ITEM 1. DESCRIPTION OF BUSINESS

(A) BUSINESS DEVELOPMENT (INCLUDING CURTAILMENT OF OPERATIONS IN 1997)

Magna-Lab Inc. (the "Company") was incorporated as a New York corporation on February 22, 1991 and commenced operations on February 10, 1992. Prior to February 10, 1992, the activities of Minkoff Research Labs, Inc. (the "Predecessor") can be considered a predecessor to the Company. Minkoff Research Labs, Inc. was formed in October 1989 by Dr. Lawrence A. Minkoff, the Company's President, Chief Executive Officer and Chairman of the Board, to, among other things, conduct research and development of magnet technologies. In February 1992, the Company was initially funded.

In October 1992, the Board of Directors approved the split (effective in December 1992) of the Company's shares approximately 21,532 for one. In December 1992, the Company effected a recapitalization pursuant to which all then outstanding shares of Common Stock were reclassified as Class B Common Stock, having 5 votes per share. In April and May of 1993, the Company completed the initial public offering of 1,150,000 units of its equity securities (see "Item 5 -- Market for Common Equity and Related Stockholder Matters" and Note 7 to Financial Statements) yielding net proceeds of approximately $5.4 million. In July and August 1995, $1,250,000 principal amount of Bridge Notes together with warrants to purchase 625,000 shares of Class A Common Stock and an additional $166,667 in cash were converted into 625,000 shares of Class A Common Stock. In January 1996, the Company completed the public offering of 1,850,000 shares of Class A Common Stock and Class E Warrants to purchase 925,000 shares of Class A Common Stock yielding net proceeds of approximately $4.6 million. In February 1997 the Company issued a Note payable in March 1997 to a shareholder for $75,000 bearing interest at prime plus 2% until March 1997 and a penalty rate thereafter. In February 1997, the Company sold 300,000 shares of its Class A Common Stock in a private placement with accredited investors for $100,000.

In May 1997 the Company vacated its principal executive office and its address is now P.O. Box 1313, Brentwood, New York 11767 and its telephone number is (516) 595-2111. In April 1996, the Company's principal executive office was relocated to 250Z Executive Drive, Edgewood, N.Y. 11767 and its telephone number was changed to 516-595-2111. Prior thereto the Company's principal executive office was located at 950 South Oyster Bay Road, Hicksville, New York 11801 and its telephone number was 516 575-2111.

The Company has been unable to generate adequate cash flow from sales and production of its first product and has been unable to complete sufficient financing to continue its planned operations. The Company's current liquidity is not adequate to meet its obligations as they come due.

In February 1997, the Board of Directors agreed to retain a consultant (subject to certain matters to be resolved) and approved a plan of restructuring of the Company's operations conceived with the assistance of the consultant (the "Plan"). The Plan has, as its objective, restructuring of the Company's existing business by elimination of production, marketing and certain system engineering by strengthening the existing relationship with Elscint Cryomagnetics, Ltd., a subsidiary of Elscint, Ltd. ("Elscint" -- see "Business of the Issuer -- General" and "Business of the Issuer -- Marketing and Distribution") for a discussion of the relationship with Elscint), and repositioning the Company into a royalty and development company in the near term. The repositioning would involve a significant new development initiative in Cardiac MRI through a joint collaboration with the Mount Sinai School of Medicine (the "Cardiac MRI Initiative"). The Company has received a proposal from Elscint (the "Elscint Proposal") for certain work which is integral to the Plan but the Company has been unable to finalize the proposal because of lack of funds. The Company has concluded an agreement with the Mount Sinai School of Medicine for the Cardiac MRI Initiative but has been unable to fund its obligations under the agreement. The Plan involves termination of the majority of the Company's workforce including the entire sales and marketing staff, the production department and portions of the engineering staff. Further, the Plan includes elimination of the Company's production, development and executive facility, reductions in the need for other assets including leased assets with remaining non-cancelable terms, and other measures. The Plan also includes raising new financing in order to support the Cardiac MRI Initiative and the financial resources needed

to proceed with the Elscint Proposal. The Company recorded a restructuring charge of approximately $1.5 million in February, 1997 for write downs of fixed assets, inventory (see next paragraph) and deposits made with strategic vendors which are non-refundable, as well as accruals for lease termination and other costs. The ultimate amount may differ from this estimate.

Pursuant to the Plan and after its further attempts to raise additional working capital were unsuccessful, on March 5, 1997, the Company informed 10 of its 20 employees that they were being indefinitely laid off and between March 5 and March 15, 1997, another 4 employees were laid off due to insufficient funds for their payroll. The remaining employees were offered the opportunity to continue with the Company in exchange for deferred compensation pending successful completion of continuing efforts to complete a financing (which has not been completed). At October 1, 1997, unpaid payroll to terminated and continuing employees totaled approximately $300,000. Of the remainder, only Lawrence A. Minkoff, Ph. D., the Company's Chairman, president and Chief Executive Officer, is in the full time employ of the Company as of October 15, 1997. The remaining employees have terminated their full time relationship with the Company and approximately four of them serve or have indicated that they may serve as part time employees or consultants to the Company. When the Company vacated its principal production, development and executive facility it agreed to a judgment against it by the landlord for unpaid rent in amounts exceeding $50,000 and for additional rent totaling approximately $70,000 in settlement of the unexpired term of the lease. The Company then placed certain inventory and equipment in storage and several key individuals continued the search for new capital. The Company's operations have, therefore, all but ceased. Additionally, various creditors have threatened or initiated legal action to recover amounts due them which the Company has no ability to pay (See -- Litigation).

The Company continues to search for new capital in order to continue its operations pursuant to the Plan. The Company has been in negotiation with an investor group to provide certain limited funding to the Company predicated on the Company's ability to significantly reduce its recorded liabilities (through creditor concessions). The funding, if completed, would result in the issuance of a number of shares of common stock in excess of the currently outstanding shares. No assurance can be made that the Company will be able to complete such financing.

(B) BUSINESS OF ISSUER

GENERAL

The Company has developed and had intended to manufacture and market the MAGNA-SL(R), the first of a planned series of anatomy-specific MRI products which are smaller and cost less to own, install and operate than present "whole body" MRI systems. Further, because the Company's scanners are open on three sides and require only the part of the body being scanned to be placed inside the scanner, they should not elicit the claustrophobic responses many patients have to most whole body scanners. Unlike new "open" whole body systems, which use "low-field" magnets, the MAGNA-SL uses a "mid-field" permanent magnet and therefore produces image quality comparable to that of "mid-field" whole body scanners (which the Company believes represent the majority of the MRI market).

The Company received US marketing clearance for the MAGNA-SL in September 1994 from the Food and Drug Administration ("FDA") through submission of a 510(k) premarket notification. The Company has sold and delivered four MAGNA-SL scanners. Three such sales were made to a related party with which the Company has entered into a sales, marketing and distribution agreement. The third scanner delivered to this related party has not been paid for by such related party and the Company has provided for this receivable. See Item 12 -- "Certain Relationships and Related Transactions" and Notes 7 and 9 to Financial Statements.

In June 1996, the Company and Elscint signed a definitive agreement covering a strategic business arrangement in which Elscint would manufacture the MAGNA-SL for marketing and sale by Elscint in certain non-United States territories including Europe, the Peoples Republic of China, parts of the Middle East and Latin America, Australia and other territories. The Company would be paid royalties on each system manufactured and sold by Elscint. To maintain its rights under the agreement, Elscint is required to sell a minimum number of systems in the first two year period (commencing after an agreed upon period of start-up) and a higher number of systems in the first permitted two

year renewal period. Thereafter, the agreement is renewable by Elscint in two year sales periods at higher minimum quantities which will be set by the parties in good faith. Elscint has the right to cure shortfalls by, among other things, making payment of approximately 87% of the minimum royalties. Upon execution of the agreement, a nonrefundable deposit of $250,000 was paid to the Company to be applied to first year royalties. Additionally, Elscint and the Company have agreed to cooperate in making certain capital expenditures and other areas of manufacturing in order to reduce production costs and increase operating margins. The parties have also agreed to collaborate in developing new features and improvements to the MAGNA-SL and the Company has agreed to provide certain ongoing research and development support. Elscint has a right of first negotiation on certain new products.

The parties agreed to certain development tasks and enhancements, which, if not completed by the Company in November 1996, could, if not cured, result in termination of the agreement by Elscint. Elscint has informed the Company that it is not satisfied with the completion of certain of the tasks agreed to by the parties. The parties then negotiated a new completion date for the tasks with Elscint reserving all of its rights including the right to complete the tasks itself at the Company's expense or to terminate the agreement. Elscint informed the Company that it was not satisfied with the Company's completion of the tasks after the new completion date. Subsequently, Elscint presented to the Company its proposal (the "Elscint Proposal") to take over the uncompleted tasks and resulting in a major alteration and improvement of certain systems comprising the MAGNA-SL. The Elscint Proposal requires a development payment of $500,000 plus certain support activities from the Company. The Company has agreed to go forward with Elscint Proposal but has been unable to make any of the required payments to initiate or complete the Elscint Proposal. In May 1997, the Company received notification from Elscint that it would reserve the right to terminate its agreement with the Company and seek damages from the Company as a result of the Company's failure to cure the deficiencies identified by Elscint or alternatively to move forward with the Elscint Proposal. Elscint has subsequently indicated to the Company that it still wished to proceed with the Elscint Proposal.

A third party had indicated to the Company that it believes the agreement with Elscint comes within the terms of a Company engagement with that third party and that a fee is due them with respect thereto. The Company disputed this. The agreement with the third party contained provisions for compensation of 6% of certain amounts received and refers to a minimum fee of $250,000 for covered transactions. The Company had discussions with this party concerning this matter and, in light of those discussions to a point in time and after discussions with counsel, had accrued (but still disputed) an amount of fee based on a percentage of the royalties received to date. In December 1996, this third party presented the Company with a demand for immediate payment of the $250,000 minimum fee it asserts is due under its agreement. During October 1997, the parties agreed to settle this matter for the issuance of 125,000 shares of Class A Common Stock.

In August 1996, Elscint placed purchase orders for certain components of the MAGNA-SL from the Company in order to accommodate the stage of its manufacturing and marketing efforts. In the third quarter ended November 30, 1996, the Company shipped approximately $99,000 of components to Elscint.

In May 1997, the Company entered into an agreement with Mount Sinai School of Medicine and Dr. Valentin Fuster (as principal investigator) for a collaborative research arrangement devoted to utilizing MRI in cardiac arterial imaging and requiring payments totaling approximately $1.5 million over three years. The initial required payment of $150,000 has not yet been made by the Company due to the lack of any available funds for such effort.

INDUSTRY BACKGROUND

MRI, also known as nuclear magnetic resonance imaging, is a medical diagnostic imaging procedure which produces images of slices of the body allowing physicians to view the internal human anatomy. MRI has certain advantages over other imaging procedures such as computerized axial tomography (CAT), Positron Emission Tomography (PET) and X-ray. MRI does not use X-rays, or any other ionizing radiation as in other nuclear medicine techniques and can produce soft tissue contrast differences many times greater than other procedures. MRI can acquire data in any planar orientation, is not limited to cross sectional slices and provides greater flexibility in imaging a wide variety of pathologies. MRI systems create images by analyzing the behavior of hydrogen atom nuclei in the body. The

living body contains a number of hydrogen atoms, mostly in the form of water. MRI systems typically consist of a large magnet, radio signal generators, radio signal receivers and computer hardware and software. By affecting the alignment and behavior of nuclei using an external magnet and radio waves, MRI systems obtain information and process the information by a computer to create an image of the internal human anatomy which is displayed on a video monitor.

MRI systems in use are often categorized into low-field, mid-field and high-field systems. Such designations refer to the strength of the magnetic field utilized in the system. Generally, higher field strength equates to greater resolution and/or speed of production of the images. Published industry data suggest that mid-field systems are the most prevalent systems. There are estimated to be over four thousand MRI scanners in operation in the United States. Substantially all of them require the human body to be placed in a long tube in which the magnetic field is generated. Whole body MRI machines generally cost in excess of $1,000,000 and typically require substantial space to install. Recently, so called "open" machines have entered the marketplace. Such systems primarily rely on low-field magnets in a more open architecture to accommodate those persons who cannot tolerate the mid-field and high-field whole body MRI systems because of the person's size or feelings of claustrophobia. An industry source has estimated that during 1991 approximately six million four hundred thousand MRI procedures were performed in the United States. The number of procedures were estimated, by that industry source, to increase to eleven million MRI procedures by 1995. Of the 1991 historical estimate and 1995 projected estimate, approximately 31% and 35%, respectively, were estimated to be head scans, 42% and 39%, respectively, were estimated to be spine scans, 19% and 19%, respectively, were estimated to be extremities (knees, elbows, wrists, feet and hands) scans and 8% and 7%, respectively, were estimated to be other (breasts, cardiac, jaw, abdomen, shoulder and hip) scans.

THE COMPANY'S MRI SYSTEM AND PROPOSED SYSTEMS

The MAGNA-SL

The Company has developed and, in September 1994, received regulatory clearance from the FDA to begin marketing, its first MRI scanner, the MAGNA-SL. The MAGNA-SL is not currently available for sale due to the Company's curtailment of operations as well as difficulties with vendors and the absence of a technical workforce to build, install and service such systems. When it was available the MAGNA-SL was to have sold for less than $500,000 and have low installation and operating costs compared to whole body MRI scanners. Four MAGNA-SL scanners have been delivered to and accepted by customers, including three scanners which were shipped to a related party, the third of which remains unpaid. If the Plan is successful, the Company may attempt to enter into relationships with others (besides Elscint) covering the production, sale and distribution of the MAGNA-SL.

The MAGNA-SL is approximately two and one-half feet high, three and one-half feet deep and two feet wide. The magnet structure is open at the top, bottom and front providing access from three sides thereby permitting non-claustrophobic scanning. A bed/chair is placed next to the magnet for various scans and would recline into the magnet for head scans (if such scans become practical in the future). Sitting or reclining in the moveable bed/chair, patients may position their leg, knee, arm, elbow, wrist, hand or (possibly) head in the magnet opening without having to put their entire body into the scanner. The magnet will rotate 90 degrees into a horizontal position for arm, elbow, wrist and hand scanning as well as certain positions for knee and leg scanning. In addition, images of legs or feet may be obtained from either a weight-bearing position (standing up) or from a sitting or lying down position. This approach adds to the inherent patient friendliness by having the patient sitting for many scans where typically they are in a prone position. Separate from the magnet is the digital and analog MRI electronics and computer terminal which controls the operation of the magnet and produces the image. The entire system may be installed in approximately 150 square feet of office space making it suitable for use in radiology suites, hospital emergency rooms, or offices of private medical practices. Management believes that, because the MAGNA-SL is specifically designed for extremities, it may be a more effective MRI scanner for these areas particularly because of its capability for bent limb and weight bearing images. Substantially all conventional whole-body MRI systems use magnets which are larger than the magnet used for the Company's product and proposed products, which surround patients on all sides, leaving access only from the front and back. Certain manufacturers have begun to introduce "open" whole body systems and one manufacturer has introduced a dedicated extremity system, which systems are less claustrophobic than traditional whole body systems. These

systems, however, use "low-field" magnets. The MAGNA-SL uses a "mid-field" permanent magnet and therefore produces image quality comparable to that of "mid-field" whole body scanners (which the Company believes represent the majority of the MRI market).

The MAGNA-SL is expected initially to have applications in radiology, orthopedics, pediatrics, chiropractic and podiatry and, if and when possible, for applications in neurology, vascular and certain areas of dentistry.

Other Proposed Products

The Company has intended to build on the technology of the MAGNA-SL magnet and system to design and develop other anatomy specific MRI scanners (including potentially a scanner dedicated to MRI mammography and a back and spine scanner, among other ideas) but has no resources with which to pursue such intentions. To date, the Company has been engaged in computer simulation of the design of magnets which it believes could be used in such MRI scanners and has not to date commenced constructing any prototypes.

PRODUCTION AND ASSEMBLY

The MAGNA-SL system is comprised of three major subsystems; a magnet subsystem (assembled by the Company), an MRI computer subsystem (purchased from a third party with which the Company is now in dispute as a result of the Company's failure to purchase commercially viable quantities, among other matters) and a rack of power and electronic components (purchased from third parties). The Plan and the Elscint Proposal involve replacing the MRI computer subsystem, among other items, with Elscint manufactured components.

The production plan was to utilize a "Systems Integration Approach," under which the magnet subsystem is assembled by the Company and then shipped to the customer's site for integration with the other subsystems shipped directly to the customer site by qualified suppliers. Early production models were integrated first at the Company's facility to ensure quality and repeatability. The customer was to be responsible for certain site preparations, such as the installation of radio frequency shielding to shield the MRI system from interference and certain electrical work. The costs of radio frequency shielding and certain other installation costs, are lower for the MAGNA-SL than for whole body systems. The magnet subsystem was to be assembled from purchased materials, tested by Company employees, and then shipped to the customer for integration.

In order to assemble the magnet, the Company has purchased generally available magnet material, steel and other mechanical components from others. Using specially manufactured tools and equipment designed by the Company, the Company has assembled the magnet for each scanner individually.

The MRI computer subsystem was purchased from a supplier in Europe. In August 1993, the Company established a multi-system purchase relationship with this vendor by making a $480,000 non-refundable deposit payment. Such agreement, as amended in July 1994, provided for purchases of MRI computer subsystems and the license of certain technology underlying the subsystems. The Company had agreed to purchase initial subsystems which, as amended, would result in an additional payment of $240,000 beyond the $480,000 paid as a deposit. Of that additional $240,000, substantially all has been paid at February 28, 1997, leaving an unamortized deposit of approximately $320,000 at February 28, 1997. Such remaining deposits have been written off at February 28, 1997 as a result of the (a) the Company's inability to go forward with purchase commitments, and
(b) the Company's intention to move forward with the Elscint Proposal which would eliminate this component. The Company believes that its prior relationship with this vendor may no longer be available. Further, it is possible that this vendor may assert damages against the Company for the Company's failure to move forward with plans which affect pricing of units delivered (volume discounts for volumes not realized) or for other costs or investments made by this vendor as a result of its relationship with the Company.

The power and electronics components necessary for the MAGNA-SL system are generally available from a variety of vendors. The Company had established sources of supply for such components but as a result of non-payment of these vendors, believes that such sources of supply may no longer be available to it.

The Company's liquidity over the past year has caused severe problems in vendor relations including pending and threatened litigation as well as certain judgments against the Company.

The Company is also required to conform to FDA Good Manufacturing Practice ("GMP") regulations and various other statutory and regulatory requirements applicable to the manufacture of medical devices. The Company's production and assembly operations are subject to FDA inspections at all times. The Company would not meet the standards of such practices at this time. See "Governmental Regulation."

MARKETING AND DISTRIBUTION

Prior to cessation of operations in March 1997 the Company was selling and marketing the MAGNA-SL in the United States through a combination of its own sales force and contractual arrangements with others. The principal markets for the MAGNA-SL include private practitioners and institutions initially for applications in radiology, orthopedics, pediatrics, chiropractic and podiatry and, if and when possible, for applications in neurology, vascular and certain areas of dentistry. The Company's sales force, which consisted of three persons (including the Vice President of Sales and Marketing, and all of whom were terminated pursuant to the Plan), concentrated primarily on the United States radiology market.

Prior to cessation of operations, the Company had entered into several separate distribution and sales representation agreements. Each agreement granted certain defined exclusive rights, generally provided (except for an agreement granting exclusive distribution rights in the orthopedic market in 20 U.S. states) that a minimum number of scanners are purchased within a specified time frame. One of these agreements is with Beta Numerics, Inc. ("Beta"), a private company founded by two directors and beneficial shareholders, and one former director and continuing shareholder, of the Company. Beta has not met the minimum number of scanners to be purchased under the agreement and has not paid for one scanner delivered to it in December 1996. The Company has sold and delivered four MAGNA-SL scanners including three to Beta, one of which remains unpaid. For a more detailed description of the relationship with Beta, see Item
12. "Certain Relationships and Related Transactions."

In June 1996, the Company and Elscint signed a definitive agreement covering a strategic business arrangement in which Elscint would manufacture the MAGNA-SL for marketing and sale by Elscint in certain non-United States territories including Europe, the Peoples Republic of China, parts of the Middle East and Latin America, Australia and other territories. The Company would be paid royalties on each system manufactured and sold by Elscint. To maintain its rights under the agreement, Elscint is required to sell a minimum number of systems in the first two year period (commencing after an agreed upon period of start-up) and a higher number of systems in the first permitted two year renewal period. Thereafter, the agreement is renewable by Elscint in two year sales periods at higher minimum quantities which will be set by the parties in good faith. Elscint has the right to cure shortfalls by, among other things, making payment of approximately 87% of the minimum royalties. Upon execution of the agreement, a nonrefundable deposit of $250,000 was paid to the Company to be applied to first year royalties. Additionally, Elscint and the Company have agreed to cooperate in making certain capital expenditures and other areas of manufacturing in order to reduce production costs and increase operating margins. The parties have also agreed to collaborate in developing new features and improvements to the MAGNA-SL and the Company has agreed to provide certain ongoing research and development support. Elscint has a right of first negotiation on certain new products.

The parties agreed to certain development tasks and enhancements, which, if not completed by the Company in November 1996, could, if not cured, result in termination of the agreement by Elscint. Elscint has informed the Company that it is not satisfied with the completion of certain of the tasks agreed to by the parties. The parties then negotiated a new completion date for the tasks with Elscint reserving all of its rights including the right to complete the tasks itself at the Company's expense or to terminate the agreement. Elscint has informed the Company that it is not

satisfied with the completion of the tasks after the revised completion date. Subsequently, Elscint presented to the Company its proposal (the "Elscint Proposal") to take over the uncompleted tasks resulting in a major alteration and improvement of certain systems comprising the MAGNA-SL and requiring a development payment of $500,000 and certain support efforts from the Company. The Company has agreed to go forward with Elscint Proposal but has been unable to make any of the required payments to initiate or complete the Elscint Proposal. In May 1997, the Company received notification from Elscint that it would reserve the right to terminate its agreement with the Company and seek damages from the Company as a result of the Company's failure to cure the deficiencies identified by Elscint or alternatively move forward with the Elscint Proposal. Elscint has subsequently indicated to the Company that it still wished to proceed with the Elscint Proposal.

Should the Company be able to complete a financing necessary to continue operations, the Company plans to attempt to go forward with the Elscint Proposal and to license Elscint or others to the territories not presently covered by the June 1996 agreement with Elscint (which agreement is not presently operative). The Company has engaged in discussions with other companies in the medical imaging industry to attempt to negotiate sales, distribution, marketing and or manufacturing agreement without any success.

WARRANTY AND SERVICE

It is customary in the medical equipment industry to warrant that each scanner will be free from defects in material and workmanship for a period of one year after acceptance of the scanner and provide routine servicing free of charge for the first year. After the first year, servicing is customarily offered to customers on a contract basis or by charges for service calls.

The Company has been unable, due to lack of financial resources, to honor its obligations for warranty and service since approximately March 1997.

In the medical device market, the ability to provide comprehensive and timely service can be a key competitive advantage and is important for establishing customer confidence. The Company's inability to service, for an extended period of time since March 1997, the four scanners placed in service creates a serious obstacle to the Company's desire to reenter this market even upon completion of a financing (which in any case is uncertain).

UNDERWRITERS LABORATORIES INC. OR EQUIVALENT LISTING

The Company's scanners are required to be listed by Underwriters Laboratories Inc. ("UL")., which is a not-for-profit independent organization, or by ETL Testing Laboratories, Inc. ("ETL"). The Company's scanners are not presently listed by such organizations.

Both UL and ETL are entities which test numerous consumer and commercial products for compliance with nationally recognized safety standards. Listing of a product indicates that samples of that product have been tested to such safety standards and found to be reasonably free from foreseeable risk of fire, electric shock and related hazards. Under the laws of certain states, the Company will not be permitted to operate and install its products without obtaining and maintaining such a listing. Even in those states where the Company is not required by law or otherwise to obtain a listing, if it is unable to obtain and maintain a listing on an ongoing basis its ability to market and sell its scanners may be adversely affected. Underwriters Laboratories Inc. or equivalent testing and review generally can be completed in a two to three month period, although the process may be extended under certain circumstances. The cost of obtaining and maintaining such a listing is estimated to be in excess of $60,000. The Company may be subject to similar requirements in the non-US countries in which the MAGNA-SL may be sold.

PROPRIETARY RIGHTS

Dr. Lawrence A. Minkoff, Chief Executive Officer, President and a Director of the Company, has received one patent relating to the permanent magnet structure of the MAGNA-SL. In December 1992, Dr. Minkoff assigned his rights to these magnet technologies to the Company. Additionally, the Company has filed applications for patent protection internationally, including an application under the Patent Cooperation Treaty ("PCT"), relating to the permanent magnet structure, but has permitted its rights under that PCT application to lapse. The Company has been informed that the PCT application was published, making it unlikely that additional foreign patent protection with respect to the permanent magnet structure can now be obtained. The Company does not believe that failure to obtain such additional patent protection will have a material adverse effect on the Company's business. In March 1995, the Company was issued a U.S. patent concerning a certain proprietary imaging sensing coil assembly. The Company has filed an application for patent protection internationally, including under the PCT, relating to the imaging sensing coil assembly.

The Company's policy has been to obtain patents to protect technology, inventions and improvements that are important to the development of its business. The Company also relies upon trade secrets, know-how, continuing technological innovation and licensing opportunities to develop and maintain its competitive position.

The patent position of any medical device manufacturer, including the Company, is uncertain and may involve complex legal and factual issues. Consequently, the Company does not know whether its application will result in the issuance of any patents, or, for any patents issued, whether they will provide significant proprietary protection or will be circumvented or invalidated. Since patent applications are maintained in the U.S. in secrecy until patents issue, and since publications of discoveries in the scientific or patent literature tend to lag behind actual discoveries by several months, the Company cannot be certain that it was the first creator of inventions covered by its pending patent application or that it was the first to file a patent application for such inventions. There can be no assurance that any of the Company's patent applications will result in any patents being issued or that, if issued, patents will offer protection against competitors with similar technology; nor can there be any assurance that others will not obtain patents that the Company would need to license or circumvent. Moreover, the Company may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine the priority of inventions, which could result in substantial cost to the Company.

The Company may utilize technologies, patents or other rights which may be held by third parties. Certain technologies utilized by the Company are covered by patents owned or administered by the British Technologies Group, PLC. The Company has had discussions with British Technologies Group, PLC. concerning licencing such technology, and although the Company believes that such licence would be available to it on terms that are generally available to MRI manufacturers, the Company has been unable to make the required payment to secure such technologies which are integral to the MAGNA-SL.

The Company has also relied upon unpatented trade secrets, and no assurance can be given that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's trade secrets or disclose such technology, or that the Company can meaningfully protect its right to unpatented technology.

The Company has, in the past, required its employees, consultants and advisors to execute confidentiality agreements upon the commencement of an employment or a consulting relationship with the Company. Since the Company has been unable to pay accrued compensation to its employees for some period of their service, the continuing enforceability of such agreements may be questionable. Each agreement provided that all confidential information developed or made known to the individual during the course of the relationship will be kept confidential and not disclosed to third parties except in specified circumstances. In the case of employees, the agreements provided that all inventions conceived by an individual shall be the exclusive property of the Company, other than inventions unrelated to the Company's business and developed entirely on the employee's own time. There can be no assurance, however, that these agreements will provide meaningful protection or adequate remedies for the Company's trade secrets in the event of unauthorized use or disclosure of such information. To the extent that consultants, key employees or other third

parties apply technological information independently developed by them or by others to Company projects, disputes may arise as to the proprietary rights to such information which may not be resolved in favor of the Company.

Dr. Minkoff, two of the Company's former executive officers and several of its scientists and other personnel were formerly employed, at various times prior to November 1989, by a company engaged in the development, manufacture and sale of MRI devices. Each of these present and former executive officers and senior scientists has informed the Company that he was not subject to any agreement with such company containing a restrictive covenant limiting competitive activities at the termination of employment with that company. However, since the prior employer is a potential competitor of the Company, it may threaten or commence legal action to deter the development of the Company's technology alleging, among other things, that it may have rights to technology developed by the Company through the efforts of such persons. The prior employer also holds patents relating to MRI devices and has instituted litigation against certain manufacturers of MRI devices including Hitachi Ltd., General Electric Company and others alleging, among other things, that the manufacture of MRI devices by such companies constitutes patent infringement, violations of the Lanham Act and unfair competition. It has been reported that the prior employer and Hitachi Ltd. have settled their action out of court and that a jury has rendered a verdict in favor of the former employer against General Electric in an amount which has been reported to be reduced by a judge and exceeds $60 million. General Electric is reported to be appealing this decision. There can be no assurance that this potential competitor will not name the Company in its current litigation, or commence a new action against the Company. The costs of defending such an action, if brought, could require substantial financial resources. Although no assurance can be given that such claims will not be instituted against the Company, the Company believes, based upon the advice of its patent counsel, that the use of its magnet technologies, at its stage of development in December 1995, in its scanners, will not infringe the patents of such competitor granted through December 1, 1995.

GOVERNMENTAL REGULATION

The operations of the Company, which have essentially been at least temporarily suspended, are subject to extensive federal and state regulation. MRI devices generally, and any scanners the Company has developed or may develop, in particular, are subject to regulation by the FDA, certain state and federal agencies that regulate the provision of health care, particularly the Health Care Financing Administration ("HCFA"), and the Environmental Protection Agency ("EPA"). In the Company's current state, it could not comply with some of the regulations to which it is subject.

A. FDA REGULATION

The FDA categorizes devices into three regulatory classifications subject to varying degrees of regulatory control. Class I devices are those devices whose safety and efficacy can reasonably be ensured through the general control provisions. These provisions include requirements that a device not be adulterated or misbranded, that the device is manufactured in conformity with GMP regulations and that appropriate FDA premarket notification requirements be met. Class II devices are those devices whose safety and efficacy can reasonably be ensured through the use of special controls, such as performance standards, post-market surveillance, patient registries and FDA guidelines. All other devices are placed in Class III. Class III devices, which are typically invasive or life sustaining products, require clinical testing to assure safety and effectiveness and FDA approval prior to marketing and distribution. The FDA also has the authority to require clinical testing of Class I and Class II devices.

The MAGNA-SL(TM) is a Class II medical device subject to clearance by the FDA prior to commercialization in the United States. Such FDA clearance was received in September 1994 through submission of a 510(k) notification (discussed below). The cessation of the Company's operations in March 1997 calls into question the Company's previously received FDA clearance.

Pursuant to the Food Drug and Cosmetic ("FDC") Act and regulations promulgated thereunder, the FDA regulates the manufacture, distribution and promotion of medical devices in and the exportation from the United States. Various states and foreign countries in which the Company's products may be sold in the future may impose additional regulatory requirements.

If a manufacturer or distributor of medical devices can establish that a device is "substantially equivalent" to a legally marketed Class I or Class II medical device or to a Class III medical device for which the FDA has not required premarket approval, the manufacturer or distributor may seek FDA marketing clearance for the device by filing a 510(k) notification. The 510(k) notification and the claim of substantial equivalence will almost certainly have to be supported by various types of data indicating that the device is as safe and effective for its intended use as a legally marketed predicate device. Until the FDA issues an order finding that a device is substantially equivalent, the manufacturer or distributor may not place the device into commercial distribution. The order may be sent within 90 days of the submission and may declare the FDA's determination that the device is "substantially equivalent" to another legally marketed device, and allow the device to be marketed in the United States. The FDA may, however, determine that the proposed device is not substantially equivalent, or may require further information, such as additional test data, before the FDA is able to make a determination regarding substantial equivalence. Such determination or request for additional information could delay the Company's market introduction of its products and could have a materially adverse effect on the Company's continued operations.

If a manufacturer or distributor cannot establish to the FDA's satisfaction that a new device is substantially equivalent, the device will be considered a Class III device and the manufacturer or distributor will have to seek premarket approval ("PMA") or reclassification of the new device. A PMA would have to be submitted and be supported by extensive data, including preclinical and clinical trial data, to demonstrate the safety and efficacy of the device. Upon receipt, the FDA will conduct a preliminary review of the PMA to determine whether the submission is sufficiently complete to permit a substantive review. If sufficiently complete, the submission is declared fileable by the FDA. By statute and regulation, the FDA has 180 days to review a PMA once determined to be fileable. During that time an advisory committee may also evaluate the application and provide recommendations to the FDA. While the FDA has responded to PMA's within the allotted time period, PMA reviews more often occur over a significantly protracted time period, and generally take approximately two or more years to complete from the date of filing. A number of devices have never been cleared for marketing. An application and petition to reclassify a device can also be extensive in time and cost.

If human clinical trials of a device are required, and the device presents "significant risk," the manufacturer or distributor of the device will have to file an investigational device exemption ("IDE") application with the FDA prior to commencing human clinical trials. The IDE application must be supported by data, typically including the results of animal and mechanical testing. If the IDE application is approved, human clinical trials may begin at the specific number of investigational sites and could include the number of patients approved by FDA. Sponsors of clinical trials are permitted to sell those devices distributed in the course of the study, provided such compensation does not exceed recovery of the costs of manufacturer, research, development and handling.

In 1988, the FDA reclassified MRI devices and all substantially equivalent devices of this generic type from Class III to Class II. This encompassed MRI systems from 13 petitioners. Accordingly, if the Company can demonstrate to the FDA that its proposed products or any other scanner developed by the Company are substantially equivalent either to the reclassified MRI devices or to other currently marketed mammography or back and spine scanning devices, its proposed products could be considered Class II medical devices which can be cleared for commercial distribution via 510(k) notification. There can be no assurance that the FDA will find such products to be substantially equivalent to reclassified MRI devices or any other legally marketed devices. The FDA may require the Company or its competitors to file PMAs for new products or technologies if the devices are sufficiently different from the reclassified MRI devices. Such a determination by the FDA would delay the Company's market introduction of products it may in the future (subject to obtaining funding) consider developing, and could have a material adverse effect on the Company's operations, should the Company resume operations and pursue development of such products. FDA recently announced its intent to impose higher safety standards on premarket clearance of devices that might pose potential risks if they fail. Such a change in policy could have a material adverse effect on the Company, should the Company resume operations and pursue development of such products.

The costs associated with the filing of applications with the FDA and of conducting clinical trials can be significant. While the MAGNA-SL has received clearance from the FDA, there is no assurance that any of the

Company's product enhancements, if any, or the Company's proposed products, should the Company resume operations and pursue development of such products will ever obtain the necessary FDA clearance for commercialization.

If determined to be Class II medical devices under the Safe Medical Devices Act of 1990, the Company's proposed products are potentially subject to performance standards and other special controls that the FDA has the authority to establish. Currently, no such performance standards or special controls applicable to the Company's products have been established. If any such performance standards or other special controls are established, obtaining initial marketing clearance for its products or maintaining continued clearance will be dependent upon the Company's ability to satisfactorily comply with such standards or controls.

The MAGNA-SL and any future products distributed by the Company pursuant to the above described clearances will be subject to pervasive and continuous regulation by the FDA. Moreover, the FDC Act will also require the Company, should it ever resume manufacturing products, to manufacture its products in registered establishments and in accordance with Good Manufacturing Practice (GMP) regulations. Once registered, the Company's facility, if any, will be subject to periodic inspections by the FDA. The Company does not presently have a facility. Labeling and promotional activities are subject to scrutiny by the FDA and, in certain instances, by the Federal Trade Commission. In addition, the Company's products, if any, are expected to be subject to technical standards established by the Federal Communications Commission regarding radio frequency emission limits. The export of medical devices is also subject to regulations in certain instances and in certain circumstances to FDA approval as well as to approval by certain countries to which these devices might be exported. In addition, the use of the Company's products may be regulated by various state agencies. There can be no assurance that the Company's products will be able to comply successfully with any such requirements or regulations. In fact, the Company's MAGNA-SL does not presently comply with the regulatory standards of several countries. Moreover, future changes in regulations or enforcement policies could impose more stringent requirements on the Company, compliance with which could adversely affect the Company's potential business. Failure to comply with applicable regulatory requirements could result in enforcement action, including withdrawal of marketing authorization, injunction, seizure or recall of products, operating restrictions, refusal of government to approve product applications or allow a company to enter into supply contracts and liability for civil and/or criminal penalties.

B. THIRD PARTY COVERAGE, REIMBURSEMENT AND RELATED HEALTH CARE REGULATIONS.

The market for MRI scanners, including the Company's products and proposed products, is affected significantly by the amount which Medicare, Medicaid or other third party payors, including private insurance companies, will reimburse hospitals and other providers for diagnostic procedures using MRI systems. The health care industry has changed dramatically during the 1980's and the 1990's in reaction to changes in third party reimbursement systems designed to contain health care costs. In the MRI market, third party reimbursement issues will focus principally on whether MRI diagnostic procedures using the Company's products and proposed products will be covered procedures and, if so, the level of reimbursement that will be available for the MRI procedure.

HCFA, the agency responsible for administering the Medicare program, sets requirements for coverage and reimbursement under the program, pursuant to the Medicare law. In addition, each state Medicaid program has individual requirements that affect coverage and reimbursement decisions under state Medicaid programs for certain health care providers and recipients. Private insurance companies also set their own coverage and reimbursement policies. Private insurance companies and state Medicaid programs are influenced, however, by the HCFA requirements.

As of November 22, 1985, under a national policy, Medicare covers certain diagnostic procedures using MRI technology (as described by Medicare) for certain clinical indications. There can be no assurance that the Company's products or proposed products, once available, will be included within the then current Medicare coverage determination. In the absence of a national Medicare coverage determination, local contractors that administer the Medicare program, within certain guidelines, can make their own coverage decisions. Favorable coverage determinations are made in those situations where a service is of a type that falls within allowable Medicare benefits and a review concludes that the service is safe, effective and not experimental. Under HCFA coverage requirements,

FDA approval for the marketing of a medical device, including the Company's proposed MRI mammography scanning systems and any other MRI technology devices, will not necessarily lead to a favorable coverage decision. A determination will still need to be made as to whether the device is reasonable and necessary for the purpose used. In addition, HCFA has proposed adopting regulations that would add cost-effectiveness as a criterion in determining Medicare coverage. Although the Company believes that its products and proposed products provide a cost effective alternative to "whole body" scanners, no assurance can be given that the scans utilizing the Company's products will be covered under Medicare, especially if HCFA changes its coverage policy to include a cost-effectiveness criterion. Changes in HCFA's coverage policy, including adoption of a cost-effective criterion could have a material adverse effect on the Company's prospects, if any, in the MRI market.

Currently, MRI diagnostic services provided on an outpatient basis are reimbursable under Part B of the Medicare program. The professional and technical components of radiological procedures which are performed in a physician's office or freestanding diagnostic imaging center, and the professional component of radiological procedures performed in a hospital setting, are currently reimbursed on the basis of a relative value scale which phased in, beginning January 1, 1992. There can be no assurance that the implementation of this system, or other governmental actions, will not limit or decrease reimbursement levels for services using any products developed by the Company. Any reduction in the willingness of physicians to perform procedures using the Company's proposed products could have a material adverse effect on the Company's prospects, if any, in the MRI market.

Medicare reimbursement for the technical component (the operating costs) for MRI diagnostic services furnished in the hospital outpatient setting generally is currently calculated on a formula that is the lesser of the hospital's reasonable costs and a 42/58 blended amount respectively of hospital reasonable costs and the blended amount of reimbursement for the technical component of the service if furnished in a physician's office in the same locality.

The market for the Company's products and proposed products could also be adversely affected by the amount of reimbursement provided by third party payors to hospitals or private practitioners for procedures performed using such products. Reimbursement rates from private insurance companies vary depending upon the procedure performed, the third-party payor, the insurance plan, and other factors. Medicare generally reimburses hospitals that are expected to purchase the Company's products and proposed products for their operating costs for in-patients on a prospectively-determined fixed amount for the costs associated with an inpatient hospital stay based on the patient's discharge diagnosis, regardless of the actual costs incurred by the hospital in furnishing care. The willingness of these hospitals ("PPS hospitals") or private practitioners to purchase the Company's products and proposed products, if any, could be adversely affected if they determined that the prospective payment amount to be received for the procedures for which the Company's products or proposed products are used would be inadequate to cover the costs associated with performing the procedures using the Company's proposed products, or to be less profitable than using an alternative procedure for the same condition.

Until October 1991, hospitals were generally able to pass their capital costs on to Medicare which reimbursed such costs on a reasonable basis subject to percentage limitations. However, under regulations which became effective October 1, 1991, reimbursement for capital-related costs began to be included in the prospective payment system. In general, under the new system, which has a 10 year phase-in period, hospitals will be reimbursed for capital costs related to services provided to inpatients through an add-on payment made to the hospital based upon the Diagnostic Related Group (DRG) for each such inpatient. While it is unclear what effects the prospective payment systems will have, it may cause hospitals to more closely scrutinize new capital expenditures and it could have an adverse effect on recovery of capital costs for equipment such as the MAGNA-SL and proposed products. Capital costs for hospital outpatient departments are currently reimbursed by Medicare in an amount equal to 90% of their reasonable capital costs.

A number of states, through Certificate of Need ("CON") laws, limit the establishment of new facility or service or the purchase of major medical equipment to situations where it has been determined that the need for such facility, service or equipment exists. The market for the MAGNA-SL and the Company's proposed products may be adversely affected by CON regulation to the extent that institutional health care facility purchasers and lessors of the products are subject to CON regulation. While many states exempt non-institutional providers from CON coverage, a number of

states have extended CON coverage to physicians' offices or medical groups by restricting the purchase of major medical equipment wherever located.

C. EPA REGULATION

The Company, and any research facility which it operates, would also be required to comply with any applicable federal and state environmental regulations and other regulations related to hazardous materials used, generated, and/or disposed of in the course of its operations. The Company presently does not have a facility.

COMPETITION

The health care industry in general, and the market for diagnostic imaging equipment in particular, is highly competitive and virtually all of the other entities known to management of the Company to be engaged in the manufacture of MRI scanners possess substantially greater resources than the Company. At the present time, manufacturers of whole body scanners include the General Electric Company; Toshiba; Bruker Medical Imaging Inc.; Elscint, Ltd.; Siemens Corporation; Philips Medical Systems, a division of Philips Industries, N.V.; Picker International Corporation; Shimadzu; and Hitachi. The Company believes that the principal elements of competition which will affect successful marketing of MRI systems, including any Elscint marketing efforts pursuant to the Proposal, will include price, product performance, service and support capability, financing terms and brand name recognition. The Company is aware of one company, Esaote Biomedica SpA. ("Esaote") engaged in marketing an MRI device for extremity imaging. Their product, the ARTOSCAN, received FDA marketing clearance in October 1993, approximately 11 months prior to the Company's receipt of clearance. The Company believes that the MAGNA-SL had substantial performance advantages over the ARTOSCAN product including: mid-field rather than low-field magnet, greater imaging volume, ability to do weight bearing and fully bent limb scans, greater patient positioning opportunities and superior image quality. However, Esaote has marketed hundreds of its extremity imaging devices. The list price of the ARTOSCAN product is believed to be approximately 25% lower than the Company's list price was for the MAGNA-SL. The Company had planned to compete with the ARTOSCAN product on the basis of image quality, a wider range of imaging opportunities and greater patient comfort, including any Elscint marketing efforts pursuant to the Proposal.

The Company also has experienced competition from the use of x-ray machines. The Company believes that the use of x-ray machines is widely established and clinically accepted. Although the Company believes that an MRI scanner will represent a safer and more effective diagnostic imaging device, there can be no assurance that any products developed by the Company will be commercially accepted, especially in light of the cost-savings involved in purchasing x-ray machines and the familiarity of current practitioners in operating such devices. While the Company believes that the price of the MAGNA-SL as well as its low operating costs would permit health care providers to conduct MRI imaging and diagnostic readings for less cost than is currently possible, there can be no assurance that the cost of the MAGNA-SL or any other products developed will be able to successfully compete with conventional x-ray machines. In addition, although the Company believes that the cost of whole body MRI scanners will render their use in screening mammography or diagnostic purposes undesirable, there can be no assurance that this technology or other technologies will not successfully compete with any MRI scanner designed to image specific parts of the body. In addition, there can be no assurance that other technologies will not be developed that will render the Company's proposed MRI scanners obsolete or uneconomical. To some extent, competition will also come from the manufacturers of other types of diagnostic imaging systems, such as ultrasound or thermography.

PRODUCT LIABILITY

Product liability claims relating to the Company's products may be asserted against the Company. If such claims are asserted against the Company, there can be no assurance that the Company will have sufficient resources to defend against any such claim or satisfy any such successful claim. The Company had product liability insurance which was terminated during 1997 for non-payment of insurance premiums.

Further, Beta has notified the Company that it is unsatisfied with the performance of the MAGNA-SL at one or more of its owned sites and has threatened product lability exposure to the Company. The Company presently has no remedy for such assertion because its lack of financial resources, unsatisfactory vendor relationships and lack of continuing technical personnel, among other factors, prevent it from addressing such concerns. In the event of an uninsured or inadequately insured product liability claim, the Company's business and financial condition, which is presently in severe distress, could further be materially adversely affected.

The Company's agreement with Elscint (which agreement is not presently operative) requires Elscint to carry product liability insurance, and the Company may attempt to require any other joint venturers or licensees to carry product liability insurance. However, there can be no assurance that such joint venturers or licensees will agree, or will be able, to obtain or maintain insurance at an acceptable cost or that, if such insurance is obtained, it will be adequate to cover the Company's potential liability.

HUMAN RESOURCES

On March 5, 1997, the Company informed 10 of its 20 employees that they were being indefinitely laid off and between March 5 and March 15, 1997, another 4 employees were laid off due to insufficient funds for their payroll. The remaining employees were offered the opportunity to continue with the Company in exchange for deferred compensation pending successful completion of continuing efforts to complete a financing (which was not completed). At March 15, 1997, unpaid payroll to terminated and continuing employees totaled approximately $150,000. Of the remainder, only Lawrence A. Minkoff, Ph. D., the Company's Chairman, president and Chief Executive Officer, is in the full time employ of the Company as of October 15, 1997. The remaining employees have terminated their full time relationship with the Company and approximately four of them serve or have indicated that they may serve as part time employees or consultants to the Company. At October 1, 1997 the Company owes over $300,000 in unpaid payroll to such employees. There is no assurance that any of such employees will not institute actions against the Company to recover their unpaid payroll.