the regulatory laws of such countries. The Company believes that
its international sales to date have been in compliance with the laws of the
foreign countries in which it has made sales. Failure to comply with the laws of
such country could have a material adverse effect on the Company's operations
and, at the very least, could prevent the Company from continuing to sell
products in such countries. Exports of most medical devices are also subject to
certain limited FDA regulatory controls.

PRODUCT LIABILITY AND INSURANCE

The nature of the Company's present and planned products may expose the
Company to product liability risks. As of March 31, 1999, no product liability
claims have been brought against the Company. The Company maintains product
liability insurance with

Page 9
<PAGE>

coverage limits of $1,000,000 per occurrence and $11,000,000 per year. While the
Company believes that it maintains adequate insurance coverage, there can be no
assurance that the amount of such insurance will be adequate to satisfy claims
made against the Company in the future or that the Company will be able to
obtain insurance in the future at satisfactory rates or in adequate amounts.
Product liability claims or product recalls could have a material adverse effect
on the business and financial condition of the Company. In addition, the Company
is required under certain of its licensing agreements to indemnify its licensors
against certain product liability claims by third parties.

COMPETITION

The distribution and manufacture of dental supplies and equipment is
intensely competitive. For example, there are at least twelve companies offering
intraoral camera systems that are competitive with the TeliCam System. The
Company's dental curing and whitening device products face competition from
existing curing and whitening systems, including laser systems. Many of the
Company's competitors have greater financial and other resources than the
Company, and, consequently, such entities may be able to develop, manufacture,
market and/or distribute systems that are functionally similar or superior to
the Company's products. Moreover, significant price reductions by the Company's
competitors could result in a similar reduction in the Company's prices.
Any of these competitive pressures may have a material adverse effect on
operating results.

In the United States, the Company competes with other companies that sell
dental products, distributors and several major manufacturers of dental
products, primarily on the basis of price, customer service and value-added
services and products. The Company's principal domestic competitors for the
TeliCam System are Patterson Dental Co., Henry Schein, Inc., Dentsply and
Ultrak. The Company's principal domestic competitors for the Apollo 95E are Air
Techniques, Kreativ Products, American Dental Technologies and Argon Laser. The
Company's principal domestic competitors for the Apollo Secret whitening product
are Kreativ Products, Ultradent Products, Discus Dental, DenMat, Shofu Dental
Corporation and American Dental Hygienics/Premier Dental. The Company's
principal domestic competitors for the ASAP composite materials are Bisco,
Jeneric/Pentron, Kerr, 3M, Dentsply/Caulk, Ultradent Products and
Heraeus/Kulzer.

The Company also faces competition in its international markets, where the
Company competes on the basis of price and product quality against the same
dental product distributors and manufacturers.

EMPLOYEES

At February 23, 1999, the Company had 79 full-time employees, 57 in the
United States, 7 in the UK and 15 in France. Of the U.S. employees, 27 were
involved in production, 5 were in customer service, 14 were in administration, 8
were engaged in sales and marketing, and 3 were involved in engineering and
research and development. Of the UK employees, 5 were in administration and 2
were engaged in sales and marketing, and of the employees in France, 9 were
involved in production, 2 were involved in engineering and research and
development, and 4 were in administration. The Company believes it has a good
relationship with its employees and none of its employees are represented by a
collective bargaining agreement.

ITEM 2. DESCRIPTION OF PROPERTIES
- ---------------------------------

The corporate headquarters and principal offices of the Company are located
in Westlake Village, California, consisting of approximately 3,900 square feet
of space under a lease that expires on November 14, 2000 ("Office Lease"). The
Office Lease provides for aggregate minimum monthly rental payments of
approximately $6,200. On January 15, 1999, the Company entered into a sublease
for approximately 1,300 square feet of space adjacent to the principal offices
("Office Sublease"). The Office Sublease expires on June 30, 2000, and provides
for aggregate minimum monthly rental payments of approximately $2,500. Further,
under a lease that expired on October 31, 1998, the Company had approximately
5,700 square feet of space in a building in Irvine, California, where it
previously manufactured and distributed the TeliCam System and conducted
research and development activities. The rental payment under this plant lease
was approximately $5,310 per month. The Company sub-leased this facility from
March 15, 1998 through October 31, 1998 at a rate of $5,049 per month. The
Company now leases a larger facility in Irvine of approximately 12,000 square
feet, under a lease that expires October 31, 1999 at a rental payment of $6,750
per month to perform these functions. All leases require the Company to pay
taxes, maintenance fees, insurance, and periodic rent increases based on a
published price index. The Company does not presently own, or have any current
plans to invest in, any interests in real property other than through its
leases.

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<PAGE>

ITEM 3. LEGAL PROCEEDINGS
- -------------------------

The Company is not involved in any material legal proceedings.

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

None.

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<PAGE>

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- ----------------------------------------------------------------

The Common Stock and Redeemable Common Stock Purchase Warrants are currently
traded on the NASDAQ SmallCap Market under the symbols "DMDS" and "DMDSW,"
respectively, and on the Boston Stock Exchange under the symbols "DMD" and
"DMDW," respectively. Prior to May 9, 1997 the Common Stock was quoted on the
OTC Bulletin Board. The following table sets forth the range of the high and low
closing prices of the Common Stock on the OTC Bulletin Board and the NASDAQ
SmallCap Market as reported by NASDAQ Trading and Market Services. These
quotations reflect inter-dealer prices, without mark-up, mark-down or
commission, and may not represent actual transactions.

<TABLE>
<CAPTION>
REDEEMABLE
COMMON STOCK
PURCHASE
COMMON STOCK WARRANTS
PERIOD ENDED HIGH LOW HIGH LOW
------------ -------- -------- -------- ------
<S> <C> <C> <C> <C>
March 31, 1997....................... $4.80 $3.10 $ -- $ --
June 30, 1997........................ 7.10 4.10 3.90 3.70
September 30, 1997................... 6.60 5.40 2.70 2.50
December 31, 1997.................... 9.50 5.90 4.00 3.80

March 31, 1998....................... 8.00 5.88 4.00 2.69
June 30, 1998........................ 7.50 4.00 3.50 1.50
September 30, 1998................... 5.50 3.63 2.13 1.13
December 31, 1998.................... 6.75 4.00 2.88 1.38
</TABLE>

On March 9, 1999, the high bid and low ask prices were $8.4375 and $7.875,
respectively for the Common Stock and $4.1875 and $3.9375, respectively, for the
Redeemable Common Stock Purchase Warrants.

RECENT SALES OF UNREGISTERED SECURITIES

On October 2, 1998, the Company issued 100,000 shares of its Common Stock,
valued at $462,500, to Chrysalis Dental, Inc. ("CDI") as a portion of the
purchase price for an exclusive worldwide license to make or have made, use, or
sell patent pending tooth whitening products created by CDI. The Company relied
on section 4(2) of the Securities Act of 1933 as an exemption from registration
of these shares.

On March 1, 1999, DMDS, Ltd. purchased the assets of DMD Germany, an
independent company organized under the laws of Germany. The Company issued
100,000 shares of its Common Stock, valued at $762,500, as the consideration for
the purchase of the assets. The assets that DMDS, Ltd. purchased include the
business (as a going concern), customer lists, goodwill, the benefit of the
lease and other contracts with third parties and all other items of whatever
nature owned by DMD Germany and used in the conduct of the business of DMD
Germany.

On March 1, 1999, DMDS, Ltd. purchased the assets of Midas, Ltd., an
independent company organized under the laws of the United Kingdom. The Company
issued 50,000 shares of its Common Stock, valued at $381,250, as the
consideration for the purchase of the assets. The assets that DMDS, Ltd.
purchased include the business (as a going concern), customer lists, goodwill,
the benefit of the lease and other contracts with third parties and all other
items of whatever nature owned by Midas, Ltd. and used in the conduct of the
business of Midas, Ltd.

DIVIDEND POLICY

The Company has not paid any cash dividends on the Common Stock since its
inception and does not intend to pay any dividends on the Common Stock in the
foreseeable future. The payment of any dividends in the future will depend on
the evaluation by the Company's Board of Directors of such factors as it deems
relevant at the time and restrictions imposed by the terms of the Company's debt
obligations. The Company bank financing agreements impose restrictions on any
payment of dividends. The Board of Directors believes that all the Company's
earnings, if any, should be retained for the development of the Company's
business.

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<PAGE>

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
- ---------------------------------------------

THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ TOGETHER WITH THE
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AND NOTES THERETO INCORPORATED
ELSEWHERE IN THIS FORM 10KSB.

INTRODUCTION

Dental/Medical Diagnostic Systems, Inc. designs, develops, manufactures and
sells high technology dental equipment and related consumables. The Company's
highest grossing product for the 1998 fiscal year was the tooth curing and
whitening device known as the "Apollo 95E." The Company also markets and sells a
line of whitening products known as "Apollo Secret" for use in conjunction with
the Apollo 95E, and in the second quarter of 1999 intends to introduce a line of
composite resin materials known as "ASAP Accelerated Solutions for Aesthetic
Procedures," also for use in conjunction with the Apollo 95E. In addition, the
Company continues to manufacture and sell intraoral camera systems, known as the
"TeliCam II System," and "TeliCam Elite," and a multi-operatory intraoral camera
system, known as the InTELInet, for use in connection with the TeliCam II System
and TeliCam Elite.

From early 1996 to mid 1998, the Company was primarily involved in
designing, developing, manufacturing, and marketing intra-oral camera systems
referred to as "TeliCam Systems". The first shipments to customers of the
TeliCam System commenced in early February 1996.

The Apollo 95E, which wasn't introduced into markets outside of the US
and Canada until March 1998 and in the US and Canada until August 1998,
accounted for over $11 million in revenues in 1998, however, revenues attributed
to the TeliCam intraoral cameras declined significantly for the fiscal year 1998
as compared to 1997 and therefore the Company's net sales were limited to an
increase of 19% from 1997 to 1998. While the Company expects that the trend of
increasing revenues each fiscal quarter attributable to the Apollo 95E to
continue for the near future, the Company also expects the trend in the decline
in sales of its TeliCam intraoral cameras to continue and therefore to at least
partially offset the increased revenues realized on the Apollo 95E.

RESULTS OF OPERATIONS

The Company derives its revenues primarily from the sale of three product
lines: TeliCam intra-oral camera systems, Apollo 95E curing and whitening
devices, and Apollo Secret tooth whitening chemicals for use in conjunction with
the Apollo 95E, which began shipping in the fourth quarter of 1998. Through
December 31, 1998, revenues from Apollo Secret have been immaterial.

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<PAGE>

Revenues by product line, for the fiscal years ended December 31, 1998 and
1997, and for the ten-month period ended December 31, 1996 are reflected in the
following table:

<TABLE>
<CAPTION>
Ten-Months Ended
December 31, For the Year Ended December 31,
------------ -------------------------------
1996 % 1997 % 1998 %
---- - ---- - ---- -
<S> <C> <C> <C> <C>
Apollo 95E $ -- -- $ -- -- $11,125,629 58%
TeliCam 10,689,179 92% 15,367,806 96% 6,555,540 34%
Other 983,923 8% 719,402 4% 1,546,629 8%
----------- ---- ----------- --- ------------ ----
$11,673,102 100% $16,087,208 100% $19,227,798 100%
=========== ==== =========== ==== =========== ====
</TABLE>

NET SALES. Net sales for the fiscal years ended December 31, 1998 and 1997,
and for the ten-month period ended December 31, 1996, were $19,227,798,
$16,087,208 and $11,673,102, respectively.

Net sales for the fiscal year ended December 31, 1998 increased
approximately 19% from the prior year, and increased 38% for the fiscal year
ended December 31, 1997 as compared with the ten-month period ended December 31,
1996. Sales are comprised primarily of the Apollo 95E and TeliCam Systems. The
increase in sales for the fiscal year ended December 31, 1998 was primarily due
to the introduction of the Apollo 95E, which began shipping in Europe during the
first quarter of 1998 and in the United States during the third quarter of 1998,
offset by reduced TeliCam sales both domestically and internationally resulting
from weaker demand and increased competition as the market for intraoral cameras
matured. The increase from 1996 to 1997 can be attributed to the two month
longer period, increased international sales volume and increased sales volume
of the InTELIinet video systems. The Company expects the decline in TeliCam
sales to continue into the future. No assurance can be given that the Apollo 95E
sales will ultimately offset the reduced TeliCam sales in the future. See -
"Risk Factors -- As a result of the decline in sales of the TeliCam, our future
depends on our ability to increase demand for our Apollo 95E and related
products as well as our ability to develop and introduce new products."

COST OF SALES. Cost of sales for the fiscal years ended December 31, 1998
and December 31, 1997, and for the ten-month period ended December 31, 1996,
were $9,820,882, or 51% of net sales, and $10,234,206, or 64% of net sales, and
$6,685,464 or 57% of net sales, respectively. Cost of sales, both on an absolute
dollar basis and as a percentage of net sales, decreased from 1997 to 1998
primarily due to more favorable margins on the Apollo 95E, which represented 58%
of net sales for the year. Cost of sales as a percentage of net sales increased
from 1996 to 1997, as the Company reduced the selling price of its TeliCams
during the year in response to the pressure of competition in the marketplace.
While the more favorable margins on the Apollo 95E have helped to decrease the
cost of sales as a percentage of net sales, the Company expects that the margins
on the sale of the TeliCams will continue to shrink, and thus the cost of sales
of the TeliCams as a percentage of TeliCam net sales will increase in the
future.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses totaled $8,764,910, or 46% of net sales, $6,031,066, or
37% of net sales, and $4,360,736 or 37% of net sales, for the fiscal years ended
December 31, 1998 and 1997, and for the ten-month period ended December 31,
1996, respectively. The absolute dollar increases in this expense category from
year to year are primarily attributed to a combination of increased sales
commissions resulting from increased sales volumes, increased salaries and legal
expenses associated with the Company's growth, and increased marketing costs
resulting from enhanced marketing efforts. The increase in selling, general and
administrative expenses as a percentage of net sales from 1997 to 1998 can be
attributed to the cost of expanding the Company's work force in anticipation of
future growth. These expenses are expected to continue to increase on an
absolute dollar basis as sales volumes increase and additional marketing costs
are incurred for the introduction of the new products.

RESEARCH AND DEVELOPMENT. Research and development expenses totaled
$549,304, or 3% of net sales, $1,213,766, or 8% of net sales, and $322,467, or
3% of net sales, for the fiscal years ended December 31, 1998 and 1997, and for
the ten-month period ended December 31, 1996, respectively. Both the decrease in
research and development expenses for fiscal 1998, and the increase in this
expense category from 1996 to 1997, both on an absolute dollar basis and as a
percentage of net sales, is primarily attributed to $875,000 of fees paid to
Suni Imaging Microsystems, Inc. to fund the development of the digital x-ray
technology for incorporation into systems for the dental market during the
fiscal year ended December 31, 1997. The Company expects research and
development expenses to increase in future periods, as it continues to pursue
the development of new technologies. See "Risk Factors - As a result of the
decline in sales of the TeliCam, our future depends on our ability to develop
and introduce new products."

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<PAGE>

INTEREST INCOME. Interest income totaled $195,532 and $205,818 for the
fiscal years ended December 31, 1998 and December 31, 1997. The Company had no
interest income for the ten-month period ended December 31, 1996. This income is
attributed to the interest earned by investing the net proceeds of both the May
1997 secondary offering and the March 1998 debt placement in a short-term
management account through Comerica Securities. These funds were not available
in the ten-month period ended December 31, 1996.

INTEREST EXPENSE. Interest expense totaled $1,739,693, $138,576 and $57,166
for the fiscal years ended December 31, 1998 and 1997, and for the ten-month
period ended December 31, 1996, respectively. This expense category includes
interest paid on capital lease obligations, on bridge notes, on notes payable to
related parties, and on the Senior Subordinated Notes. The substantial increase
in fiscal 1998 is primarily due to the accrued interest and the amortization of
the debt discount on the $4.5 million of Senior Subordinated Notes, which was
repaid in January 1999 with proceeds from the new credit facility with Imperial
Bank.

Amortization of debt issuance cost totaled $235,484, $76,431 and $31,548 for
the fiscal years ended December 31, 1998 and 1997, and for the ten-month period
ended December 31, 1996, respectively. This represents the amortization of the
issuance costs incurred in connection with the Bridge Notes issued in November
1996 and the 12% Senior Subordinated Notes issued in March 1998. These costs
were amortized over the term of the Notes. The Company repaid the Bridge Notes
out of the proceeds of the May 1997 secondary offering. In addition, the Senior
Subordinated Notes were repaid in January 1999 out of the proceeds of the
Company's new credit facility with Imperial Bank.

NET LOSS. Net loss for the fiscal year ended December 31, 1998 totaled
$1,816,702, or $0.35 per share. Net loss for the fiscal year ended December 31,
1997 totaled $2,044,729, or $0.47 per share, and net income for the ten-month
period ended December 31, 1996 totaled $137,151, or $0.05 per share.

CAPITAL RESOURCES AND LIQUIDITY

For the fiscal year ended December 31, 1998, the Company used net cash of
$3,781,610 in operations. Accounts receivable increased from $1,967,614 at
December 31, 1997 to $3,757,865 at December 31, 1998, primarily as a result of
the increase in sales of the Apollo 95E in the fourth quarter. See "Risk Factors
- - Fluctuation in quarterly results may result in declines in our stock price."
Accounts payable and accrued liabilities totaling $3,653,831 at December 31,
1998 increased from $2,539,585 at the prior year-end period primarily due to
increased inventory purchases. Inventory levels increased approximately $2.7
million to accommodate the increased sales volume generated by the Apollo 95E.

Capital expenditures for the fiscal year ended December 31, 1998 were
approximately $722,000, with approximately $170,000 spent for the purchase of an
exhibit booth used at dental trade shows, approximately $171,000 spent for a new
computer network system, and approximately $131,000 spent for molds. Cash and
cash equivalents on hand at the end of the period were $3,941,305. The Debt
Placement in March 1998 provided approximately $4,200,000 in cash to the Company
after expenses.

In July 1997, the Company finalized a credit agreement with Comerica Bank
("Comerica") extending up to a $2,000,000 line of credit to the Company, secured
by a first priority security interest in the Company's assets and by an
assignment of the Company's rights under the Boston Marketing Distribution
Agreement. The credit facility bears interest at the rate of prime plus .25% per
annum (8.0% at December 31, 1998). All borrowings under the facility are subject
to a formula based, generally, on accounts receivable and inventory. The Company
intends to use the credit facility, when needed, for working capital and general
corporate purposes. No amounts were outstanding at December 31, 1998.

In December 1997, the Company finalized a second credit agreement with
Comerica extending up to a $500,000 line of credit to the Company for capital
expenditures, secured by a first priority interest in the Company's assets. The
credit facility bears interest at a rate of prime plus .5% per annum (8.25% at
December 31, 1998). The line expired on December 10, 1998, at which time the
principal balance began to amortize over a thirty-six (36) month period.
Borrowings are at 80% of the capital expenditure.
At December 31, 1998, $343,890 was outstanding.

On January 4, 1999, the Company replaced its credit agreements with Comerica
with a $6,950,000 facility with Imperial Bank ("Imperial"). The Imperial
facility comprises a $2,500,000 fixed rate non-revolving line of credit due May
31, 2000; a $4,000,000 variable rate revolving line of credit due May 31, 2000;
and a $450,000 variable interest rate loan repayable in 16 monthly installments.
The facilities are collateralized by the assets of the Company. The Company
intends to use the credit facilities, when

Page 15
<PAGE>

needed, for working capital, capital expenditures and general corporate
purposes. On January 21, 1999, the Company borrowed against the Imperial
facility to repay the balance owing on the Comerica capital credit line of
$343,890 plus accrued interest of $1,120. On January 25, 1999, the Company
borrowed against the Imperial facility to repay the $4,500,000 12% Senior
Subordinated Notes plus accrued interest of $189,000.

As of the end of March 1999, the expenditures for continued research and
development for products incorporating digital x-ray technology (including the
additional development fee due to Suni upon acceptance by the Company of the
final prototype subsystem and minimum royalty obligations), the minimum purchase
obligations under the BMC Agreement and the purchase obligations under the Suni
Manufacturing Agreement, are the only significant future commitments which will
be financed by cash from continuing operations and the remaining proceeds of the
$4.5 million debt placement. Based on its current operating plan, the Company
anticipates that unless a substantial portion of the Company's outstanding
redeemable warrants are exercised, cash on hand, cash generated from operations,
and borrowings available under the Imperial credit facility may not be
sufficient to satisfy the Company's expected increased working capital and
research and development requirements for new products during the next twelve
months, in which case further capital may be required. Exercise of the Company's
redeemable warrants in the near future, by the holders thereof, is only likely
if the market price of the Company's common stock meets the requirements
necessary to allow the Company to redeem the warrants and, consequently, there
can be no assurance that a significant portion of the Company's outstanding
redeemable warrants will be exercised. If the market price of the Company's
common stock reaches the requisite level for the requisite amount of days, the
Company may choose to redeem the warrants, in which case, some of the Company's
requirements for additional capital may be satisfied by the exercise of the
redeemable warrants. In addition, the Company is currently exploring
alternatives to fulfill these financing requirements. No assurance can be given
that additional financing will be available when needed or that, if available,
it will be on terms favorable to the Company or its stockholders. If needed
funds are not available, the Company may be required to curtail its operations,
which could have a material adverse effect on the Company's business, operating
results and financial condition. There can be no assurance that the Company's
working capital requirements during this period will not exceed its available
resources or that these funds will be sufficient to meet the Company's
longer-term cash requirements for operations. See "Risk Factors - We will need
additional capital to finance research and development of our new products."

FLUCTUATIONS IN QUARTERLY RESULTS

The Company's business is subject to certain quarterly influences. As
reflected in the chart below, net sales and operating profit are generally
higher in the fourth quarter due to the purchasing patterns of dentists in the
United States and are generally lower in the first quarter due primarily to the
effect upon demand or increased purchases in the prior quarter. It is also
expected that the Company's business will experience lower sales in the summer
months as a consequence of holiday vacations and a lesser number of trade shows.

Page 16
<PAGE>

The following table sets forth unaudited data regarding operations for each
quarter of fiscal 1998. This quarterly information has been prepared on the same
basis as the annual consolidated financial statements and, in management's
opinion, contains all adjustments necessary to fairly state the information set
forth herein. The operating results for any quarter are not necessarily
indicative of results for any future period.

<TABLE>
Fiscal 1998
<CAPTION>
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Net sales $2,110,531 $2,618,513 $6,157,358 $8,341,396
Cost of sales 1,550,089 1,946,906 2,866,104 3,457,783
--------- --------- --------- ---------
Gross profit 560,442 671,607 3,291,254 4,883,613
Selling, general and administrative
expense 1,729,619 2,134,639 1,845,232 3,055,420
Research and development expense 142,387 182,302 197,283 27,332
---------- ---------- --------- ---------
Operating income (loss) (1,311,564) (1,645,334) 1,248,739 1,800,861
Interest income (44,273) (64,057) (47,103) (40,099)
Interest expense 83,793 549,497 551,416 554,987
Amortization of debt issuance costs 10,484 75,000 75,000 75,000
---------- --------- --------- ---------
Income (loss) before income taxes (1,361,568) (2,205,774) 669,426 1,210,973
Provision for income taxes -- -- -- 129,759
---------- ---------- --------- ---------
Net income (loss) $(1,361,568) $(2,205,774) $669,426 $1,081,214
=========== =========== ======== ==========
</TABLE>

Quarterly results may be adversely affected in the future by a variety of
other factors, including the possible costs of obtaining capital, as well as the
release of new products and promotions taking place within the quarter. The
Company plans to continue to fund research and development and to increase
working capital requirements for the new products. Also, the expenses of the
Company are to a large extent fixed and not susceptible to rapid reduction. To
the extent that such expenses precede or are not subsequently followed by
increased revenues, the Company's business, operating results and financial
condition will be adversely affected.

YEAR 2000 ISSUE

The Year 2000 readiness issue, which is common to most businesses,
arises from the inability of information systems, and other time and date
sensitive products and systems, to properly recognize and process date-sensitive
information or system failures. Estimates of the potential cost and effects of
Year 2000 issues vary significantly among businesses, and it is extremely
difficult to predict the actual impact. Recognizing this uncertainty, management
is continuing to actively analyze, assess and plan for various Year 2000 issues
across its businesses.

The Year 2000 issue has an impact on both information technology
systems and non-information technology systems, such as its manufacturing
systems and physical facilities including, but not limited to, security systems
and utilities. We have tested all of our information technology systems and
non-information technology systems for Year 2000 readiness. All of our
non-information technology systems are Year 2000 compliant. With respect to
information technology systems, our strategy is to replace all non-Year 2000
compliant information technology systems by June 30, 1999. As of April 15, 1999,
our in-house data network is Year 2000 compliant. Also as of April 15, 1999,
eighty percent of our workstations are Year 2000 compliant, with the remainder
to be replaced with Year 2000 compliant workstations by June 30, 1999. Although
our management believes that its efforts will be successful and the costs will
be immaterial to our consolidated financial position and results of operations,
it also recognizes that any failure or delay could cause a potential impact.

The Year 2000 readiness of our customers varies. We are not
investigating whether or not our customers are evaluating and/or preparing their
own systems to be Year 2000 compliant. These efforts by customers to address
Year 2000 issues may affect the demand for certain products and services;
however, the impact on our revenue is highly uncertain.

We have investigated the Year 2000 readiness of our key suppliers. Our
direction of this effort is to ensure that there are adequate resources and
supplies available to us to minimize any potential business interruptions. Our
assessment of our key suppliers is now complete and we have determined that our
policy of maintaining an inventory of resources and supplies sufficient to last
a minimum of a one to three months will be adequate to minimize almost any
potential business interruptions. We believe that our one to three

Page 17
<PAGE>

month inventories will allow enough time for our suppliers to remedy Year 2000
problems that may arise in their respective businesses.

The Year 2000 issue presents a number of other risks and uncertainties
that could impact us, such as public utilities failures, potential claims
against us for damages arising from products and services that are not Year 2000
compliant, and the response ability of certain government commissions of the
various geographic areas where Dental/Medical conducts business. While we
continue to believe the Year 2000 issues described above will not materially
affect our financial position, it remains uncertain as to what extent, if any,
we may be impacted.

If we, our customers or suppliers are unable to resolve any Year 2000
compliance problems in a timely manner, we could face business interruptions or
a shutdown, financial loss, regulatory actions, reputational harm and/or legal
liability. We anticipate that 100% of our internal systems will be Year 2000
compliant by June 30, 1999 and that we will have adequate resources and supplies
available to us to minimize any potential business interruptions that may result
from Year 2000 compliance problems suffered by our suppliers. As a result, we
have determined that we will not be developing any contingency plans that
address a reasonably likely worst case scenario.

RISK FACTORS

WE HAVE A LIMITED OPERATING HISTORY UPON WHICH TO EVALUATE OUR LIKELIHOOD OF
SUCCESS.

We have only manufactured and distributed our TeliCam systems since October
1995 and manufactured and distributed our Apollo 95E since March 1998.
Therefore, we have a limited relevant operating history upon which to evaluate
the likelihood of our success. Factors such as the risks, expenses and
difficulties frequently encountered in the operation and expansion of a
relatively new business and the development and marketing of new products must
be considered in evaluating the likelihood of success of our company.

WE HAVE A HISTORY OF LOSSES AND ACCUMULATED DEFICIT.

For the period from October 23, 1995 to March 2, 1996, we incurred a net
loss of $1,625,213. For the fiscal year ended December 31, 1997 we had a net
loss of $2,044,729 and for the fiscal year ended December 31, 1998 we had a net
loss of $1,816,702. At December 31, 1998, our accumulated deficit was
$5,349,493. Our ability to obtain and sustain profitability will depend, in
part, upon the successful marketing of our existing products and the successful
and timely introduction of new products. Although the Company was profitable in
the quarter ended December 31, 1998, there can be no assurance that the Company
will continue to be profitable.

FLUCTUATION IN QUARTERLY RESULTS MAY RESULT IN DECLINES IN OUR STOCK PRICE.

Certain quarterly influences may affect our business. Sales are generally
higher in the fourth quarter due to the purchasing patterns of dentists in the
United States and are generally lower in the first quarter due primarily to the
effect upon demand of increased purchases in the prior quarter. It is also
expected that our business will experience lower sales in the summer months as a
consequence of holiday vacations and a lesser number of trade shows. These
fluctuations could result in significant fluctuations, including significant
declines in our stock price.

ONE OF OUR PRIMARY PRODUCTS HAS HAD A SIGNIFICANT DECLINE IN SALES.

The TeliCam systems, together with related products such as the InTELInet
system, and the Apollo 95E have been our primary products and during the last
fiscal year have made up a substantial portion of our revenue. We believe that
the market for intraoral cameras, such as the TeliCam systems, is a market that
has declined. TeliCam systems sales have recently been below levels of prior
comparable periods, a trend that we expect to continue.

Page 18
<PAGE>

AS A RESULT OF THE DECLINE IN SALES OF THE TELICAM, OUR FUTURE DEPENDS ON OUR
ABILITY TO INCREASE DEMAND FOR OUR APOLLO 95E AND RELATED PRODUCTS AS WELL
AS OUR ABILITY TO DEVELOP AND INTRODUCE NEW PRODUCTS.

As a result of the decline in the intraoral camera market, our future
depends upon our ability to increase demand for our related products and our
ability to develop and successfully introduce new products to make up for the
diminished sales of the Telicam systems. Development of new product lines is
risk intensive and often requires:

o long-term forecasting of market trends;
o the development and implementation of new designs;
o compliance with extensive governmental regulatory requirements; and
o a substantial capital commitment.

Also, the medical and dental device industry is characterized by rapid
technological change. As technological changes occur in the marketplace, we may
have to modify our products in order to become or remain competitive or ensure
that our products do not become obsolete. If we fail to anticipate or respond in
a cost-effective and timely manner to government requirements, market trends or
customer requirements, or if there are any significant delays in product
development or introduction, this could have a material adverse effect on our
business.

WE WILL NEED ADDITIONAL MONEY FOR BOTH GENERAL WORKING CAPITAL AND TO FINANCE
RESEARCH AND DEVELOPMENT OF OUR NEW PRODUCTS.

We anticipate that we will need additional money during fiscal 1999 to
satisfy our expected increased working capital and research and development
requirements for our planned new products. We are currently exploring
alternatives to fulfill these requirements, but cannot assure you that
additional financing will be available when needed or that, if available, it
will be on terms favorable to us. If needed funds are not available, we may be
required to limit or forego the development of new products or even limit
current operations, which could have a material adverse effect on our business,
operating results and financial condition.

WE SUBSTANTIALLY DEPEND UPON THIRD PARTY DEVELOPMENT AGREEMENTS AND LICENSING
AGREEMENTS FOR THE DEVELOPMENT OF MANY OF OUR PRODUCTS AND THE LICENSING OF
TECHNOLOGY OWNED BY OTHERS FOR USE IN OUR PRODUCTS.

We are dependent upon third party developers and suppliers for the
development and manufacture of all of the components used in our dental
equipment and for the development and manufacture of our consumable products.
Outside of updating our current products, we do not develop any of our own
technology, rather we continually seek out third parties that own new and
innovative technology that they may be willing to license to us or develop into
new dental products under a development agreement. We have had problems in the
past obtaining a marketable product from companies with whom we had entered into
a licensing arrangement. We entered into a licensing arrangement with Ion Laser
Technology under which ILT was unable to develop a product in accordance with
the delivery schedule established by our agreement that met our specifications;
as a result, we were forced to find an alternative product to that which we had
contracted for with ILT.

Under licensing and development arrangements we have obtained exclusive
marketing rights to products for the dental market incorporating certain digital
x-ray technology developed by Suni. We have paid significant non-refundable
advances to, and are dependent upon Suni to successfully develop the digital
x-ray technology and to commercialize the digital x-ray technology. We do not
guarantee that Suni will be successful in this endeavor. If Suni should not
develop a digital x-ray product which is accepted in the marketplace, and has
sufficient sales to achieve profits, this could have a material adverse effect
on our future prospects.

IN ORDER TO MAINTAIN OUR EXCLUSIVE RIGHTS TO THE DIGITAL X-RAY TECHNOLOGY
DEVELOPED BY SUNI WE MUST MAKE CERTAIN MINIMUM ROYALTY PAYMENTS TO SUNI.

In order to maintain our rights to be the exclusive dental licensee of the
digital x-ray technology developed by Suni, our agreement with Suni requires us
to make minimum royalty payments. The royalty payments begin coming due when
products incorporating the developed technology are introduced to the market. We
cannot guarantee that we will be able to make the minimum royalty payments
required to maintain our rights to be the exclusive distributor. If we do not
make the required royalty payments, Suni will be able to license the developed
technology to our competitors, or grant an exclusive license to a competitor,
which could have a material adverse effect on our future prospects.

Page 19
<PAGE>

THE GOVERNMENT EXTENSIVELY REGULATES OUR PRODUCTS.

The United States Food and Drug Administration, as well as state and foreign
agencies, regulate almost all aspects of our medical devices including:

o entry into the marketplace;
o design;
o testing;
o manufacturing procedures;
o reporting of complaints;
o labeling; and
o promotional activities.

Under the Federal Food, Drug, and Cosmetic Act, FDA has the authority to
control the introduction of new products into the marketplace. Unless
specifically exempted by the agency, medical devices enter the marketplace
through either FDA approval of premarket approval application or FDA approval of
an application for 510k clearance. FDA conducts periodic inspections to assure
compliance with that agency's regulations.

Unless specifically exempted by FDA's regulations, we will need to file a
510k submission or PMA application for any new products developed in the future
including any using digital x-ray technology. The process of obtaining a
clearance or approval can be time-consuming and expensive. Compliance with FDA's
regulatory requirements can be burdensome. We don't guarantee that the required
regulatory approvals or clearances will be obtained. Any approval or clearance
obtained from FDA may include significant limitations on the use of the medical
device which is the subject of the approval or clearance. We cannot market a
medical device if needed FDA approval or clearance is not granted. Inability to
obtain such approval or clearance could result in a delay or suspension of the
manufacture and sale of affected medical devices. Any such delay or suspension
would have a material adverse effect on our business. In addition, changes in
existing regulations or the adoption of new regulations could make regulatory
compliance by us more difficult in the future. The failure to obtain the
required regulatory clearances or to comply with applicable regulations could
result in one or more of the following:

o fines;
o delays or suspensions of device clearances;
o seizure actions;
o mandatory needs;
o Injunctive Action; and
o Criminal Prosecution.

WE DO NOT HAVE CALIFORNIA LICENSING.

The State of California requires that each facility manufacturing a medical
device apply for and obtain from the State's Department of Health Services a
Medical Device Manufacturing License. To qualify for the license, a facility
must be in compliance with FDA's regulatory requirements. We filed a timely
application for this license and in early March of 1999 the DHS conducted an
inspection of our manufacturing facility in Irvine, California and found no
"reportable observations." We received a list of adjustments and clarifications
recommended by the DHS. We filed a response to this list on March 19, 1999 and
we expect to receive a California Medical Device Manufacturing License in early
April, 1999. We cannot guarantee that DHS will grant our license. We cannot
manufacture devices at our facility if the license is not granted. Inability to
obtain this license could result in a delay or suspension of the manufacture and
sale of our medical devices. Any such delay or suspension would have a material
adverse effect on our business.

THE LOSS OF OUR CHIEF EXECUTIVE OFFICER WOULD HAVE AN ADVERSE EFFECT ON OUR
BUSINESS.

Our success is highly dependent upon our Chairman of the Board and Chief
Executive Officer, Robert H. Gurevitch. Unlike larger companies, we rely heavily
on a small number of officers to conduct a large portion of our business. The
loss of service of Robert H. Gurevitch along with the loss of his numerous
contacts and relationships in the industry would have a material adverse effect
on our business. We have entered into an Employment Agreement with Robert H.
Gurevitch under which he has agreed to render services to

Page 20
<PAGE>

us until October 1, 1999. We have obtained "key person" life insurance on Mr.
Gurevitch in the amount of $2,000,000, of which we are the sole beneficiary, but
there can be no assurance that the proceeds of such insurance will be sufficient
to offset the loss to us in the event of his death.

OUR PRODUCTS HAVE VERY LIMITED PATENT PROTECTION.

Our future success and ability to compete is dependent in part upon our
proprietary technology used in the Apollo 95E. The Apollo 95E is currently only
protected by a patent in France. Patent protection is being sought in all of the
countries of the world in which this technology can be marketed. There can be no
assurance (i) that patents outside of France will be granted for the Apollo 95E
system, and (ii) if granted, the patents will provide adequate protection for
the Company's technologies. Consequently, we rely primarily on trademark, trade
secret and copyright laws to protect our technology. However, there can be no
assurance that third parties will not try to copy our products. In addition,
many foreign countries' laws may not protect us from improper use of our
proprietary technology overseas. We may not have adequate remedies if our
proprietary rights are breached and therefore a breach of our proprietary rights
could have a material adverse effect on our financial condition.

ISSUANCE OF PREFERRED STOCK MAY HAVE THE EFFECT OF PREVENTING A CHANGE OF
CONTROL.

We have authorized 1,000,000 shares of preferred stock, which may be issued
by the Board of Directors with certain rights not granted to the holders of
common stock. Issuance of such preferred stock, depending upon the terms and the
rights thereof, may have the effect of delaying, deterring or preventing a
change in control.

WE ARE SUSCEPTIBLE TO PRODUCT LIABILITY SUITS.

Although we have not yet had any product liability claims, because of the
nature of the medical/dental device industry, there can be no assurance that we
will not be subject to such claims in the future. Our products come into contact
with more vulnerable areas of the human body, such as the mouth, tongue, teeth
and gums, and, therefore, the sale and support of dental products makes us
susceptible to the risk of such claims. A successful product liability claim or
claim arising as a result of use of our products brought against us, or the
negative publicity brought up by such claim, could have a material adverse
effect upon our business. We maintain product liability insurance with coverage
limits of $1,000,000 per occurrence and $11,000,000 per year. While we believe
that we maintain adequate insurance coverage, we do not guarantee that the
amount of insurance will be adequate to satisfy claims made against us in the
future, or that we will be able to obtain insurance in the future at
satisfactory rates or in adequate amounts.

THE YEAR 2000 ISSUE COULD HAVE AN IMPACT ON OUR INFORMATION TECHNOLOGY AND
NON-INFORMATION TECHNOLOGY SYSTEMS AS WELL AS THOSE OF OUR SUPPLIERS AND/OR
CUSTOMERS, ANY OF WHICH COULD NEGATIVELY AFFECT SALES OF OUR PRODUCTS.

Page 21
<PAGE>

Page 22
<PAGE>

ITEM 7. FINANCIAL STATEMENTS.

DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

PAGE
----
Report of Independent Accountants...................................... 22

Consolidated Balance Sheets as of December 31, 1998
and December 31, 1997................................................ 23

Consolidated Statements of Operations for the Fiscal Years
ended December 31, 1998 and 1997 and for the Ten-Month Period
ended December 31, 1996.............................................. 24

Consolidated Statements of Stockholders' Equity for the Fiscal Years
ended December 31, 1998 and 1997 and for the Ten-Month Period
ended December 31, 1996.............................................. 25

Consolidated Statements of Cash Flows for the Fiscal Years
ended December 31, 1998 and 1997 and for the Ten-Month Period
ended December 31, 1996.............................................. 26

Consolidated Statements of Comprehensive Income for the Fiscal Years
ended December 31, 1998 and 1997 and for the Ten-Month Period
ended December 31, 1996.............................................. 27

Notes to Consolidated Financial Statements............................ 28

Page 23
<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and
Shareholders of Dental/Medical Diagnostic Systems, Inc.

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity, cash flows and
compehensive income (loss) present fairly, in all material respects, the
financial position of Dental/Medical Diagnostic Systems, Inc. and its
subsidiaries (the "Company") at December 31, 1998 and 1997, and the results of
their operations and their cash flows for the fiscal years ended December 31,
1998 and 1997 and for the ten month period ended December 31, 1996, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.

/s/ PricewaterhouseCoopers LLP

Woodland Hills, CA
February 5, 1999, except for subsequent events
described in Note 19, as to which the date is
March 18, 1999.

Page 24
<PAGE>

<TABLE>
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997

ASSETS

<CAPTION>
1998 1997
------------ -----------
Current assets
<S> <C> <C>
Cash and cash equivalents..................................... $ 3,941,305 $ 3,981,062
Accounts receivable, less allowance for returns and doubtful
accounts of $20,975 at both December 31, 1998 and 1997........ 3,757,865 1,967,614
Inventories................................................... 5,559,751 2,896,270
Prepaid expenses and other current assets..................... 1,332,427 389,061
Debt issuance costs, net of accumulated amortization.......... 64,516 --
------------ -----------
Total current assets.................................. 14,655,864 9,234,007
Property and equipment, net of accumulated depreciation....... 996,940 553,119
Intangible assets, net of accumulated amortization............ 798,437 86,950
Loans to related parties...................................... 70,000 126,000
Other assets.................................................. 49,119 491,950
------------ -----------
Total assets.......................................... $ 16,570,360 $10,492,026
============ ===========
</TABLE>

<TABLE>
LIABILITIES AND STOCKHOLDERS' EQUITY
<CAPTION>
Current liabilities:
<S> <C> <C>
Current portion of capital lease obligations.................. $ 22,440 $ 23,356
Notes payable ................................................ 4,277,505 --
Notes payable to related parties.............................. -- 45,030
Borrowings under line of credit .............................. 114,630 --
Accounts payable.............................................. 2,413,767 1,522,412
Accrued liabilities........................................... 1,240,064 1,017,173
Customer deposits............................................. 60,833 42,995
------------ -----------
Total current liabilities............................. 8,129,239 2,650,966
Borrowings under line of credit .............................. 229,260 --
Capital lease obligations..................................... 22,935 39,858
Other long term liabilities................................... 15,061 11,052
------------ -----------
Total liabilities..................................... 8,396,495 2,701,876
------------ -----------
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock, par value $.01 per share; 1,000,000 shares
authorized; none issued and outstanding....................... -- --
Common stock, par value $.01 per share; 20,000,000 shares
authorized; 5,255,694 and 5,115,777 shares issued and
outstanding at December 31, 1998 and 1997..................... 52,556 51,157
Additional paid in capital.................................... 13,469,597 11,271,784
Accumulated translation adjustment............................ 1,205 --
Accumulated deficit........................................... (5,349,493) (3,532,791)
------------ -----------
Total stockholders' equity............................ 8,173,865 7,790,150
------------ -----------
Total liabilities and stockholders' equity............ $ 16,570,360 $10,492,026
============ ===========
</TABLE>

The accompanying notes are an integral part of these
consolidated financial statements.

Page 25
<PAGE>

<TABLE>

DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
AND FOR THE TEN-MONTH PERIOD ENDED DECEMBER 31, 1996

<CAPTION>
FOR THE YEAR ENDED TEN MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net sales........................................ $ 19,227,798 $ 16,087,208 $ 11,673,102
Cost of sales.................................... 9,820,882 10,234,206 6,685,464
----------- ------------ ------------
Gross profit................................... 9,406,916 5,853,002 4,987,638
Selling, general and administrative expense...... 8,764,910 6,031,066 4,360,736
Research and development expense................. 549,304 1,213,766 322,467
Non-recurring charge............................. -- 256,250 --
---------- ------------ ------------
Operating income (loss)........................ 92,702 (1,648,080) 304,435
Interest and other income....................... (195,532) (205,818) --
Interest expense................................. 1,739,693 138,576 57,166
Amortization of debt issuance costs.............. 235,484 76,431 31,548
--------- --------- -----------
Income (loss) before income taxes and
extraordinary item............................. (1,686,943) (1,657,269) 215,721
Provision for income taxes....................... 129,759 153,311 78,570
---------- --------- -------
Income (loss) before extraordinary item........ (1,816,702) (1,810,580) 137,151
Extraordinary loss on early extinguishment of debt
(net of tax benefit of $143,511)............... -- (234,149) --
----------------- ------------ ------------
Net income (loss)...................... $ (1,816,702) $ (2,044,729) $ 137,151
============= ============ ============
Earnings (loss) per share before extraordinary
item:
Basic.......................................... $ (.35) $ (.42) $ .05
Diluted........................................ (.35) (.42) .05
Earnings (loss) per share after extraordinary
item:
Basic.......................................... $ (.35) $ (.47) $ .05
Diluted........................................ (.35) (.47) .05
Weighted average number of shares:
Basic.......................................... 5,151,614 4,341,498 2,893,298
Diluted........................................ 5,151,614 4,341,498 3,019,213
</TABLE>

The accompanying notes are an integral part of these
consolidated financial statements.

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<PAGE>

<TABLE>
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
AND FOR THE TEN-MONTH PERIOD ENDED DECEMBER 31, 1996

<CAPTION>
ADDITIONAL ACCUMULATED
COMMON STOCK PAID IN ACCUMULATED TRANSLATION
SHARES AMOUNT CAPITAL DEFICIT ADJUSTMENT TOTAL
------ ------ --------- ------- ------------ -----
<S> <C> <C> <C> <C> <C> <C>
Balance, March 2, 1996............................. 2,563,318 $ 25,633 $ 1,339,248 $(1,625,213) $ -- $ (260,332)
Issuance of common stock for cash,
net of issuance costs........................... 422,219 4,222 1,050,281 -- -- 1,054,503
Issuance of warrants for cash.................... -- -- 259,103 -- -- 259,103
Issuance of stock options to nonemployees........ -- -- 47,200 -- -- 47,200
Net income....................................... -- -- -- 137,151 -- 137,151
-------- ---------- ----------- ---------- ------------ ------------
Balance, December 31, 1996......................... 2,985,537 29,855 2,695,832 (1,488,062) -- 1,237,625
Issuance of common stock for cash,
net of issuance costs........................... 2,120,000 21,200 8,509,192 -- -- 8,530,392
Exercise of stock options........................ 10,240 102 8,910 -- -- 9,012
Amortization of deferred compensation............ -- -- 57,850 -- -- 57,850
Net loss......................................... -- -- -- (2,044,729) -- (2,044,729)
-------- ------- ----------- ---------- ------------ ----------
Balance, December 31, 1997......................... 5,115,777 51,157 11,271,784 (3,532,791) -- 7,790,150
Issuance of common stock for
distribution rights............................ 100,000 1,000 461,500 -- -- 462,500
Issuance of warrants with
Senior Subordinated Notes...................... -- -- 1,619,755 -- -- 1,619,755

Exercise of stock options........................ 39,917 399 116,558 -- -- 116,957
Net loss......................................... -- -- -- (1,816,702) -- (1,816,702)
Translation adjustment........................... -- -- -- -- 1,205 1,205
--------- ------- ----------- ----------- ----------- -----------
Balance, December 31, 1998......................... 5,255,694 $52,556 $13,469,597 $(5,349,493) $ 1,205 $ 8,173,865
========= ======= =========== =========== ========= ============
</TABLE>

The accompanying notes are an integral part of these
consolidated financial statements.

Page 27
<PAGE>

<TABLE>
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED DECEMBER 31, 1998 AND 1997
AND FOR THE TEN-MONTH PERIOD ENDED DECEMBER 31, 1996

<CAPTION>
FOR THE YEAR ENDED TEN MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) .................................. $(1,816,702) $(2,044,729) $ 137,151
Adjustments to reconcile net income (loss) to
net cash used by operating activities;
Depreciation and amortization .................... 338,462 92,993 108,047
Amortization of debt issue costs ................. 235,484 -- --
Amortization of debt discount .................... 1,271,790 -- --
Allowance for returns and doubtful accounts ...... -- (86,428) 79,123
Inventory write down ............................. 156,620 29,205 20,822
Extraordinary item ............................... -- 377,660 --
Amortization of deferred compensation ............ -- 57,850 --
Deferred taxes ................................... -- 90,000 (90,000)
Deferred rent .................................... 4,009 (3,046) 1,469
Common stock and stock options issued for
services......................................... -- -- 47,200
Changes in operating assets and liabilities:
Accounts receivable ........................... (1,782,471) (722,742) (1,188,544)
Inventories ................................... (2,818,298) (1,412,400) (461,812)
Prepaid expenses and other current assets ..... (941,706) (180,509) (55,567)
Other assets .................................. 442,831 (449,680) (6,230)
Accounts payable .............................. 889,808 433,080 (448,316)
Accrued liabilities and income taxes payable .. 220,725 538,430 441,052
Customer deposits ............................. 17,838 9,388 (215,738)
----------- ----------- -----------
Net cash used by operating activities ...... (3,781,610) (3,270,928) (1,631,343)
----------- ----------- -----------

Cash flows from investing activities:
Loans to related parties ......................... 56,000 (126,000) --
Purchase of intangible assets .................... (304,494) (86,950) --
Purchase of property and equipment ............... (722,056) (284,082) (200,686)
----------- ----------- -----------
Net cash used in investing activities ...... (970,550) (497,032) (200,686)
----------- ----------- -----------
Cash flows from financing activities:
(Decrease) increase in book overdraft ............ -- -- (49,906)
Accounts payable to related party in excess of
terms .......................................... -- -- (79,218)
Issuance of common stock, net of offering costs .. -- 8,530,392 1,054,503
Proceeds from exercise of stock options .......... 116,957 9,012 --
Repayment of bridge loan ......................... -- (1,600,000) --
Proceeds from issuance of notes payable .......... 4,625,509 -- 1,314,766
Debt issuance costs .............................. (300,000) -- --
Proceeds from line of credit ..................... 343,890 -- --
Proceeds from borrowings from related parties .... -- -- 25,000
Payments on borrowings from related parties ...... (45,030) (227,936) (29,049)
Principal payments on capital lease obligations .. (17,839) (21,282) (11,842)
----------- ----------- -----------
Net cash provided by financing activities.. 4,723,487 6,690,186 2,224,254
----------- ----------- -----------
Net increase (decrease) in cash and
cash equivalents ....................... (28,673) 2,922,226 392,225
Effect of exchange rate changes on cash and cash
equivalents ...................................... (11,084) -- --
Cash and cash equivalents, beginning of period ..... 3,981,062 1,058,836 666,611
----------- ----------- -----------
Cash and cash equivalents, end of period ........... $ 3,941,305 $ 3,981,062 $ 1,058,836
=========== =========== ===========
Supplemental cash flow information:
Interest paid .................................... $ 310,615 $ 281,693 $ 8,219
Income taxes paid ................................ 17,553 50,279 --
Supplemental schedule of non-cash investing and
financing activities:
Issuance of common stock for purchase of
intangible asset ............................... $ 462,500 $ -- $ --
Capital lease obligations incurred ............... -- -- 5,997
</TABLE>

The accompanying notes are an integral part of these
consolidated financial statements.

Page 28
<PAGE>

<TABLE>
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE FISCAL YEARS ENDED DECEMBER 31, 1998 AND 1997
AND FOR THE TEN-MONTH PERIOD ENDED DECEMBER 31, 1996

For the Year Ended Ten Months
December 31, Ended
------------------------------ December 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income (loss) $(1,816,702) $(2,044,729) $ 137,151
Other comprehensive income:
Foreign currency translation
adjustment 1,205 -- --
----------- ----------- -----------
Comprehensive income (loss) $(1,815,497) $(2,044,729) $ 137,151
=========== =========== ===========
</TABLE>

The accompanying notes are an integral part of these
consolidated financial statements.

Page 29
<PAGE>

DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. GENERAL

The Company designs, develops, manufactures and sells high technology dental
equipment. The Company's primary existing product emphasis is on the manufacture
and sale of a tooth curing and whitening device known as the "Apollo 95E." The
Company also markets and sells a line of whitening products known as "Apollo
Secret" for use in conjunction with the Apollo 95E, and in Q2 of 1999 intends to
introduce a line of composite resin materials known as "ASAP - Accelerated
Solutions for Aesthetic Procedures." In addition, the Company continues to
manufacture and sell intraoral camera systems, known as the "TeliCam II System,"
and "TeliCam Elite," and a multi-operatory intraoral camera system, known as the
InTELInet, for use in connection with the TeliCam II System and TeliCam Elite."

On February 2, 1998 the Company formed "DMDS, Ltd." a wholly owned
subsidiary created under the laws of the United Kingdom. DMDS, Ltd. holds the
assets acquired in 1997 from S.E.D. Gerant, a company organized under the laws
of France. In addition, the Company is marketing certain of its new products
internationally through DMDS, Ltd.

2. BASIS OF PRESENTATION

On February 5, 1997, the Company changed its fiscal year-end from a fiscal
year ending on the nearest Saturday to February 28th to a December 31 fiscal
year-end. The accompanying consolidated financial statements reflect the
operating results of the Company for the fiscal years ended December 31, 1998
and 1997 and for the ten-month period from March 3, 1996 through December 31,
1996.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of DMDS and its
wholly owned subsidiaries. All intercompany balances and transactions have been
eliminated.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. The significant estimates made in the preparation of the
consolidated financial statements relate to the assessment of the carrying value
of accounts receivable, inventories, and estimated provision for warranty costs.
Actual results could differ from those estimates.

RISKS AND UNCERTAINTIES

The Company buys certain key components from one supplier or from a limited
number of suppliers. Although there are a limited number of suppliers of the key
components, management believes that other suppliers could provide similar
components on comparable terms. Changes in key suppliers could cause delays in
manufacturing and distribution of products and a possible loss in sales, which
could adversely affect operating results.

The Company has derived substantially all of its revenues from the sale of
two product families. The Company believes that the inability to attract new
customers, the loss of one or more of its major customers, a significant
reduction in business from such customers, or the uncollectibility of amounts
due from any of its larger customers, could have a material adverse affect on
the Company.

Page 30
<PAGE>

REVENUE RECOGNITION

The Company recognizes revenue from the sales of systems and supplies at
the time of shipment, net of an allowance for estimated sales returns. The
Company generally warranties its systems for one year. A provision for estimated
future costs relating to warranty is recorded when systems are shipped.

CASH AND CASH EQUIVALENTS

For purposes of the statement of cash flows, the Company considers all
highly liquid investments purchased with an original maturity of three months or
less to be cash equivalents.

INVENTORIES

Inventories are carried at standard costs which approximate the lower of
actual cost (first-in; first-out) or market. Such amounts include the cost of
materials and, when applicable, labor and overhead.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost, less accumulated depreciation.
Capitalized leases are recorded at the lower of fair market value or the present
value of future minimum lease payments, less accumulated amortization.
Maintenance and repairs are expensed as incurred. The cost and related
accumulated depreciation and amortization of property and equipment sold or
retired are removed from the accounts and the resulting gains or losses are
included in current operations. Depreciation and amortization are provided on a
straight line basis over the estimated useful lives of the related asset, or
with respect to leasehold improvements and capital leases over the primary term
of the lease, whichever is less, as follows:

Equipment and software, including capitalized leases........... 5 years
Furniture and fixtures......................................... 7 years
Leasehold improvements and tooling............................. 3 years

PATENTS, TRADEMARKS AND OTHER INTANGIBLES

Patents, trademarks and other intangibles are carried at cost less
accumulated amortization which is calculated on a straight-line basis over the
estimated useful lives of the assets, not exceeding 15 years. Accumulated
amortization was $59,968 and $0 as of December 31, 1998 and 1997, respectively.

LONG-LIVED ASSETS

The carrying value of long-lived assets is periodically reviewed by
management, and impairment losses, if any, are recognized when the expected
nondiscounted future operating cash flows derived from such assets are less than
their carrying values.

ADVERTISING AND PROMOTION COSTS

Production costs of future media advertising and costs of dental industry
trade shows are deferred until the advertising or trade show occurs. All other
advertising and promotion costs are expensed as incurred. Total advertising and
promotion expenses incurred for the fiscal years ended December 31, 1998 and
1997, and for the ten-month period ended December 31, 1996, were $2,256,179,
$1,528,203, and $1,008,879, respectively. Prepaid advertising and promotion
costs at December 31, 1998 and 1997 were $376,316 and $214,667, respectively.

RESEARCH AND DEVELOPMENT COSTS

Costs related to research and development are expensed as incurred.

Page 31
<PAGE>

INCOME TAXES

The Company accounts for income taxes under the liability method. Under this
method, deferred tax assets and liabilities are determined based on the
differences between the financial statement and tax bases of assets and
liabilities, using enacted tax rates in effect for the year in which the
differences are expected to reverse. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
Income tax expense is the tax currently payable for the period and the change
during the period in deferred tax assets and liabilities.

STOCK-BASED EMPLOYEE COMPENSATION AWARDS

Statement of Financial Accounting Standards No. 123, "Accounting for the
Awards of Stock-Based Compensation to Employees" ("SFAS No. 123") encourages,
but does not require companies to record compensation cost for stock-based
compensation plans at fair value. The Company has adopted the disclosure
requirements of SFAS No. 123, which involves proforma disclosure of net income
under SFAS No. 123, detailed descriptions of plan terms and assumptions used in
valuing stock option grants. The Company has chosen to continue to account for
stock-based employee compensation awards in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."

CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS

Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of trade accounts receivable.
Also, at various times throughout the year, cash balances are maintained in
excess of Federally insured deposit limits.

For the fiscal years ended December 31, 1998 and 1997, and for the ten-month
period ended December 31, 1996, international customers accounted for 40%, 24%
and 19% of sales, respectively. At December 31, 1998 and 1997, international
customers accounted for approximately 78% and 57% of accounts receivable,
respectively. No customer accounted for more than 10% of revenues in any of the
periods presented. Five customers accounted for 54% of the Company's accounts
receivable at December 31, 1998.

The Company performs ongoing credit evaluations of its customers' financial
condition and generally does not require collateral. Estimated credit losses and
returns have been provided for in the financial statements.

The majority of the Company's current customers consist of dental
professionals and independent distributors. Certain of the dental professionals
lease the Company's products through third party leasing companies. Under the
terms of the sales, the leasing companies have no recourse against the Company.

FAIR VALUE OF FINANCIAL INSTRUMENTS

Statement of Financial Accounting Standards No. 107, "Disclosure About Fair
Value of Financial Instruments," requires disclosure of fair value information
about all financial instruments held by a company except for certain excluded
instruments and instruments for which it is not practical to estimate fair
value. The carrying value of the Company's financial instruments approximates
their fair value.

COMPUTATION OF EARNINGS PER SHARE

The Company adopted Statement of Financial Accounting Standards (SFAS) No.
128; "Earnings Per Share" for the year ended December 31, 1997, and has reported
earnings per common share for all periods presented in accordance with the new
standard. Net income (loss) per common share is computed by dividing net income
(loss) by the weighted average number of shares of common stock outstanding
during the period. Net income (loss) per common share assuming dilution is
computed by dividing net income (loss) by the weighted average number of shares
of common stock outstanding plus the number of additional common shares that
would have been outstanding if all dilutive potential common shares had been
issued, using the treasury stock method. Potential common shares related to
stock options and stock warrants are excluded from the computation when their
effect is antidilutive.

Page 32
<PAGE>

COMPREHENSIVE INCOME

In January 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 establishes standards for reporting and displaying comprehensive
income and its components (revenues, expenses, gains and losses) in financial
statements. SFAS 130 requires that all items that are required to be recognized
under accounting standards as components of comprehensive income be reported in
a financial statement that is displayed with the same prominence as other
financial statements.

No tax effect has been allocated to the foreign currency translation
adjustment for the periods presented.

The following is a reconciliation of accumulated other comprehensive income
balance for the year ended December 31, 1998.

Beginning balance $ --
Current period change 1,205
------
Ending balance $1,205
======

FOREIGN CURRENCY

Financial statements of foreign subsidiaries are translated to US dollars
using the exchange rate at the balance sheet date for assets and liabilities and
a weighted average exchange rate for each period for revenues, expenses, gains
and losses. The effect of unrealized exchange rate fluctuations on translating
foreign currency assets and liabilities into US dollars are accumulated as a
separate component of shareholders' equity. Gains (losses) resulting from
foreign currency transactions are included in the statement of operations and
amounted to ($69,726) and $0 for the years ended December 31, 1998 and 1997,
respectively, and $0 for the ten months ended December 31, 1996.

RECLASSIFICATIONS

Certain prior year balances have been reclassified to conform with current
year presentation.

RECENTLY ISSUED ACCOUNTING STANDARDS

In 1998, the Company adopted SFAS No. 131. " Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 supercedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise," replacing the
"industry segment" approach with the "management" approach. The management
approach designates the internal organization that is used by management for
making operating decisions and assessing performance as the source of the
Company's reportable segments. SFAS No. 131 also requires disclosures about
products and services, geographic areas and major customers. The adoption of
SFAS No. 131 did not affect the results of operations or financial position but
did affect the disclosure of segment information (see "Segment Information").

4. RELATED PARTY TRANSACTIONS

From December 1995 through February 1996, Robert H. Gurevitch, Chairman of
the Board and Chief Executive Officer of the Company, and Boston Marketing
Company, Ltd. ("Boston Marketing"), an affiliate of Hiroki Umezaki, a former
Director of the Company, loaned the Company an aggregate of $377,015. The
Promissory Notes evidencing such loans bear interest at 6% per annum and were
originally payable within six months. On February 26, 1996, the Company repaid
$50,000 to each of Mr. Gurevitch and Boston Marketing. In November 1996, Mr.
Gurevitch and Boston Marketing each agreed to extend the term of their
respective notes. On May 23, 1997, Boston Marketing was paid the remaining
principal balance of $150,000 of its loan plus the accrued interest of $3,526.
Mr. Gurevitch was paid $25,000 on July 10, 1997; $26,850 on October 22, 1997;
$5,000 on October 30, 1997; $13,787 on November 1, 1997; and $3,447 on December
1, 1997; $3,447 on January 1, 1998; $5,319 on February 1, 1998; $12,806 on
February 19, 1998; $3,447 on April 1, 1998; $1,341 on May 1, 1998; $3,512 on May
18, 1998; $3,976 on June 3, 1998; $81 on June 17, 1998; and the balance was paid
during the third quarter of 1998.

Page 33
<PAGE>

On May 27, 1997, the Company loaned Dewey Perrigo, Vice President of Sales
of the Company, and Andrea Niemiec-Perrigo, an employee of the Company, $126,000
for the purpose of buying a home. The Promissory Notes evidencing such loans
bear interest at prime plus .25% (8.0% at December 31, 1998), and are due and
payable on May 27, 1999. On August 19, 1998, a principal payment of $56,000 and
an interest payment of $6,152 were made leaving a loan balance of $70,000.

5. INVENTORIES

Inventories consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
---- ----
<S> <C> <C>
Raw materials................... $2,313,810 $1,387,695
Work in process................. 874,002 555,049
Finished goods.................. 2,371,939 953,526
---------- ----------
$5,559,751 $2,896,270
</TABLE>

6. PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Prepaid advertising and industry trade show fees .. $376,316 $214,667
Prepaid inventory ................................. 220,219 --
VAT recoverable ................................... 321,254 --
Other ............................................. 414,638 174,394
---------- ---------
$1,332,427 $ 389,061
========== =========
</TABLE>

7. PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Equipment and software, including $112,853
of capitalized leases at both
December 31, 1998 and 1997......................... $1,128,919 $ 569,729
Furniture and fixtures.............................. 295,360 135,034
Leasehold improvements.............................. 47,251 44,222
---------- ---------
1,471,530 748,985
Less accumulated depreciation and amortization,
including $45,142 and $22,571 relating to
capitalized leases at December 31, 1998 and
1997.............................................. (474,590) (195,866)
--------- ---------
$996,940 $ 553,119
======== =========
</TABLE>

Page 34
<PAGE>

8. INTANGIBLE ASSETS

Intangible assets consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
Patents and trademarks.......................... $395,905 $86,950
License agreements.............................. 462,500 --
-------- -------
858,405 86,950
Less accumulated amortization................... (59,968) --
-------- -------
$798,437 $86,950
======== =======
</TABLE>

On October 2, 1998, the Company acquired the exclusive worldwide license
agreement for certain tooth whitening products from Chrysalis Dental, Inc.
through the issuance of 100,000 shares of common stock.

9. ACCRUED LIABILITIES

Accrued liabilities consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
---------- ----------
<S> <C> <C>
Accrued commissions.................. $362,019 $223,750
Accrued warranty..................... 85,000 84,730
Accrued salaries and wages........... 84,661 82,112
Accrued interest..................... 161,488 5,965
Income taxes payable................. 124,452 --
Deferred revenue..................... 32,866 1,200
Accrued advertising.................. 78,983 --
Accrued vacation..................... 64,225 66,911
Accrued development payments......... -- 350,000
Other................................ 246,370 202,505
---------- ----------
$1,240,064 $1,017,173
---------- ----------
</TABLE>

10. BORROWINGS UNDER LINE OF CREDIT

On July 1, 1997, the Company finalized a credit agreement with Comerica Bank
("Comerica") extending up to a $2,000,000 line of credit to the Company,
collateralized by a first priority security interest in the Company's assets and
by an assignment of the Company's rights under the Boston Marketing Distribution
Agreement. The credit facility bears interest at the rate of prime plus .25% per
annum (8.00% at December 31, 1998). All borrowings under the facility are
subject to a formula based, generally, on accounts receivable and inventory. No
amounts were outstanding under this line of credit at December 31, 1998.

On December 10, 1997, the Company finalized a second agreement with Comerica
Bank ("Comerica") extending up to a $500,000 line of credit to the Company for
capital expenditures, collateralized by a first priority interest in the
Company's assets. The credit facility bears interest at a rate of prime plus .5%
per annum (8.25% at December 31, 1998). The line expired on December 10, 1998,
at which time the principal balance began to amortize over a thirty-six (36)
month period. Borrowings are at 80% of the capital expenditure. At December 31,
1998, $343,890 was outstanding under this line of credit.

On January 4, 1999, the Company replaced its credit agreements with Comerica
with a $6,950,000 facility with Imperial Bank ("Imperial"). The Imperial
facility comprises of a $2,500,000 fixed rate non-revolving line of credit due
May 31, 2000; a $4,000,000 variable rate revolving line of credit loan due May
31, 2000; and a $450,000 variable interest rate loan repayable in 16 monthly
installments. The facilities are collateralized by the assets of the Company.
The Company intends to use the credit facilities, when needed, for working
capital, capital expenditures and general corporate purposes. On January 21,
1999, the Company borrowed against the Imperial facility to repay the balance
owing on to Comerica capital credit line of $343,890 plus accrued interest of
$1,120.

Page 35
<PAGE>

On January 25, 1999, the Company borrowed against the Imperial facility
to repay the $4,500,000 12% Senior Subordinated Notes plus accrued interest of
$189,000.

11. NOTES PAYABLE:

Notes payable consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
1998
------------
<S> <C>
$4,500,000 12% Senior Subordinated Notes
due March 19, 1999, net of unamortized
discount of $348,435 $4,151,565
Notes payable to certain individuals bearing
interest at 12% at December 31, 1998.
Due on demand prior to December 2000 125,940
-----------

$4,277,505
===========
</TABLE>

12. COMMITMENTS AND CONTINGENCIES

LEASES

The Company leases two facilities under operating leases that expire in 1999
and 2000. The leases require the Company to pay taxes, maintenance fees, and
insurance and provide for periodic fixed rent increases based on a published
price index. The Company also leases certain equipment under capital leases
which expire in 2000 and has the right to purchase the underlying equipment at
the termination of the leases for its fair market value. Rent expense for all
operating leases was approximately $189,000, $132,000 and $102,000 for the
fiscal years ended December 31, 1998 and 1997 and for the ten-month period ended
December 31, 1996, respectively. The two non-cancelable leases are guaranteed by
Robert H. Gurevitch, Chief Executive Officer and Chairman of the Board of the
Company.

The aggregate liability for future rentals under lease agreements with
noncancelable lease terms in excess of one year as of December 31, 1998, is
summarized as follows:

<TABLE>
<CAPTION>
CAPITAL OPERATING
YEAR ENDED DECEMBER 31 LEASES LEASES
---------------------- ------- ---------
<S> <C> <C>
1999............................................ $25,672 $76,308
2000............................................ 22,539 69,949
------- --------
48,211 $146,257
========
Less amounts representing:
Interest...................................... 2,836
Current portion............................... 22,440
-------
Long term portion............................... $22,935
=======
</TABLE>

DISTRIBUTION AGREEMENTS

Effective October 1, 1996, the Company amended its distribution agreement
("BMC Distribution Agreement") with Boston Marketing, a licensed distributor of
the Teli manufactured CCD chip which includes the Teli CCU processor. Pursuant
to the BMC Distribution Agreement, the Company has the exclusive right (i) to
market certain Teli manufactured CCD chip assemblies with CCU processors (model
numbers CS6110 S/B with Frame Grabber, CS6110 P S/B with Frame Grabber and the
CS6110 S/B without Frame Grabber (each a "Teli Unit" and collectively the "Teli
Units")) to the dental market, and (ii) to use the "TeliCam" trademark. The Teli
Units are key components of the Company's intraoral digital cameras. The BMC
Distribution Agreement has a five-year initial term. The Company has agreed to
purchase a minimum of 2,500 Teli Units per year for each of the five years, at
an initial price of $750 per Teli Unit. The Boston Marketing Distribution
Agreement is terminable by Boston Marketing if the Company fails to meet its
annual minimum purchase obligation. The term of the BMC Distribution Agreement
may be extended by mutual agreement of the Company and Boston Marketing for an
additional five year term.

Page 36
<PAGE>

On October 10, 1997, the Company entered into an agreement with Suni Imaging
Microsystems, Inc. ("Suni") to develop digital x-ray technology for
incorporation into systems for the dental market. The Company has obtained
exclusive rights to market products to the dental market incorporating certain
digital x-ray technology developed by Suni. Suni will retain the rights to
developed microchip technology underlying the x-ray system it develops for the
Company. The Company will determine whether or not to proceed with the marketing
of such products based upon the results of the development.

Under the agreement with Suni, the Company was required to pay a non
refundable fee of $875,000 to Suni to develop technology for a digital x-ray
system for the dental market. This non-refundable fee was charged to research
and development expense during the year ended December 31, 1997. If the initial
prototype developed subsystem is not accepted by the Company, the fee is not
refundable to the Company and the Company is under no obligation to pay any
additional development fees or financial penalties to Suni. If the initial
prototype subsystem is accepted by the Company, upon acceptance of the final
prototype subsystem, the Company is obligated to pay an additional development
fee of $375,000. Through December 31, 1998, only the initial portion of the fee
($875,000) has been paid to Suni. The remaining $375,000 is expected to be paid
in the first quarter of 1999 upon acceptance of the final prototype developed
subsystem. Under the terms of the agreement, the Company will also be required
to pay a per unit royalty on each licensed product sold.

On October 2, 1998, the Company entered into an agreement with Chrysalis
Dental, Inc. to acquire the exclusive worldwide license agreement for certain
new tooth whitening products ("New Products"). Pursuant to the terms of the
agreement the Company is required to pay minimum annual royalties of $150,000
during the term of the agreement. Should the Company fail to make the minimum
annual royalty payments after December 31, 2000, the Company shall have the
option to convert the exclusive agreement to a non-exclusive agreement and
thereafter forego payment of the minimum annual royalties. The Company is also
required to pay an earned royalty of 7% on the net sales of the New Products by
the Company in excess of the minimum payments, unless within five years of the
date of agreement no patents have been filed covering the New Products, then the
royalty rate will be reduced to 4%.

13. CAPITAL TRANSACTIONS

On May 30, 1996, the Company completed the sale of a total of 422,219 shares
of its common stock to six foreign investors. Each share was sold at a price of
$2.58 per share and, consequently, the Company raised approximately $1,055,000
from the sale, net of related expenses of approximately $34,000.

On November 27, 1996, the Company raised approximately $1,314,000, net of
issuance costs of $285,000, through a private placement of 32 Units to certain
accredited investors. Each Unit consisted of a secured promissory note in the
principal amount of $50,000 ("Bridge Note") and a warrant to purchase 18,750
shares of Common Stock ("Bridge Warrant") at a purchase price of $2.67 per
share. The Notes bore interest at a rate of 10% per annum and the principal and
all accrued interest were payable upon the earliest to occur of: (a) May 27,
1998; (b) certain change in control events effecting the Company; (c) a public
offering of the Company's securities; or (d) the sale by the Company's Chief
Executive Officer of all or substantially all of his holdings of the Common
Stock. Upon the happening of certain events the holders of the Notes had the
right to convert the outstanding balances of their Notes into shares of the
Common Stock at a rate of $2.67 per share. The Warrants were first exercisable
on November 27, 1997 and expire on November 27, 2002. As a result of the
warrants, these notes were discounted by $259,104, which amount was being
amortized over the term of the notes. The Bridge Warrants were converted into
1,600,000 Redeemable Common Stock Purchase Warrants upon closing of the
Company's Offering on May 14, 1997.

On May 14, 1997, the Company closed a secondary offering of 2,070,000 shares
of common stock. Each share of common stock included one redeemable warrant to
purchase one share of common stock at a purchase price of $5.00. This offering
resulted in gross proceeds of $10,350,000 less expenses of approximately
$2,075,858 for net proceeds of approximately $8,274,142. In addition, the
underwriter to the secondary offering received an option to purchase 180,000
shares of common stock and/or 180,000 warrants at a purchase price of $4.95 per
share and $0.55 per warrant. Further, approximately $1,600,000 of the net
proceeds were used to repay the principal on the Bridge Notes plus an additional
$100,000 was used to pay off accrued interest. The Bridge Notes consisted of
secured convertible promissory notes in the aggregate principal amount of
$1,600,000 bearing interest at 10% per annum and were payable the earlier of May
27, 1998 or consummation of the offering. The Bridge Warrants were automatically
converted at the date of the secondary offering. Approximately $224,000 was used
to repay loans from related parties. The remaining net proceeds have or will be
used for product development, acquisition, and to repay the remaining loans from
related parties, and working capital and general corporate purposes.

Page 37
<PAGE>

On September 17, 1997, the Company issued 50,000 shares of Common Stock to
DMD NV, the Company's licensed exclusive distributor of the TeliCam system in
Europe, in exchange for termination of DMD NV's exclusive distribution rights in
Europe. The market value of the Common Stock issued was $256,250.

On March 2, 1998, the Company entered into an agreement with accredited
investors and institutional purchasers for the private placement (the "Debt
Placement") of its 12% Senior Subordinated Notes due 1999, and 450,000 warrants
(the "1998 Warrants"). The Debt Placement was consummated on March 19, 1998. The
1998 Warrants are (i) exercisable commencing on May 15, 1998, and for five years
thereafter for the purchase of one share of Common Stock per Warrant; and (ii)
at an exercise price of $5.812 per share. The Senior Subordinated Notes (i) bear
interest payable semi-annually at a rate of 12% per annum; (ii) mature on the
first anniversary of the date of issuance; and (iii) may be repaid by the
Company prior to maturity at one hundred and two (102%) percent of the amount of
the unpaid principal plus interest due as of the date of repayment. As a result
of the warrant issuance, the Senior Subordinated Notes were discounted by
$1,620,225, which is being amortized over the term of the Notes. On September
16, 1998, accrued interest of $270,000 was paid to the Note holders in
accordance with the Debt Placement agreement. On January 27, 1999, the Company
repaid the Senior Subordinated Notes, in full, plus $189,000 of accrued
interest.

14. STOCK OPTIONS AND WARRANTS

In March 1997, the Company's Board of Directors approved the "1997 Stock
Incentive Plan." Under the plan, incentive stock options and non-statutory stock
options may be granted to employees, directors, and consultants to purchase a
specified number of shares of common stock at a price not less than the fair
market value on the date of grant and for a term not to exceed 10 years. Options
for employees generally vest over a period of 5 years. The maximum number of
shares authorized for grants of options under the 1997 Stock Incentive Plan at
December 31, 1998 is 700,000.

SFAS No. 123, "Accounting for Stock-Based Compensation," encourages but does
not require companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Accordingly, no compensation expense
has been recognized for the Company's stock based compensation plans. Had
compensation costs for the Company's stock option plan (for options granted in
the years ended December 31, 1998 and 1997, and in the ten-month period ended
December 31, 1996, only) been determined based upon the methodology prescribed
under SFAS No. 123, the Company's net (loss) would approximate the pro forma
amounts below:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998: AS REPORTED PRO FORMA
- ----------------------------- ----------- ---------
<S> <C> <C>
Net income/(loss).................................. $(1,816,702) $(2,215,967)
Net income/(loss) per share (basic and diluted).... $ (.35) $ (.43)

YEAR ENDED DECEMBER 31, 1997: AS REPORTED PRO FORMA
- ----------------------------- ----------- ---------
Net income/(loss).................................. $(2,044,729) $(2,180,726)
Net income/(loss) per share (basic and diluted).... $ (.47) $ (.50)

TEN-MONTH PERIOD ENDED DECEMBER 31, 1996: AS REPORTED PRO FORMA
- ----------------------------------------- ----------- ---------
Net income/(loss)................................ $ 137,151 $ (158,129)
Net income/(loss) per share (basic and diluted).. $ .05 $ (.05)
</TABLE>

The fair value of options granted during 1998, 1997 and 1996 is estimated as
$970,215, $1,278,280 and $295,280, respectively, on the dates of grants using
the Black-Scholes option pricing model. The following assumptions were used for
1998, 1997 and 1996: (i) risk-free interest rate of 4.82%, 6.33% and 6.85%,
respectively (ii) expected option life of 5 years, (iii) forfeiture rate of 0,
(iv) expected volatility of 72.6%, 68.73% and 143%, respectively and (v) no
expected dividends.

The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. SFAS No. 123 does not apply to awards prior to
1996.

Page 38
<PAGE>

A summary of the status of the Company's stock options as of December 31,
1998, 1997 and 1996, and the changes during the years ended December 31, 1998
and 1997, and the ten-month period ended December 31, 1996, is presented below:

<TABLE>
<CAPTION>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NUMBER OF OPTION GRANT DATE
SHARES EXERCISE PRICE FAIR VALUE
--------- -------------- ----------
<S> <C> <C> <C>
Outstanding at March 2, 1996............... -- $ --
Granted.................................. 139,943 2.63 $2.11
Exercised................................ -- --
------- ----
Options outstanding at December 31, 1996... 139,943 2.63
Granted.................................. 471,691 3.79 2.71
Canceled................................. (513) 2.95
Exercised................................ (10,240) .88
------- ----
Options outstanding at December 31, 1997... 600,881 3.63
Granted.................................. 362,950 4.20 2.67
Canceled................................. (32,108) 4.85
Exercised................................ (39,917) 2.93
------- ----
Options outstanding at December 31, 1998... 891,806 4.15
======= ====
Options exercisable at December 31, 1998. 279,367 $3.27
Options available for future grant....... 54,858
</TABLE>

OPTIONS OUTSTANDING
------------------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED AVERAGE ----------------------------------------
RANGE OF NUMBER OUTSTANDING AT REMAINING WEIGHTED AVERAGE NUMBER OUTSTANDING WEIGHTED AVERAGE
EXERCISE PRICE DECEMBER 31, 1998 CONTRACTUAL LIFE EXERCISE PRICE AT DECEMBER 31, 1998 EXERCISE PRICE
------------------ ---------------------- ------------------ ------------------ --------------------------------------
<S> <C> <C> <C> <C> <C>
$0.88 - 2.93 178,357 2.25 years $2.34 178,717 $2.34
$4.00 - 4.50 385,950 8.79 years $4.08 36,000 $4.50
$5.00 - 5.875 327,499 8.77 years $5.22 64,650 $5.15
------- -------
891,806 279,367
======= =======
</TABLE>

The following is a summary of warrants outstanding at December 31, 1998:

<TABLE>
<CAPTION>
NUMBER OF COMMON
SHARES UNDER WARRANTS EXERCISE PRICE EXPIRATION DATE
--------------------- -------------- ---------------
<S> <C> <C>
450,000 $5.81 May 15, 2003
180,000 5.55 May 14, 2002
2,070,000 5.00 May 14, 2002
1,600,000 5.00 November 27, 2002
---------
4,300,000
=========
</TABLE>

15. INCOME TAXES

The income tax expense (benefit) for the fiscal years ended December 31,
1998 and 1997, and for the ten-month period ended December 31, 1996 is as
follows:

<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Current:
Federal.................... $ -- $113,299 $132,570
State...................... 1,600 40,012 36,000
Foreign.................... 128,159 -- --
------- -------- ----------
129,759 153,311 168,570
Deferred:
Federal.................... -- -- (67,000)
State...................... -- -- (23,000)
-------- -------- -------
Total................. $129,759 $153,311 $78,570
======== ======== =======
</TABLE>

Page 39
<PAGE>

The Company's effective tax rate for the fiscal years ended December 31,
1998 and 1997, and for the ten-month period ended December 31, 1996 differs from
the statutory federal income tax rate as follows:

<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Tax provision at the statutory rate.................... (34.0)% (34.0)% 34.0%
Nondeductible expenses................................. -- 2.0 10.0
State taxes, net of federal benefit.................... (7.1) (6.0) 14.0
Research & development credit.......................... -- (5.0) --
Establishment of valuation allowance................... -- 52.0 --
Increase (reduction) in deferred asset valuation
allowance.............................................. 43.2 -- (27.0)
Foreign taxes.......................................... 2.3 -- --
Other.................................................. 3.3 0.3 5.0
--- -- ---
7.7% 9.3% 36.0%
====== ====== =====
</TABLE>

The components of the net deferred taxes are as follows:

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1998 1997 1996
------------- ------------- ---------
<S> <C> <C> <C>
Deferred Tax Assets:
Inventory reserves........................... $ 64,600 $ 39,000 $28,300
Warranty accrual............................. 33,900 33,000 22,600
Allowance for returns and doubtful accounts.. 8,300 20,700 37,900
Net operating loss carry forwards............ 1,625,000 1,029,700 --
Research and development credits............. 171,800 100,000 --
Accrued vacation............................. 25,600 24,100 --
Fixed assets................................. (7,800) 31,400 --
Intangible assets............................ (127,000) -- --
State tax credits............................ (111,500) -- --
Other........................................ 81,500 17,100 1,200
Valuation allowance.......................... (1,764,400) (1,295,000) --
----------- ----------- -------
$ -- $ -- $90,000
=========== =========== =======
</TABLE>

As a result of the Company's recent loss history, a valuation allowance has
been recorded for the full amount of the Company's deferred tax asset at
December 31, 1998.

The Company has federal tax and state NOL carryforwards of $3,852,000 and
$3,742,000, respectively, which begin to expire in 2017 and 2002, respectively.

Page 40
<PAGE>

16. EARNINGS PER SHARE

The following table provides a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for the years ended
December 31, 1998 and 1997, and for the ten-month period ended December 31,
1996:

<TABLE>
<CAPTION>
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
<S> <C> <C> <C>
For the year ended December 31, 1998:
Basic earnings per share......................... $(1,816,702) 5,151,614 $(.35)
Effect of dilutive securities--stock options and
warrants........................................ -- -- --
----------- --------- -----
Diluted earnings per share....................... $(1,816,702) 5,151,614 $(.35)
=========== ========= =====
For the year ended December 31, 1997:
Basic earnings per share......................... $(2,044,729) 4,341,498 $(.47)
Effect of dilutive securities -- stock options
and warrants.................................... -- -- --
----------- --------- -----
Diluted earnings per share....................... $(2,044,729) 4,341,498 $(.47)
=========== ========= =====
For the ten months ended December 31, 1996:
Basic earnings per share......................... $137,151 2,893,298 $.05
Effect of dilutive securities -- stock options and
warrants........................................ -- 125,915 --
----------- --------- ----
Diluted earnings per share....................... $137,151 3,019,213 $.05
======== ========= ====
</TABLE>

The computation for diluted number of shares excludes unexercised stock
options and warrants that are anti-dilutive. The number of such shares for the
years ending December 31, 1998 and 1997, and for the ten-month period ended
December 31, 1996 were 5,372,806, 4,580,881 and 830,395, respectively.

17. EXTRAORDINARY ITEM AND NON-RECURRING CHARGE

On May 14, 1997, the Company repaid the $1,600,000 principal amount Bridge
Notes in connection with the Company's Offering. An extraordinary charge of
$234,149 (net of tax benefit of $143,511) was incurred for the early
extinguishment of those notes.

On September 17, 1997, the Company repurchased the exclusive distribution
rights of its products into the European market from an independent distributor
for 50,000 shares of common stock. This resulted in a non-recurring charge of
$256,250.

18. SEGMENT INFORMATION

The Company operates in one segment - dental medical equipment which, at
December 31, 1998, comprised three main products: TeliCam Systems - an intraoral
camera and dental networking system; Apollo 95E tooth whitening and curing
system; and other accessories including the Apollo Secret whitening product.
Accordingly no separate segment information is provided other than Enterprise
Wide disclosures as required by SFAS No. 131.

The following are sales by product lines for the year ended December 31,
1998:

<TABLE>
<CAPTION>
DECEMBER 31,
1998
------------

<S> <C>
TeliCam $6,555,540
Apollo 95E 11,125,629
Other 1,546,629
-----------
$19,227,798
===========
</TABLE>

Sales for the year ended December 31, 1997 and for the ten-month period
ended December 31, 1996 consisted primarily of TeliCam sales.

Page 41
<PAGE>

The Company ships products from its operations in the US and Europe. The
following are sales by its US and European locations for the years ended
December 31, 1998 and 1997 and the ten-month period ended December 31, 1996:

TEN-MONTH PERIOD
FOR THE YEAR ENDED DECEMBER 31, ENDED
-------------------------------------- DECEMBER 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Sales by geography:
United States $13,182,354 $16,087,208 $11,673,102
Europe 6,045,444 -- --
----------- ----------- -----------
$19,227,798 $16,087,208 $11,673,102
=========== =========== ===========
</TABLE>

The following is long-lived asset information by geographic area as of
December 31, 1998 and 1997:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------
1998 1997
---- ----
<S> <C> <C>
Long Lived assets:
United States $866,950 $553,119
Europe 129,990 --
-------- --------
$996,940 $553,119
</TABLE>

19. SUBSEQUENT EVENTS

On March 1, 1999, DMDS, Ltd. purchased the assets of DMD Germany, an
independent company organized under the laws of Germany, for a purchase price
consisting of 100,000 shares of the Common Stock of the Company. DMD Germany's
sole business was the sale and distribution of the Company's products in
Germany. The assets that DMDS, Ltd. purchased include the business (as a going
concern), customer lists, goodwill, the benefit of the lease and other contracts
with third parties and all other items of whatever nature owned by DMD Germany
and used in the conduct of the business of DMD Germany. Under the terms of the
agreement, if DMD Germany generates greater than (1) $4 million in revenues, or
(2) Apollo and/or TeleCam unit sales of at least 780 units during the first year
under the agreement, the Company shall pay contingent consideration equal to the
difference between $1.6 million and the market value of 100,000 shares of Common
Stock. The Company also entered into an employment agreement with Ralf Muller,
the General Manager of DMD Germany. The Company intends to continue the business
of DMD Germany as currently operated. The Company purchased the assets of DMD
Germany for the purpose of increasing its revenues and the margins on products
sold in Germany.

Page 42
<PAGE>

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

None.

Page 43
<PAGE>

PART III

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

The information required in Item 9, is hereby incorporated by reference to
the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission for the 1999 Annual Meeting of its Stockholders ("Proxy
Statement").

ITEM 10. EXECUTIVE COMPENSATION
- --------------------------------

The information required in Item 10 is hereby incorporated by reference to
the Registrant's Proxy Statement.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------

The information required in Item 11 is hereby incorporated by reference to
the Registrant's Proxy Statement.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------

The information required in Item 12 is hereby incorporated by reference to
the Registrant's Proxy Statement.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------

(a) EXHIBITS.

EXHIBIT
NO. DOCUMENT DESCRIPTION
- ------- ---------------------

1.1 Form of Underwriting Agreement.(1)

1.2 Form of Underwriter's Purchase Option granted to M.H. Meyerson & Co.,
Inc. (1)

2.1 Dental/Medical Diagnostic Systems, Inc. 1997 Stock Incentive Plan.(2)

3.1 Amended and Restated Certificate of Incorporation of the Registrant.(2)

3.2 Bylaws of the Registrant.(2)

4.1 Specimen Stock Certificate of the Registrant.(1)

4.2 Form of Warrant Agreement between American Stock Transfer & Trust
Company and the Registrant and form of Warrant Certificate.(3)

10.1 Agency Agreement dated as of October 23, 1996, by and between the
Registrant and M.H. Meyerson & Co., Inc.(4)

10.2 Form of Registration Rights Agreement Letter, dated January 31, 1997,
from Registrant to those certain purchasers of the Registrant's Common
Stock listed on the Schedule thereto.(2)

10.3 Commitment Letter, dated February 13, 1997, from Comerica Bank
confirming the existence of a secured line of credit for the
Registrant.(2)

10.4 Employment Agreement, dated as of October 1, 1996, entered into by the
Registrant and Robert H. Gurevitch.(4)

10.5 Employment Agreement, dated as of October 1, 1996, entered into by the
Registrant and Dewey Perrigo.(4)

10.6 Distribution Agreement, dated as of October 1, 1996, between the
Registrant and Boston Marketing Company, Ltd., as amended.(2)

10.7 Promissory Note, dated February 1, 1996, between the Registrant and
Robert H. Gurevitch.(2)

10.8 Promissory Note, dated February 15, 1996, made by the Registrant in
favor of Robert H. Gurevitch.(2)

10.9 Extension of Promissory Note, dated November 5, 1996, between the
Registrant and Robert H. Gurevitch.(4)

10.10 Form of Indemnification Agreement and Schedule of Indemnified
Parties.(3)

10.11 Standard Office Lease, dated October 30, 1995, between John Hancock
Mutual Life Insurance Company ("John Hancock") and the Registrant, for
Suite 202 at 200 North Westlake Boulevard Office; and Guaranty of Lease,
dated November 6, 1995, made by Robert H. Gurevitch in favor of John
Hancock.(2)

10.12 Agreement between the Registrant and DMD NV dated as of September 30,
1997.(6)

10.13 Agreement between the Registrant and Suni Imaging Microsystems, Inc.
dated October 10, 1997.(7)

Page 44
<PAGE>

10.14 Extension of automatic termination provisions of agreement between the
Registrant and Suni Imaging Microsystems, Inc., dated November 11,
1997.(7)

10.15 Purchase Agreement by and among the Registrant and the purchasers named
therein with respect to the sale and purchase of an aggregate of
$4,500,000 aggregate principal amount of the Registrant's 12% Senior
Subordinated Notes due 1999, and Warrants dated as of March 2, 1998. (7)

10.16 Form of 12% Senior Subordinated Note due 1999.(7)

10.17 Form of Common Stock Purchase Warrant.(7)

10.18 Revolving Credit Loan and Security Agreement between the Registrant and
Comerica Bank-California, dated as of December 10, 1997.(7)

10.19 Variable Rate-Single Payment Note of the Company in form of Comerica
Bank-California, dated as of December, 10, 1997.(7)

10.20 First modification to Variable Rate-Single Payment Note, between the
Company and Comerica Bank-California, dated as of December 24, 1997.(7)

10.21 Exclusive License Agreement, by and between the Registrant and Chrysalis
Dental, Inc., dated as of October 2, 1998.(8)

10.22 Agreement for the Sale of the Seller's Business and Assets, by and among
the Registrant, Fadi Nahab and DMDS Ltd., dated March 1, 1999.(8)

10.23 Agreement for the Sale of the Seller's Business and Assets, by and among
DMD Gmbh, Ralf Muller and DMDS Ltd., dated March 1, 1999.(8)

10.24 Credit Agreement between the Registrant and Imperial Bank, dated January
4, 1999.(8)

10.25 Standard Office Lease, between the Company and Frank F. Parker (with
addendum), dated as of August 8, 1997, for 16722 Millikan Avenue,
Irvine, CA.(8)

10.26 Second Addendum to Standard Office Lease, between the Company and Frank
F. Parker, dated July 29, 1998, for 16722 Millikan Avenue, Irvine, CA.
(8)

10.27 Suni-DMD Manufacturing, Assembly & Test Services Agreement, by and
between Registrant and Suni Imaging Microsystems, Inc., dated as of
March 17, 1999.(8)

21.1 Subsidiaries of the Registrant.(8)

23.1 Consent of PriceWaterhouseCoopers LLP.

24.1 Power of Attorney (included in signature page attached to the Form
10-K/SB).(8)

27.1 Financial Data Schedule.(8)

- ----------
* The Registrant has requested Confidential Treatment of portions of the
referenced exhibit.

(1) Incorporated by reference to exhibits to Pre-effective Amendment No. 1 to
the Registration Statement on Form SB-2 of the Registrant filed on April 7,
1997 (File No. 333-22507).

(2) Incorporated by reference to exhibits to the Registrant's Registration
Statement on Form SB-2 filed on February 28, 1997 (File No. 333-22507).

(3) Incorporated by reference to exhibits to Pre-effective Amendment No. 2 to
the Registrant's Registration Statement on Form SB- 2 filed on April 30
(File No. 333-22507).

(4) Incorporated by reference to exhibits to the Registrant's Report on Form
10-QSB, dated November 30, 1996.

(5) Incorporated by reference from the Registrant's Report on Form 8-K, dated
March 1,1996.

(6) Incorporated by referenced from exhibits to the Registrant's Report on Form
10-QSB dated September 30, 1997.

(7) Incorporated by reference to exhibits to Registrant's Report on Form 10-KSB
for the fiscal year ended December 31, 1997.

(8) Incorporated by reference to exhibits to Registrant's Report on Form 10-KSB
for the fiscal year ended December 31, 1998, filed on March 31, 1999.

(b) REPORTS ON FORM 8-K.

In the fourth quarter, the Registrant filed no Reports on Form 8-K.

Page 45
<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this Amendment No. 1 to
Report on Form 10KSB to be signed on its behalf by the undersigned thereunto
duly authorized in the City of Los Angeles and State of California on the 19th
day of April, 1999.

DENTAL/MEDICAL DIAGNOSTIC
SYSTEMS, INC.

By: /S/ Robert Gurevitch
-------------------------------------------
Robert H. Gurevitch
CHAIRMAN AND CHIEF EXECUTIVE OFFICER

Pursuant to the requirements of the Securities and Exchange Act of 1934,
this Report has been signed below by the following persons in the capacities and
on the date indicated:

SIGNATURE TITLE DATE

/S/ Robert H. Gurevitch Chairman, Chief Executive
----------------------------- Officer, and Director April 19, 1999
Robert H. Gurevitch

* Director April 19, 1999
- ------------------------------
Jack D. Preston

* Chief Financial Officer,
- ------------------------------ Principal Accounting Officer April 19, 1999
Stephen F. Ross

* Director
- ------------------------------ April 19, 1999
Marvin H. Kleinberg

*By /S/ ROBERT H. GUREVITCH
- ------------------------------
Robert H. Gurevitch
his Attorney-In-Fact

Page 46

CONSENT OF INDEPENDENT ACCOUNTANTS

We consent to the incorporation by reference in previously filed registration
statements of Dental/Medical Diagnostic Systems, Inc., including, without
limitation, registration statements on Form S-3 (Registration Nos. 333-42865,
333-51775, 333-68271) and Form S-8 (Registration Nos. 333-42867, 333-66441) of
our report dated February 5, 1999 except for subsequent events described in Note
19, as to which the date is March 18, 1999, on our audits of the consolidated
financial statements of Dental/Medical Diagnostic Systems, Inc. as of December
31, 1998 and 1997 and for the fiscal years ended December 31, 1998 and 1997 and
the ten-month period ended December 31, 1996, which report is included in this
Annual Report on Form 10-KSB/A.

/s/ PricewaterhouseCoopers, LLP

PricewaterhouseCoopers, LLP
Woodland Hills, CA
April 19, 1999