10-K 1 f78124e10-k.txt FORM 10-K FOR PERIOD ENDED 9/30/01 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NO. 0-27186 --------------------- RAYTEL MEDICAL CORPORATION (Exact name of Registrant as specified in its charter) DELAWARE 94-2787342 (State or other jurisdiction of (I.R.S. Employer incorporation of organization) Identification No.) 2755 CAMPUS DRIVE, SUITE 200, SAN MATEO, CA 94403 (Address of principal executive offices) (Zip Code)

(650) 349-0800 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $0.001 PAR VALUE (TITLE OF CLASS) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock of the Registrant held by non-affiliates of the Registrant, based on the closing price of the Registrant's Common Stock as quoted on the Nasdaq SmallCap Market on November 30, 2001, was $8,297,135.60. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares of the Registrant's Common Stock outstanding as of November 30, 2001, was 2,919,776. DOCUMENTS INCORPORATED BY REFERENCE ~~DOCUMENT WHERE INCORPORATED Proxy Statement for the 2002 annual meeting Part III~~

-------------------------------------------------------------------------------- -------------------------------------------------------------------------------- PART I This report includes a number of forward-looking statements which reflect Raytel's current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including those discussed in "Item 17. Management's Discussion and Analysis of Financial Conditions and Results of Operations -- Business Environment and Future Financial Results" and elsewhere in this report, that could cause actual results to differ materially from historical results or those anticipated. In this report, the words "anticipates," "believes," "expects," "intends," "future," "goals" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. ITEM 1. BUSINESS Raytel Medical Corporation is a provider of healthcare services, focusing on the needs of patients with cardiovascular disease, or "CVD". We believe, based on our industry experience, that we are the leading provider of remote cardiac monitoring and testing services utilizing transtelephonic monitoring technology in the United States. Raytel also owns and operates four freestanding cardiovascular diagnostic facilities and two freestanding facilities that provide nuclear cardiology diagnostic services. In addition, we provide outpatient diagnostic imaging services, through operating and investment interests in nine freestanding imaging centers and two ancillary facilities associated with two of the centers. We also manage a diagnostic imaging provider network that operates in eight mid-Atlantic states. Raytel was incorporated in California in October 1981 under the name Raytel Labs, Inc. In August 1987, we were reincorporated in Delaware under the name Raytel Systems Corporation. In October 1992, we changed our name to Raytel Medical Corporation. Unless the context otherwise requires, "Raytel" as used herein refers to Raytel Medical Corporation, a Delaware corporation, and its consolidated subsidiaries. Raytel's executive offices are located at 2755 Campus Drive, Suite 200, San Mateo, California 94403, and its telephone number is (650) 349-0800. RECENT CORPORATE DEVELOPMENTS DISPOSITION OF FLORIDA MEDICAL CLINIC Through its acquisition of Cardiovascular Ventures, Inc. in August 1997, Raytel acquired a 20-physician multi-specialty medical clinic located in Port St. Lucie, Florida, which was operated by Raytel's wholly-owned subsidiary, Heart & Family Health Institute of Port St. Lucie, or "HFHI." Effective January 1, 2001, Raytel completed the sale of HFHI to a new company organized by physicians practicing at HFHI, including David E. Wertheimer, M.D., who had served as President of HFHI, as well as an officer of Raytel and a member of Raytel's Board of Directors. Raytel received a cash purchase price of $8,311,000, net of transaction expenses, in exchange for all of the outstanding common stock of HFHI. Following the completion of the transaction, Dr. Wertheimer resigned as an officer and director of Raytel. Raytel's divestiture of the Port St. Lucie Clinic follows the sale of Raytel's physician practice management operations during 2000 as a part of Raytel's strategy of focusing on its core businesses of providing cardiac monitoring and testing services and operating cardiac diagnostic facilities and diagnostic imaging centers. REVERSE STOCK SPLIT On May 9, 2001, Raytel effected a one-for-three reverse split of its common stock. The reverse split was implemented to increase the per share trading price of Raytel's common stock in order to meet requirements for continued listing on the Nasdaq SmallCap Market. All of the share and per share data in this report reflect the reverse stock split. 1 RESOLUTION OF INVESTIGATION BY THE U.S. DEPARTMENT OF HEALTH AND HUMAN SERVICES Raytel's wholly-owned subsidiary, Raytel Cardiac Services, or "RCS", was the subject of a grand jury investigation begun in June 2000 and conducted under the direction of the United States Attorney for the District of Connecticut and the Office of the Inspector General of the U.S. Department of Health and Human Services, or the "OIG." The investigation involved allegations of improprieties in RCS' transtelephonic pacemaker monitoring operations and its billing practices related to Medicare-covered services. In June 2001, RCS reached an agreement with the federal government to resolve the issues which were the subject of the investigation. In accordance with that agreement, RCS plead guilty to a charge of obstructing a criminal investigation. In addition, in September 2001, RCS entered into a settlement agreement with the government to resolve related civil claims. Under the criminal and civil settlements, RCS agreed to pay a total of $11,500,000 to the government over a five-year period. See "Item 3. Legal Proceedings." CONSIDERATION OF STRATEGIC ALTERNATIVES In October 2001, Richard F. Bader, Raytel's Chairman and Chief Executive Officer, Albert J. Henry, an investor and former director of Raytel, and RT Acquisition Group, Inc., or "RTA," an entity formed by Messrs. Bader and Henry, filed a Schedule 13-D with the Securities and Exchange Commission to announce that the were evaluating the feasibility of entering into discussions regarding a possible acquisition of Raytel by RTA. On December 18, 2001, this group amended its filing to disclose that Balfour LLC, an entity controlled by Rory Riggs, a Raytel stockholder, had agreed to act in concert with the other filing stockholders for the purpose of submitting a non-binding proposal regarding a possible acquisition of Raytel by RTA. The filing also disclosed a proposal by RTA to acquire all of the outstanding shares of common stock of Raytel not owned by Messrs. Bader, Henry, and Riggs and RTA and Balfour LLC (collectively, the "RTA Bidding Group"). Raytel's Board of Directors has appointed a Special Committee consisting of independent directors Gene I. Miller and Allan Zinberg to act on the Board's behalf with respect to any proposal made by the RTA Bidding Group. The Special Committee has engaged Houlihan, Lokey, Howard & Zukin Capital, Inc. to serve as financial advisors to the Special Committee with respect to the proposal and any potential alternative transactions and also has engaged counsel to advise the Special Committee. Raytel's Board of Directors, on the recommendation of the Special Committee and with Mr. Bader abstaining, has granted to the RTA Bidding Group a limited waiver under the triggering provisions of the Rights Agreement dated as of August 14, 1998 between Raytel and BankBoston, N.A. to the extent necessary to permit the RTA Bidding Group to evaluate, prepare, negotiate and finance a potential acquisition of Raytel. The waiver under the Rights Agreement is conditioned upon the RTA Bidding Group and its affiliates both holding less than 25% of the beneficial ownership of the outstanding common stock of the Company and not acquiring additional securities of Raytel. For stockholders outside the RTA Bidding Group, or in the event that the RTA Bidding Group violates the conditions to the limited waiver, the triggering level under the Rights Agreement remains ownership of 15% or more of Raytel's outstanding shares without the prior approval of Raytel's Board of Directors. In addition, on December 6, 2001, the Special Committee of the Board of Directors and RTA entered into a letter agreement under which Raytel agreed to advance $75,000 to RTA to reimburse RTA for certain expenses incurred by RTA in connection with a potential transaction, including the expenses of RTA's financial advisers and counsel. The expense reimbursement is refundable by RTA to Raytel only in the event that RTA acts in concert with another party who is in the Company's industry, or an affiliate of such a party. The Special Committee has advised Raytel that its financial advisors have recently received additional confidential, non-binding expressions of interest to acquire Raytel from unaffiliated third parties who, unlike the RTA Bidding Group, are not subject to the beneficial ownership disclosure requirements under federal securities laws applicable to stockholders or groups of stockholders who hold in excess of 5% of Raytel's outstanding common stock and who, accordingly, have not made public their expressions of interest. The Special Committee has also advised Raytel that it is undertaking a review of all the expressions of interest, each of which is subject to various conditions. 2 There is no present agreement between any member of the bidding parties and Raytel with regard to any acquisition transaction. There can be no assurance that the Special Committee will recommend to the Board any acquisition proposal, or that any acquisition proposal, if recommended by the Special Committee and approved by the Board, will be consummated. In the absence of any subsequent event that would cause the Company to make a different determination, Raytel does not currently intend to announce the outcome of the Special Committee's deliberations until either a definitive agreement has been entered into or the Special Committee has discontinued its work. OVERVIEW OF CARDIOVASCULAR DISEASE AND ITS TREATMENT Cardiovascular disease is the leading cause of death in the United States and represents the highest percentage of hospital patient days of stay. CVD is a category of illnesses that generally develop progressively, and in many cases asymptomatically, over a number of years. As a result, CVD frequently goes undiagnosed until the patient suffers an acute episode such as a stroke or heart attack. CVD manifests itself in a number of disease states, such as atherosclerosis, electrophysiological defects, valvular dysfunction, congestive heart failure, hypertension and congenital defects. Based upon 1998 data, the American Heart Association estimates that approximately 60.8 million people in the United States suffer from one or more forms of CVD. According to the AHA's estimates, CVD claimed approximately 950,000 lives in 1998, representing 40.6% of all deaths. According to the AHA, the risk of developing coronary heart disease after the age of 40 is 49% for men and 32% for women. Due to the aging of the United States population, Raytel believes that the need for medical services to diagnose and treat CVD will continue to increase significantly in the future. BUSINESS STRATEGY Our principal objective is to maintain and extend our leadership position as a provider of cardiac transtelephonic monitoring and testing services. We are pursuing this objective through the following strategies: Expand Raytel's Telemedical Business. We intend to utilize our technology and expertise to address additional transtelephonic applications in the treatment and management of cardiac patients and thereby widen the range of services that Raytel offers. Develop Affiliations with Providers. We intend to expand our telemedical business in cooperation with cardiology groups and hospitals with a reputation for the delivery of high quality services among referring primary care physicians and the general population in the communities that they serve. Expand Managed Care Relationships. We believe that interaction with managed care organizations will become an increasingly important element in the provision of cardiac care, including care for Medicare patients, and that third-party payors will increasingly prefer to contract with providers offering a wide range of cardiovascular services provided on a multi-state or regional basis. We actively market our existing healthcare services to managed care plans and provide value added services. Pursue Strategic Acquisitions. We have built our existing organization largely through a series of acquisitions. We believe that it is often more cost-effective to acquire and reconfigure an existing business than to establish a new business. We believe that our experience in identifying, structuring and completing acquisitions of healthcare service organizations and effectively integrating these organizations will enable us to take advantage of future acquisition opportunities that arise as a result of the trends toward consolidation of healthcare service providers. We intend to explore opportunities to expand our cardiac businesses through additional strategic acquisitions. RAYTEL CARDIAC INFORMATION SERVICES Raytel is the largest provider of cardiac monitoring and testing services in the United States utilizing transtelephonic pacemaker monitoring, or "TTM," cardiac event detection, and Holter monitoring technologies. We believe that our TTM-based services are the most cost-effective means of testing the performance of implanted cardiac pacemakers and detecting symptoms of transient arrhythmias. 3 PACEMAKER MONITORING We believe, based on our industry experience, that we are the largest provider of transtelephonic pacemaker monitoring services in the United States, currently serving over 80,000 patients with implanted pacemaker systems. Pacemaker systems are designed to assist the human heart in maintaining an adequate pumping rate. A pacemaker is an electronic device that is implanted in the patient and is designed to monitor and, if necessary, to stimulate the patient's heartbeat. As it senses the heart's failure to respond to normal physiologic signals, the pacemaker emits electrical pulses directly into the atrium and/or the ventricle of the heart, causing the heart muscle to contract and pump blood through the patient's body. A pacemaker system consists of the generator which includes the device and a battery and the leads from the device to the patient's heart. The purpose of pacemaker monitoring is to enable the patient to maintain a normal lifestyle without the fear of an unexpected system failure. Pacemaker monitoring can detect failures in the pacemaker system as well as changes in the patient's heart rhythms that can cause the system to become ineffective. In TTM-based pacemaker monitoring, the pacemaker system and its interaction with the patient's heart is tested by conducting periodic, prescheduled ECG examinations. The patient is provided with a battery-powered ECG transmitter which detects the heart's impulses from the surface of the skin, converts these impulses into an acoustic signal and transmits the signal over ordinary telephone lines to one of Raytel's three technical operations centers, where the signal is converted and displayed on a computer screen or strip chart recorder. Raytel's pacemaker monitoring services are prescribed by the patient's physician. After receipt of a prescription and enrollment by Raytel, the patient is sent a transmitter and trained to use the device over the telephone by one of our technologists. Unlike most physician-operated monitoring services, our monitoring services are provided 24 hours a day, seven days a week in order to accommodate unscheduled calls from patients experiencing problems. Each patient is tested on a schedule recommended by his or her prescribing physician with such prescription updated annually. Raytel generates most of its pacemaker monitoring revenues from reimbursement by Medicare and payors of supplemental Medicare benefits. Patients are typically tested between three and twelve times per year. We are reimbursed for pacemaker monitoring services on a per-call basis. Routine pacemaker testing is performed in accordance with a prearranged, computer generated schedule. A trained technologist telephones the patient and requests that the patient initiate transmission of ECG data which is received by recorders in one of our technical operations centers. Once a continuous graph displaying the rhythm of the heart and the pacemaker is generated, this data is interpreted by the technologist to determine the status of the implanted pacemaker and its relationship to the patient's cardiac rhythm. If problems with the pacemaker system are noted or a serious abnormality is detected, including an abnormality in the heart's own rhythm (an arrhythmia), the patient's physician is notified immediately by telephone. After each test, the results are promptly reviewed by a supervising technologist and a cardiologist and a written report is mailed to the patient's physician. CARDIAC EVENT DETECTION SERVICE Raytel operates the Cardiac Event Detection Service, or "CEDS," which tests and documents transtelephonically an ambulatory patient's cardiac rhythm irregularities while the patient is experiencing symptoms. CEDS testing aids in the diagnosis of transient cardiac arrhythmias, including atrial and ventricular abnormalities, such as tachycardia, which causes the heart to beat at an abnormally rapid and potentially life threatening rate. During the fiscal year ended September 30, 2001, we tested approximately 34,000 patients for potential transient arrhythmic events. Upon enrollment in our CEDS program, we provide the patient with a cardiac event recorder for a testing period lasting up to 30 days. Upon experiencing symptoms, the patient activates the event recorder to capture one or more ECGs which the patient will later transmit to one of our two CEDS technical operations centers for analysis. Skilled technologists, under the supervision of cardiac care nurses and cardiologists, make preliminary evaluations of these transmissions for cardiac irregularities. Unlike similar services offered by 4 individuals or small clinics, our centers are staffed 24 hours a day, seven days a week to respond to a patient's needs on a timely basis. Emergency medical response is initiated for CEDS patients when necessary. Regardless of the number of calls placed, payors reimburse Raytel on a 30-day program basis for its CEDS service. HOLTER MONITORING SERVICES We believe, based on our industry experience, that we are the largest provider of Holter monitoring services in the United States. Holter monitoring tests and documents an ambulatory patient's cardiac rhythm irregularities while the patient is fitted with a recording device, with leads attached to the patient's chest, typically for a single 24-hour period. Should Holter monitoring or other testing procedures fail to detect an arrhythmia event in a symptomatic patient, the patient's physician often will refer the patient to an event detection service such as CEDS. Raytel processed approximately 48,000 Holter monitoring tapes during fiscal 2001. IMPLANTABLE CARDIOVERTER DEFIBRILLATORS In November 1999, Raytel and St. Jude Medical, Inc. announced the launch of the Housecall transtelephonic monitoring system, the first commercially available system capable of downloading a complete set of diagnostic data from an implantable cardioverter-defibrillator, or ICD, over the telephone. ICDs are pacemaker-like devices that can sense ventricular tachyarrhythmias (life-threatening fast heart rates) and automatically deliver an electrical shock to restore a normal rhythm. The number of times the ICD was activated is also monitored. Previously, patients with ICDs were required to return to the physician's office on a routine basis in order to have the ICD's battery tested and for an examination of the ICD system integrity. The Housecall system will reduce the frequency of physician office visits by extending the transtelephonic monitoring procedures presently used for pacemakers to ICDS. The new system enables trained technicians to interrogate the device's memory and transmit stored data as well as real-time clinical and technical information on the patient's cardiac activity and ICD status. The test results are interpreted by trained technicians and a comprehensive report is communicated to the patient's physician for clinical evaluation. Under an exclusive agreement with St. Jude Medical, Raytel manufactures the initial version of the Housecall transmitters and receiving units and monitors St. Jude ICD patients using Housecall. TRAINING AND QUALITY ASSURANCE All of our pacemaker monitoring technologists undergo a formal six-week training program that includes basic cardiac physiology, the operation of pacemaker devices, the interaction of pacemaker systems with the heart, and the administration and interpretation of ECG tests. As technologists become more experienced, they are trained to monitor increasingly complex pacemaker systems. Technologists administering our CEDS and Holter services undergo training in the interpretation of ECG data to detect symptoms of cardiac arrhythmia. We maintain a rigorous quality assurance program. Board-certified cardiologists direct our technologists who have special training in the fields of cardiac pacing and electrophysiology. Each pacemaker-monitoring test is separately reviewed by a supervising technologist and a cardiologist. CEDS transmissions and Holter test results are evaluated by technologists under the supervision of cardiac care nurses and cardiologists. The State of Connecticut has approved Raytel's training program for college credit toward a bachelor of science degree within the Connecticut state university system. RAYTEL CARDIOVASCULAR FACILITIES Raytel currently operates four freestanding cardiovascular diagnostic facilities. Two of our cardiovascular diagnostic facilities are located in Texas and two are located in Louisiana. Raytel also provides consulting services to a hospital relating to its on-site heart center and leases cardiac catheterization equipment and related leasehold improvements to the hospital. 5 CARDIOVASCULAR DIAGNOSTIC FACILITIES Raytel operates four freestanding cardiovascular diagnostic facilities which perform cardiac catheterization and related services (the "Cardiovascular Diagnostic Facilities"). Cardiac catheterization utilizes catheters and sophisticated diagnostic instruments to evaluate the functioning of the heart and the coronary arteries. A narrow, flexible tube, or catheter, is inserted through a main artery in the leg or arm and guided into the patient's coronary arteries, where a cardiologist can use the catheter to perform various tests to diagnose the nature and extent of the patient's coronary artery disease. The Cardiovascular Diagnostic Facilities are located in Texas and Louisiana. At each Cardiovascular Diagnostic Facility, we provide the facilities, equipment, supplies and support personnel necessary for the cardiologist to perform interventional cardiac imaging and peripheral therapeutic procedures. All of the Cardiovascular Diagnostic Facilities are owned by limited partnerships. Raytel, through a separate wholly-owned subsidiary for each limited partnership, serves as the corporate general partner which acts as the day-to-day manager of each facility. Raytel owns a majority interest in two of the facilities. Raytel also owns and operates two nuclear cardiology diagnostic facilities, formerly operated in conjunction with Cardiovascular Diagnostic Facilities. Physicians practicing at the Cardiovascular Diagnostic Facilities are not obligated to refer patients to or practice at these facilities and also practice at nearby hospitals. RAYTEL HEART CENTER AT GRANADA HILLS COMMUNITY HOSPITAL In March 1999, Raytel and Granada Hills Community Hospital, or GHCH, terminated the management consulting agreement which they had entered into in September 1998, as the result of an advisory opinion from the Regional Office of the Health Care Finance Agency which raised issues regarding the hospital's eligibility to continue to participate in the Medicare program. Effective with the termination of the management consulting agreement, the Company entered into a revised five-year consulting services agreement with GHCH, pursuant to which we provide consulting services to the hospital with regard to the operations of its integrated heart center. GHCH is a general acute care hospital located in the San Fernando Valley area of Los Angeles. The hospital's heart program includes cardiac catheterization procedures, stress testing, ultrasound and other diagnostic services, cardiovascular and cardiothoracic surgical procedures and cardiac rehabilitation programs. Under the consulting services agreement, we provide specified consulting services to GHCH, including quality management and assurance, technology assessment and management, strategic planning and other services. We also lease cardiac catheterization equipment and related leasehold improvements to the hospital. All medical services at the facility are the responsibility of the hospital and its medical staff. Through an affiliated medical group, Raytel and GHCH entered into an exclusive agreement for Raytel to act as the exclusive provider of cardiac surgery services at the hospital and to manage the hospital's cardiovascular surgery program. We have entered into an agreement with a leading cardiothoracic surgeon to provide the cardiac surgery services at the hospital. The initial term of the agreement coincides with the term of the consulting agreement with the hospital. Raytel, through a subsidiary, provides management services to the medical group. RAYTEL DIAGNOSTIC IMAGING SERVICES Raytel provides outpatient diagnostic imaging services through operating and investment interests in nine freestanding imaging centers (the "Imaging Centers") and two ancillary facilities associated with two of the Imaging Centers. Raytel also operates the Raytel Imaging Network, a specialized preferred provider network currently consisting of 700 independent imaging centers located from Virginia to New York, including seven centers owned and managed by Raytel. Diagnostic imaging technology consists of a number of medical diagnostic modalities, many of which integrate computer hardware and software. These modalities include magnetic resonance imaging, or MRI, computed tomography, or CT, nuclear medicine, radiography/fluoroscopy, or R/F, ultrasound, general x-ray 6 and mammography. These imaging modalities are generally non-invasive (with the exception of the injection of contrast material in certain techniques and the occasional use of sedating agents) and subject the patient either to sound waves (ultrasound), X-rays (CT, R/F and X-ray mammography) or radio waves and magnetic fields (MRI) to gather data that aid in medical diagnosis. These diagnostic technologies enable physicians to view certain internal body anatomy and pathology and in many instances provide early diagnostic capability and aid in effective treatment planning without the need for more costly exploratory surgery. The principal diagnostic imaging modality in use at the Imaging Centers is MRI. MRI is used to provide high resolution images of the soft tissue of the body. In the field of cardiology, MRI is used for the assessment of congenital and anatomical cardiac defects. Other MRI techniques, such as MR angiography, are also used in the assessment of peripheral vascular and other cardiovascular diseases. The Imaging Centers also provide a wide range of imaging services for the diagnosis of neurological disorders of the head, neck and spine, as well as imaging of the musculoskeletal system and a variety of internal organs, including the liver and prostate, and the female pelvis. RAYTEL IMAGING CENTERS The Imaging Centers are located in four states. All of the Imaging Centers offer MRI services, and four offer other imaging modalities. Raytel owns four of the Imaging Centers and holds its interests in the other three through investments in limited partnerships (the "Ventures"), to which we provide management services, including data processing, billing and collection, accounting, marketing services and operational supervision. The Ventures have terms that expire between 2008 and 2025. RAYTEL IMAGING NETWORK The trends toward cost containment and managed care have resulted in changes in the patterns of patient referrals to diagnostic imaging facilities, adversely affecting the profitability of independent imaging centers and encouraging the formation of networks of independent centers. Many independent operators of diagnostic imaging facilities lack the management and marketing expertise and systems, as well as the experience in dealing with large managed care organizations, that are necessary to effectively establish and operate such networks. Our experience in dealing with a wide variety of managed care organizations and our established, centralized marketing, scheduling, billing and accounting systems provide us with the capability to establish and operate networks of independent diagnostic imaging centers. In addition, Raytel's purchasing power allows us to provide participating centers with supplies, such as contrast agents, film and other medical and technical supplies, and with equipment maintenance and other services at considerable cost savings. The Raytel Imaging Network (the "Network") is a dedicated network of diagnostic imaging facilities established to provide services to patients participating in healthcare benefit programs offered by municipal and state employers, corporations that self-insure, third-party insurance carriers, union health and welfare plans and managed care providers. Independent imaging centers enter into fixed fee contractual relationships with the Network to provide imaging services to patients referred by payors which have contracted with the Network for services at a negotiated fee. The Network handles scheduling for patients whose healthcare benefit programs participate in the Network and guarantees these participating entities a fixed fee for all radiology procedures performed in Network centers. The Network also offers centralized billing services for those procedures, promptly reports the results of the studies to the patient's referring physician and the outcomes of the studies to the administrators responsible for the management of the patient's healthcare program. The Network is a preferred provider organization with participating imaging centers in the states of New Jersey, Pennsylvania, Delaware, Maryland, New York and Virginia. The Network currently provides diagnostic imaging services under referral arrangements with approximately 135 organizations administering healthcare programs covering more than 700,000 individual participants. 7 SALES AND MARKETING Our marketing activities are directed at managed care organizations, cardiologists and referring physicians. We maintain a central managed care sales group that negotiates and manages contracts with managed care organizations. Our marketing organization also supervises the marketing of our TTM-based services to physicians nationwide and supports the efforts of local centers to market their services to referring physicians in the communities they serve. RAYTEL CARDIAC INFORMATION SERVICES We market our cardiac monitoring and testing services nationwide by using regional sales managers coordinating the activities of approximately 400 sales representatives who are employees of the pacemaker equipment manufacturers or part-time employees of Raytel. Our sales organization is supported by our customer service and telemarketing personnel. We work closely with all major pacemaker manufacturers and have agreements with certain manufacturers for the distribution of Raytel's services through the direct sales forces of the manufacturers. Our sales force works closely with the approximately 10,000 physicians currently prescribing Raytel's pacemaker monitoring services. Raytel differentiates its cardiac monitoring and testing services from most of its competitors by providing its services 24 hours a day, seven days a week. In addition, we offer technologists who specialize in monitoring specific pacemaker models (the more complex the unit, the more expertise a technologist is required to have), extensive quality control procedures, computerized reports for complex pacemakers, detailed reporting procedures for abnormal findings and an extensive database on pacemaker performance. RAYTEL DIAGNOSTIC IMAGING SERVICES We market the services of the Imaging Centers we manage through a team approach tailored to the needs of each Imaging Center. Our central sales organization coordinates the Imaging Center's marketing activities with the Imaging Center's radiologists. The principal selling effort is directed toward the local base of referring physicians. In support of the selling effort, Raytel provides marketing materials, including newsletters and brochures and holds routine educational sessions for physicians. Raytel also assists the Imaging Center in addressing needs of managed care organizations by negotiating contracts with these organizations and working closely with insurance plan administrators, HMO personnel, workers' compensation coordinators and hospital administrators. RAYTEL CARDIOVASCULAR DIAGNOSTIC FACILITIES We market the services of our Cardiovascular Diagnostic Facilities using the basic approach employed with the Imaging Centers. Each facility undertakes marketing activities specifically structured for its local or regional market. The manager of each facility initiates and maintains contact with local referring physicians. Raytel's central sales organization supports the local selling effort with marketing materials and assistance in the development of clinical outreach programs designed to make the capabilities of the center available to underserved segments of the community. The center manager coordinates local physician contacts with our cardiac monitoring and testing sales force to cross-sell our transtelephonic pacemaker monitoring, Holter monitoring and cardiac event detection services. We negotiate contacts with managed care organizations centrally from our Connecticut facility. This central sales group also assists the center manager in addressing the needs of such organizations. BILLING AND COLLECTION Our cardiac monitoring and testing operations generate a high volume of relatively low-cost services delivered to patients living throughout the United States. Raytel derives substantially all of its transtelephonic pacemaker monitoring, cardiac event detection services and Holter monitoring revenues from Medicare and other third-party payors and, in most cases, renders bills for its pacemaker monitoring services to at least two payors for each procedure. In the year ended September 30, 2001, we generated more than 780,000 bills to 8 Medicare and other third-party payors related to these businesses. Accordingly, our success in these businesses is substantially dependent upon the efficiency of our billing and collection systems. All of the billing and collection functions for Raytel's cardiac testing operations are centralized at our facilities in Connecticut. We have specialized data management systems that we use to obtain and record primary and secondary insurance data at the time of patient enrollment and to maintain and update that information. Our billing and collection staff is specially trained in third-party coverage and reimbursement procedures. We communicate continuously with carriers administering Medicare and have established procedures that allow us to submit most primary Medicare claims electronically, on a batch-billing basis. In addition, we maintain a database on the billing procedures and requirements of more than 1,500 insurance carriers, which enables it to efficiently process claims to primary, secondary and tertiary private insurers. Computerized billing and collection reports allow our personnel to continually monitor open accounts. Due to the complexity of the billing and collection process, Raytel, like many other healthcare service providers, experiences normal payment cycles that are considerably longer than those customary in many other industries. We typically experience billing cycles of 60 to 240 days from the billing date, depending on the type and number of third-party payors, although billing cycles can be even longer in certain situations. Based upon our experience, we believe that our specialized data processing system used in billing for our pacemaker monitoring services and our extensive background in processing high volume, third-party claims serve to minimize collection cycles and the incidence of rejected claims due to incomplete or inaccurate information. In 1998, we converted our billing processing for CEDS and Holter monitoring services to a system based on commercially available software. This system has not performed to our expectations, and we are in the process of converting this segment of our billing operations back to our internally-developed system. Raytel also bills and collects for the Imaging Centers, the Cardiovascular Diagnostic Facilities, and the other facilities that it manages. THIRD-PARTY REIMBURSEMENT Raytel derives substantially all of its revenues from Medicare, HMOs and commercial insurers and other third-party payors. Both government and private payment sources have instituted cost containment measures designed to limit payments made to healthcare providers, by reducing reimbursement rates, limiting services covered, increasing utilization review of services, negotiating prospective or discounted contract pricing and seeking competitive bids. There can be no assurance that such measures will not adversely affect the amounts or types of services that may be reimbursable to Raytel in the future, or that the future reimbursement for any service offered by Raytel will be sufficient to cover the costs and overhead allocated to such service, either of which could have a material adverse effect on our operating results. We cannot predict with any certainty whether or when additional changes in Medicare, Medicaid or other third-party reimbursement rates or policies will be implemented. However, such future changes could have a material adverse effect on our business. Reimbursement rates vary depending on the type of third-party payors. Changes in the composition of third-party payors from higher reimbursement rate payors to lower reimbursement rate payors could have an adverse effect on Raytel's operating results. In addition, Raytel anticipates that it may increasingly offer its services to third party payors on a capitated or other risk-sharing basis. To the extent that patients or enrollees covered by a risk-sharing contract require more frequent or extensive services than is anticipated by Raytel, the revenue derived from such contract may be insufficient to cover the costs of the services provided. Insufficient revenue under capitated or other risk-sharing contracts could have a material adverse effect on our business. GOVERNMENT REGULATION The healthcare industry is highly regulated, and there can be no assurance that the regulatory environment in which Raytel operates will not change significantly and adversely in the future. In general, the scrutiny of methods and levels of payment of healthcare providers and companies is increasing. 9 On August 5, 1997, President Clinton signed the Balanced Budget Act of 1997, or the "BBA", into law. Two of the areas affected most profoundly by this law were (1) fraud and abuse, and (2) the effort of the federal government to use its purchasing power to expand health care options for Medicare beneficiaries while using pressure from increased competition to control costs. The fraud and abuse provisions build on many of the provisions that were enacted by the Health Insurance Portability and Accountability Act of 1996, or "HIPPA". In addition to the specific changes, the fraud and abuse provisions of the BBA signify an apparent shift to the Office of the Inspector General of the Department of Health and Human Services, or the "OIG," of not only enforcement power, but policy-making authority as well. In addition, the BBA broadened the authority for the HCFA to enter into contracts for providing managed care to Medicare beneficiaries by expanding the type of managed care options available to Medicare beneficiaries. Raytel believes that healthcare legislation, regulations and interpretations will continue to change and, as a result, routinely monitors developments in healthcare law. We expect to modify our agreements and operations from time to time as the business and regulatory environment changes. While we believe we will be able to structure our agreements and operations in accordance with applicable law, the lack of definitive interpretations of many statutory and regulatory provisions means that there can be no assurance that Raytel's arrangements are in compliance with such provisions or will not be successfully challenged. GOVERNMENT REIMBURSEMENT PROGRAMS The federal government maintains the Medicare health insurance program for the aged. Individual states have programs for medical assistance to the indigent known generally as Medicaid, which are partially financed by the federal government. Federal Medicaid funds are currently conditioned on state compliance with federal requirements. A significant portion of Raytel's revenues is received under Medicare and other government programs. Both the Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings, interpretations of policy, intermediary determinations, and government funding restrictions, all of which may materially increase or decrease the rate of program payments to healthcare facilities and other healthcare suppliers and practitioners. Raytel's existing cardiac monitoring and testing services, diagnostic imaging services and Cardiovascular Diagnostic Facilities derive a substantial portion of their revenue from payments made under the Medicare program, and we anticipate that any future facilities or services will also derive significant revenues from these sources. In order to participate in this program, a newly-developed facility must be certified after officials administering the Medicare program in the state where the facility is located, or their designees, have conducted a survey of the facility, a process that cannot commence until the facility opens and begins providing services to patients. Once a facility is certified, it will be reimbursed by Medicare for services performed from the date on which a satisfactory survey is conducted in connection with the certification of the facility or such later date as an acceptable plan is submitted to correct any deficiencies noted in the survey. We expect that delays in the certification process may occur and may increase with the funding limitations being imposed on certifying authorities. Combined with the billing and collection cycle for Medicare reimbursement that all healthcare facilities experience, these delays could result in a three to six month working capital deficiency during the start-up phase for newly developed facilities. These working capital deficiencies will have to be funded by Raytel through working capital advances to the facilities using funds provided by operating or financing activities. THE STARK LAW AND MEDICARE FRAUD AND ABUSE LAWS Raytel is subject to a variety of laws and regulations governing the referral of patients to facilities with whom the referring physician has a financial relationship. Subject to certain exceptions, physicians who have a financial relationship with an entity providing healthcare services are prohibited by federal law, often referred to as the "Stark Law," from referring or admitting patients to that entity for the provision of certain designated services reimbursable under Medicare or Medicaid, as well as certain other federally assisted state healthcare programs. The entity providing healthcare services is also prohibited from presenting, or causing to be presented, a claim or bill for the 10 designated services furnished pursuant to a prohibited referral. Possible sanctions for violations of the Stark Law include civil monetary penalties, exclusion from the Medicare and Medicaid programs and forfeiture of amounts collected in violation of such prohibition. The Stark Law prohibits a physician who owns stock of a company from referring patients to the medical facilities in which such company has an ownership interest unless such company's stockholders' equity exceeds $75.0 million. The Stark Law was originally enacted in December 1989, and prohibited a physician (or an immediate family member of a physician) with a financial relationship with a clinical laboratory from making a referral to the clinical laboratory for the furnishing of clinical laboratory services for which payment otherwise would be made by the Medicare program. In 1993, the Stark Law was amended to expand the referral prohibition to apply to certain "designated health services." The 1993 amendments are commonly referred to as "Stark II." Generally, the Stark Law prohibits physicians from referring Medicare patients to facilities for "designated health services" if the physician (or immediate family member of the physician) has a financial arrangement with the entity, unless the arrangement fits within an exception. The definition of designated health services specifically includes radiology services, including MRI, CT, ultrasound and nuclear medicine. However, regulations adopted to implement the Stark Law specifically exclude "invasive" radiology, which includes cardiac catheterization, PTCA and similar imaging modalities used to guide a needle, probe or catheter accurately. Thus, the Stark Law does not prohibit physician ownership of an entity or facility which provides "invasive" radiology, such as cardiac catheterization services provided at Raytel's Cardiovascular Diagnostic Facilities. In addition to the limitations of the Stark Law, a number of states have laws which apply to referrals made for services reimbursed by all payors, and not simply Medicare or Medicaid. Some of these laws may extend to the services furnished by medical facilities in which Raytel has an ownership interest and, absent the availability of an exception under such laws, could prohibit physicians with ownership interests in Raytel from referring any patients to such facilities. We are also subject to the illegal remuneration provisions of the federal Social Security Act and similar state laws, often referred to as "Fraud and Abuse Laws," which impose civil and criminal sanctions on persons who solicit, offer, receive or pay any remuneration, directly or indirectly, for referring a patient for treatment that is paid for in whole or in part by Medicare, Medicaid or similar state or private programs. The courts and the OIG have stated that the Fraud and Abuse Laws are violated where even one purpose, as opposed to a primary or sole purpose, of the arrangement is to induce referrals. Violations of the Fraud and Abuse Laws are punishable by criminal or civil penalties, which may include exclusion or suspension of the provider from future participation in the Medicare, Medicaid and similar state and federal programs, as well as substantial fines. The federal government has published exemptions, or "safe harbors," for business transactions that will be deemed not to violate the federal Fraud and Abuse Laws. Although satisfaction of the requirements of these safe harbors provides protection from criminal prosecution or penalties under the federal anti-kickback legislation, failure to meet the safe harbors does not necessarily mean a transaction violates the statutory prohibitions. Due to the breadth of the statutory provisions of the Fraud and Abuse Laws and the absence of definitive regulations or court decisions addressing the type of arrangements by which Raytel and its affiliated entities conduct and will conduct their business, from time to time certain of their practices may be subject to challenge under these laws. We have attempted to structure our business relations to comply with the Stark Legislation, the Fraud and Abuse Laws and all other applicable healthcare laws and regulations. However, there can be no assurance that such laws will be interpreted in a manner consistent with our practices. In addition, state legislatures and other governmental entities are considering additional measures restricting or regulating referrals, and there can be no assurance that new laws or regulations will not be enacted which will require restructuring of Raytel's operations or otherwise have a material adverse effect on our business, financial condition or operating results. 11 CERTIFICATES OF NEED AND OTHER LICENSING REQUIREMENTS Certain states in which we operate or may operate in the future prohibit the establishment, expansion or modification of certain healthcare facilities and the services provided at such facilities, including heart centers, catheterization laboratories and diagnostic imaging centers, without first obtaining a certificate of need, or "CON," or comparable license from the appropriate state regulatory agency. In addition to any CON or comparable licensing requirements that may apply, heart centers, catheterization laboratories and diagnostic imaging centers developed or operated by Raytel may also be required to comply with other licensing requirements, which vary from state to state. Obtaining CON approval or comparable licensing is typically an expensive and lengthy process and may involve adversarial proceedings initiated by competing facilities or taxpayer groups. The existence of these laws or future legislation changing these laws may make it more difficult or prohibitive for Raytel to develop heart centers, catheterization laboratories or other diagnostic facilities, maintain existing facilities or expand the services provided at such facilities or its other diagnostic imaging facilities. Raytel from time to time is required to upgrade or modify its facilities in order to maintain its licenses. In many states, a facility, such as a free-standing heart center, must be completed before a license will be issued allowing the facility to operate, and even once the facility is built there can be no assurances that a license or certification for operations will be issued by the appropriate government agency. RESTRICTIONS ON CORPORATE PRACTICE OF MEDICINE The laws of certain states in which we operate or may operate in the future prohibit non-physician entities from practicing medicine, exercising control over physicians or engaging in certain practices such as fee-splitting with physicians. Although we have structured our affiliations with physician groups so that the physicians maintain exclusive authority regarding the delivery of medical care, there can be no assurance that these laws will be interpreted in a manner consistent with our practices or that other laws or regulations will not be enacted in the future that could have a material adverse effect on our business. If a corporate practice of medicine law is interpreted in a manner that is inconsistent with our practices, we would be required to restructure or terminate its relationship with the applicable physician group to bring its activities into compliance with such law. The termination of, or failure of Raytel to successfully restructure, any such relationship could result in fines or a loss of revenue that could have a material adverse effect on our business, financial condition or operating results. MEDICAL MALPRACTICE INSURANCE In general, Raytel does not, itself, engage in the practice of medicine and requires physicians performing medical services at its facilities to maintain medical malpractice insurance. Raytel's employees do not practice medicine. However, certain of our employees are involved in the delivery of healthcare services to the public under the supervision of physicians. To protect Raytel from medical malpractice claims, including claims associated with our employees' activities, Raytel, or the Ventures for which Raytel serves as general partner, maintain professional liability and general liability insurance on a "claims made" basis in amounts deemed appropriate by management based upon the nature and risks of Raytel's business. Such policies provide malpractice coverage in the amount of $1 million per occurrence with an aggregate limit of $3 million. Insurance coverage under such policies is contingent upon a policy being in effect when a claim is made, regardless of when the events which caused the claim occurred. The cost and availability of such coverage has varied widely in recent years. While we believe our insurance policies are adequate in amount and coverage for our current operations, there can be no assurance that the coverage maintained by Raytel is sufficient to cover all future claims. In addition, there can be no assurance that we will be able to obtain such insurance on commercially reasonable terms in the future. COMPETITION The healthcare service businesses in which Raytel is currently engaged are highly competitive. The restructuring of the healthcare system is leading to rapid consolidation of the existing highly fragmented 12 healthcare delivery system into larger and more organized groups and networks of healthcare providers. We expect competition to increase as a result of this consolidation and ongoing cost containment pressures among other factors. In executing Raytel's business strategy, we compete with management services organizations, for-profit and nonprofit hospitals, HMOs and other competitors that are seeking to form strategic alliances with physicians or provide management services to physicians or to diagnostic and therapeutic facilities owned by such physicians. Raytel's cardiac monitoring and testing programs compete with a number of smaller, regional commercial entities as well as hospitals, clinics and physicians who generally provide these services as an adjunct to their primary practice. Principal competitive factors are the availability and quality of service. We believe that we compete favorably with most of our smaller competitors based on our 24-hour a day, seven-day a week service, specialized technical staff and sophisticated billing and collection system. Certain of our competitors, including local physicians and hospitals, may have certain competitive advantages over Raytel based upon their direct relationships with referring physicians. Cardiac catheterization and other cardiac diagnostic and therapeutic procedures, as well as diagnostic imaging procedures, are performed in hospitals, private physicians' offices, clinics operated by group practices of physicians and independent catheterization facilities. Although Raytel and its affiliates operate in locations throughout the United States, competition focuses on physician referrals at the local market level. Principal competitors in each of our markets are hospital and physician affiliated facilities, some of which may have greater financial and other resources than Raytel, more experience and greater name recognition than the local managers and physicians associated with our Imaging Centers and Cardiovascular Diagnostic Facilities, or better ties to the local medical community. Successful competition for referrals is a result of many factors, including quality and timeliness of test results, type and quality of equipment, facility location, convenience of scheduling and, increasingly, relationships with managed care programs. Other independent companies (including some which have substantially greater financial and operating resources than Raytel) are in the business of establishing facilities similar to the facilities in which we have or may obtain interests and providing management services to such facilities. EMPLOYEES As of November 30, 2001, Raytel employed approximately 600 full time equivalent employees. None of our employees are covered by collective bargaining contracts. ITEM 2. PROPERTIES The principal operations of Raytel and its subsidiaries are conducted at facilities located in Windsor, Connecticut; New York, New York; Haddonfield, New Jersey; and San Mateo, California. The Windsor facility, consisting of approximately 45,000 square feet, is occupied under a lease expiring in July 2004. The New York facility, consisting of approximately 23,300 square feet, is occupied under a lease expiring in September 2004. The Haddonfield facility, consisting of approximately 10,000 square feet, is occupied under a lease expiring in June 2002. The San Mateo facility, consisting of approximately 2,400 square feet, is occupied under a lease expiring in May 2003. In addition, through eight of its consolidated Imaging Centers, Raytel leases a total of approximately 36,000 square feet in facilities located in New York, New Jersey, California and Pennsylvania. Through its acquisition of CVI in August 1997, Raytel acquired Cardiovascular Diagnostic Facilities in Texas and Louisiana. The Ventures that operate the Cardiovascular Diagnostic Facilities lease a total of approximately 50,000 square feet in these facilities. We generally consider our properties to be in good condition and suitable for our anticipated needs. ITEM 3. LEGAL PROCEEDINGS Raytel's wholly-owned subsidiary, Raytel Cardiac Services, or "RCS", was the subject of a grand jury investigation begun in June 2000 and conducted under the direction of the United States Attorney for the District of Connecticut and the Office of the Inspector General of the U.S. Department of Health and Human Services, or the "OIG." The investigation involved allegations of improper practices in RCS' transtelephonic 13 pacemaker monitoring operations and its billing practices related to Medicare-covered services. The investigation did not involve Raytel's other healthcare services, such as RCS' cardiac event detection services or Raytel's diagnostic imaging services or other cardiac-related businesses. In connection with the investigation, Raytel has reviewed its compliance with Medicare billing and record-keeping requirements on a patient-by-patient basis. Pending such review, Raytel held Medicare reimbursement checks received subsequent to June 23, 2000 in payment of invoices for pacemaker monitoring services and established a special account for funds inadvertently deposited with respect to such services. In addition, Raytel suspended billing for such services. Most of the checks have been deposited, most of the cash has been released from the special account, and new billings for services performed has commenced, as most of the affected patients' records have been reviewed and found to be in compliance with applicable Medicare requirements. The total amount of such uncashed checks and funds remaining in such special account was approximately $400,000 as of September 30, 2001. In June 2001, RCS reached an agreement with the federal government to resolve the issues which were the subject of the investigation. In accordance with that agreement, RCS plead guilty in U.S. District Court in Hartford, Connecticut to a charge of obstructing a criminal investigation arising out of activities related to the initial stage of the investigation in June 2000. In addition, in September 2001, RCS entered into a settlement agreement with the government to resolve related civil claims. Under the criminal and civil settlement, RCS agreed to pay a total of $11,500,000, plus interest at the rate of 7% per annum, to the government over a five-year period, and Raytel guaranteed RCS' payment obligations. As of September 30, 2001, $1,500,000 had been paid to the government. In connection with the settlement, RCS entered into a corporate integrity agreement under which it agreed that its ongoing operations would conform to specific guidelines. RCS' guilty plea did not constitute the type of conviction that would adversely affect its participation in the Medicare program or other federal healthcare programs. In connection with the OIG investigation and its resolution, RCS incurred substantial legal fees and other expenses. Raytel has accrued a reserve of $4,600,000 to cover the estimated amount of these expenses. Expenses in excess of this reserve, if any, will adversely affect operating results in future periods. The investigation, the related internal review and settlement negotiations with the government also diverted the efforts and attention of Raytel and RCS management and a number of RCS' administrative personnel. The impact of this diversion reduced the efficiency of RCS' pacemaker monitoring operations during the second half of fiscal 2000 and throughout fiscal 2001. Although the investigation has been concluded, implementation of the corporate integrity agreement continues to require the time and attention of RCS management and administrative personnel. In addition, RCS' guilty plea entered into under its agreement with the government constituted a default under Raytel's bank credit facility. In November 2001, Raytel entered into a new revolving credit arrangement and repaid indebtedness under its bank facility. However, RCS' guilty plea could adversely affect Raytel's ability to obtain debt or equity financing in the future. Raytel and its subsidiaries are parties to other litigation and claims arising out of its ongoing business operations. We believe that none of these matters, either individually or in the aggregate, are likely to have a material adverse effect on our business, financial condition or operating results. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of Raytel's fiscal year ended September 30, 2001. 14 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Since our initial public offering in December 1995, our common stock has traded in the Nasdaq Stock Market under the symbol "RTEL." Until February 26, 2001, our common stock traded on the Nasdaq National Market, and since that date it has traded on the Nasdaq SmallCap Market. The following table sets forth the range of high and low sales prices of our common stock (adjusted to reflect the one-for-three reverse stock split effected on May 9, 2001), as reported by Nasdaq, for the periods indicated:

As of September 30, 2001, there were 349 holders of record of our common stock. Raytel has never paid cash dividends on its capital stock. It is the present policy of Raytel to retain earnings to finance the development of its business and, therefore, we do not anticipate paying cash dividends in the foreseeable future. 15 ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the notes thereto included elsewhere in this report.

--------------- (1) Includes current portion of long-term debt and capital lease obligations. 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion and analysis includes a number of forward-looking statements which reflect Raytel's current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including those discussed under "Business Environment and Future Results" and elsewhere in this discussion, that could cause actual results to differ materially from historical results or those anticipated. In this discussion, the words "anticipates," "believes," "expects," "intends," "future" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. OVERVIEW The Company generates its revenues from cardiac information services (which include telephonic monitoring services for cardiac pacemaker patients ("Pacing"), cardiac event detection services ("CEDS") and Holter monitoring), from diagnostic imaging services and from facilities providing diagnostic, therapeutic and patient management services primarily associated with cardiovascular disease. Since 1995, the Company has entered into a series of transactions which have expanded its heart center and physician practice management businesses. As a result, revenue has also been provided from: the Raytel Heart Center at Granada Hills ("RHCGH") beginning on February 1, 1996; the management of Southeast Texas Cardiology Associates II, L.L.P. ("SETCA") beginning on September 18, 1996 and ending on May 31, 2000; the management of Comprehensive Cardiology Consultants, a Medical Group, Inc. ("CCMG") beginning on November 1, 1996 and ending on May 31, 2000; and Cardiovascular Ventures, Inc. ("CVI") beginning on August 15, 1997, which included the multi-specialty clinic, Heart and Family Health Institute ("HFHI") and six cardiovascular diagnostic facilities. HFHI was sold effective January 1, 2001. On August 15, 1997, the Company acquired all of the outstanding capital stock of CVI, of New Orleans, Louisiana. CVI managed, owned, and operated cardiovascular diagnostic facilities in Texas, Louisiana and Florida and also owned and managed HFHI in Florida. Total original consideration for the transaction consisted of cash and transaction costs of approximately $16,980,000 and 166,666 shares of Raytel's common stock. During fiscal 1998, there were additional transaction costs of approximately $280,000 and an additional 15,556 shares of the Company's Common Stock has been or will be issued. Contingent promissory notes in the aggregate principal amount of $820,000 delivered as part of the consideration were cancelled in accordance with the terms of the agreement. Effective March 27, 1999, the Company entered into a revised agreement with RHCGH. The new agreement results in significantly lower revenues and expenses than revenues and expenses recognized under the previous agreements. In November 1999, the Company filed a demand for arbitration against CCMG with JAMS/Endispute, Inc. The Company provided management services to CCMG pursuant to a long-term management services agreement entered into between the parties in November 1996. The demand for arbitration asserted that Raytel was entitled to rescission, restitution and/or damages as a result of CCMG's material breaches of the management services agreement. The arbitration was settled in fiscal 2001 with no material adverse effect to the Company. In order to settle a dispute and avoid protracted litigation, initiated by SETCA, effective May 31, 2000, the Company's Board of Directors approved management's plan to sell SETCA. Effective May 31, 2000, the Company sold substantially all of the assets of Raytel Nuclear Imaging-Orange, L.P. and the common stock of Raytel Texas Physicians Services, Inc. in exchange for the cancellation of promissory notes in the aggregate amount of approximately $2,300,000 payable by the Company to the physicians and the physicians' agreement to cancel existing rights to receive 40,689 shares of Raytel's common stock. Accordingly, the Company reported the results of operations of those discontinued entities and the loss on disposal as discontinued operations. The loss on disposal of $4,965,000, recorded at June 30, 2000, is net of an estimated tax benefit of approximately $3,367,000. 17 From June 2000 through June 2001, Raytel was the subject of a grand jury investigation of allegations concerning certain business practices of the trans-telephonic cardiac pacemaker monitoring business conducted by Raytel Cardiac Services, Inc., a wholly-owned subsidiary of the Company ("RCS"). The investigation did not involve Raytel's other healthcare services, such as RCS' cardiac event detection services or Raytel's diagnostic imaging services or other cardiac-related businesses. In connection with the investigation, Raytel has reviewed its compliance with Medicare billing and record-keeping requirements on a patient-by-patient basis. Pending such review, Raytel held Medicare reimbursement checks received subsequent to June 23, 2000 in payment of invoices for pacemaker monitoring services and established a special account for funds inadvertently deposited with respect to such services received since the date the investigation began. In addition, Raytel suspended billing for such services. Most of the checks have been deposited, most of the cash has been released from the special account, and new billings for services performed has commenced as most of the affected patients' records have been reviewed and found to be in compliance with applicable Medicare requirements. The total amount of such uncashed checks and funds deposited in such special account was approximately $400,000 as of September 30, 2001. Since Raytel recognizes revenue when patient services are provided, neither the special account arrangement nor the deferred billing has had a direct impact on Raytel's operating results. If the Company's review discloses any patient billings that have not been fully compliant with Medicare requirements, any resulting billing adjustments or reversals will be charged against operating results in that current period. In addition, the Company has incurred substantial legal fees and other expenses in connection with the investigation and has accrued a reserve of $4,600,000 to cover the estimated amounts of these expenses. Additional expenses, if any, will adversely affect operating results in future periods. As of September 30, 2001, the Company had incurred legal fees and other expenses of approximately $3,945,000 related to the investigation. The remaining balance is included in "accrued other liabilities" on the Company's balance sheet. These expenses include legal fees incurred by certain employees in connection with the on-going investigation which were reimbursed by the Company in accordance with the requirements of Delaware Law and the Company's By-Laws. In June 2001, RCS reached an agreement with the federal government to resolve the issues that were the subject of the investigation. In accordance with that agreement, on June 25, 2001, RCS plead guilty in U.S. District Court in Hartford, Connecticut to a charge of obstructing a criminal investigation arising out of the initial investigation in June 2000. In addition, in September 2001, the Company and RCS entered into an agreement with the government to resolve related civil claims. Under the criminal and civil settlements, RCS agreed to pay a total of $11,500,000 to the government over a five year period, with interest of 7% per annum on the unpaid balance, and Raytel guaranteed RCS payment obligations. RCS also entered into a corporate integrity agreement under which it agreed that its ongoing operations would conform to specified guidelines. As of September 30, 2001, $1,500,000 had been paid to the government, and the next payment of $2,000,000 is due in June 2002. RCS' guilty plea did not constitute the type of conviction that would adversely affect its participation in the Medicare program or other federal healthcare programs. The investigation, the related internal compliance review, and settlement negotiations with the government diverted the efforts and attention of a number of Raytel's management and administrative personnel. The impact of this diversion reduced the efficiency of RCS' pacemaker monitoring operations during the last week of the quarter ended June 30, 2000 and adversely affected both revenues and operating expenses for that period as well as the quarter ended September 30, 2000, and throughout the fiscal year ended September 30, 2001. Although the investigation has been concluded, implementation of the corporate integrity agreement continues to require the time and attention of Raytel and RCS management and a number of RCS' administrative personnel. In addition, RCS' guilty plea entered into under its agreement with the government constituted a default under Raytel's bank credit facility. In November 2001, Raytel entered into a new revolving line of credit arrangement and repaid indebtedness under its bank facility. However, RCS' guilty plea could adversely affect Raytel's ability to obtain debt or equity financing in the future. In March 2001, effective January 1, 2001, the Company completed the sale of its wholly-owned subsidiary, HFHI, to a new company organized by physicians practicing at HFHI, including David Wertheimer, M.D., who had served as President of the subsidiary as well as an officer of Raytel and a 18 member of Raytel's Board of Directors. Raytel received a cash purchase price of $8,311,000, net of transaction expenses, in exchange for all of the common stock of HFHI. Approximately $1,234,000 of the proceeds was used to pre-pay leases for equipment used at the HFHI facility, $5,100,000 was used to reduce the indebtedness under the Company's bank credit facility and the balance was used for working capital purposes. The Company reported the results of operations of HFHI and the loss on disposal as discontinued operations for all applicable periods presented. The loss on disposal of $19,353,000 represents a one-time non-cash charge, consisting primarily of the write-off of intangible assets. Due to the uncertainty of the ultimate tax benefit to be realized as a result of the loss, the Company has not provided for any tax benefit that may result from this transaction. On May 9, 2001, the Board of Directors effected a one-for-three reverse split of the Company's common stock. The accompanying consolidated financial statements reflect such reverse stock split for all periods presented. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain data derived from the Consolidated Statements of Operations as a percentage of total revenues:

FISCAL YEAR ENDED SEPTEMBER 30, 2001 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30, 2000 Revenues. For the fiscal year ended September 30, 2001, total revenues were $71,268,000 compared to $72,321,000 for fiscal 2000, representing a decrease of $1,053,000, or 1.5%. Cardiac information services revenues were $37,776,000 in fiscal 2001, compared to $40,782,000 in fiscal 2000, a decrease of $3,006,000, or 7.4%. The decrease in revenues for cardiac information services was due primarily to lower revenues from Pacing as a result of lower test volumes and lower average selling prices. Diagnostic imaging services revenues were $25,694,000 in fiscal 2001, compared to $22,652,000 in fiscal 2000, an increase of $3,042,000, or 13.4%, due primarily to increases in revenue at certain centers and the imaging network resulting from increases in patient volumes. Heart facilities and other revenues were $7,798,000 in fiscal 2001, compared to $8,887,000 in fiscal 2000, a decrease of $1,089,000, or 12.3%, due primarily to lower revenues at certain cardiovascular diagnostic facilities as a result of restructuring the operating agreements for these facilities to conform to new regulations and the termination of an agreement with Baptist Hospital of Beaumont, Texas. Operating Expenses. Operating costs and selling, general and administrative expenses increased by $1,286,000, or 2.1% (excluding the provision for OIG investigation expenses and the settlement with the 19 federal government), from $61,612,000 in fiscal 2000 to $62,898,000 in fiscal 2001 due primarily to higher expenses at diagnostic imaging services partially offset by decreases in costs and expenses at cardiac information services and heart facilities and other. Operating costs and selling, general and administrative expenses (excluding the provision for OIG investigation expenses and the settlement with the federal government) as a percentage of total revenues increased from 85.2% in fiscal 2000 to 88.3% in fiscal 2001. Provision for OIG Investigation Expenses. The Company provided $2,600,000 and 2,000,000 for expected expenses associated with the OIG investigation for the fiscal years ended September 30, 2001 and 2000, respectively. Settlement with Federal Government. The Company recorded a one-time charge of $11,500,000 in June 2001 related to the settlement of criminal and civil proceedings entered into between its subsidiary, Raytel Cardiac Services, and the federal government. Depreciation and Amortization. Depreciation and amortization expense decreased by $97,000, or 1.5%, from $6,582,000 in fiscal 2000 to $6,485,000 in fiscal 2001 but remained at 9.1% as a percentage of total revenues for both fiscal 2000 and 2001. Operating Income (Loss). As a result of the foregoing factors, the Company had operating income of $2,127,000 in fiscal 2000 compared to an operating loss of $12,215,000 in fiscal 2001. Interest Expense. Interest expense decreased by $186,000, or 9.5%, from $1,960,000 in fiscal 2000 to $1,774,000 in fiscal 2001 due primarily to a decrease in the average amount of debt outstanding and, to a lesser extent, a decline in interest rates. Other Expense (Income). Other income decreased by $341,000 from $941,000 for fiscal 2000 to $600,000 for fiscal 2001 due primarily to a series of insignificant items. Minority Interest. Minority interest decreased by $37,000 from $602,000 in fiscal 2000 to $565,000 in fiscal 2001 due primarily to decreased income in certain cardiovascular diagnostic facilities. Income Taxes (Benefit). The provision for income taxes decreased by $808,000 from income taxes of $173,000 in fiscal 2000 to an income tax benefit of $635,000 in fiscal 2001 as a result of decreased taxable income. Income (Loss) from Continuing Operations. As a result of the foregoing factors, the Company recorded income from continuing operations of $333,000 in fiscal 2000 compared to a loss from continuing operations of $13,319,000 in fiscal 2001. Discontinued Operations. Income from operations of a discontinued segment decreased by $1,022,000 from income of $830,000 in fiscal 2000 to a loss of $192,000 in fiscal 2001, net of tax. The loss on disposal of a discontinued segment increased from $4,965,000 (net of an estimated tax benefit of $3,367,000) to $19,353,000. Due to the uncertainty of the ultimate tax benefit to be realized as a result of the $19,353,000 loss, the Company has not provided for any tax benefit that may result from the HFHI transaction. Net Loss. As a result of the foregoing factors, the Company incurred a net loss of $32,864,000 in fiscal 2001 compared to $3,802,000 in fiscal 2000. FISCAL YEAR ENDED SEPTEMBER 30, 2000 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30, 1999 Revenues. For the fiscal year ended September 30, 2000, total revenues were $72,321,000 compared to $79,921,000 for fiscal year 1999, representing a decrease of $7,600,000, or 9.5%. Cardiac information services revenues were $40,782,000 in fiscal 2000, compared to $44,731,000 in fiscal 1999, a decrease of $3,949,000, or 8.8%. The decrease in revenues for cardiac information services was due primarily to lower revenues from Pacing and CEDS as a result of lower test volumes. Diagnostic imaging services revenue was $22,652,000 in fiscal 2000, compared to $20,143,000 in fiscal 1999, an increase of $2,509,000, or 12.5%, due primarily to increases in revenue at certain centers and the imaging network due to an increase in patient volumes. Heart facilities and other revenues were $8,887,000 in fiscal 2000, compared to 20 $15,047,000 in fiscal 1999, a decrease of $6,160,000, or 40.9%, due primarily to lower revenue at RHCGH due to the amended agreement and, to a lesser extent, lower revenue at certain cardiovascular diagnostic facilities. Operating Expenses. Operating costs and selling, general and administrative expenses decreased by $2,771,000, or 4.3% (excluding the provision for OIG investigation expenses), from $64,383,000 in fiscal 1999 to $61,612,000 in fiscal 2000 due primarily to lower expenses at RHCGH due to the amended agreement, partially offset by increases in costs and expenses in diagnostic imaging services and cardiac information services. Operating costs and selling, general and administrative expenses (excluding the provision for OIG investigation expenses) as a percentage of total revenues increased from 80.6% in fiscal 1999 to 85.2% in fiscal 2000. Provision for OIG Investigation Expenses. The Company provided $2,000,000 for expected expenses associated with the OIG investigation in fiscal 2000. Depreciation and Amortization. Depreciation and amortization expense decreased by $226,000, or 3.3%, from $6,808,000 in fiscal 1999 to $6,582,000 in fiscal 2000 and increased as a percentage of revenues from 8.5% in fiscal 1999 to 9.1% in fiscal 2000. Operating Income. As a result of the foregoing factors, operating income decreased by $6,603,000, or 75.6%, from $8,730,000 in fiscal 1999 to $2,127,000 in fiscal 2000. Interest Expense. Interest expense decreased by $343,000, or 14.9%, from $2,303,000 in fiscal 1999 to $1,960,000 in fiscal 2000 due primarily to a decrease in the average amount of debt outstanding. Other Expense (Income). Other income decreased by $158,000 from $1,099,000 for fiscal 1999 to $941,000 for fiscal 2000 due primarily to a series of insignificant items. Minority Interest. Minority interest decreased by $398,000 from $1,000,000 in fiscal 1999 to $602,000 in fiscal 2000 due primarily to decreased income in certain cardiovascular diagnostic facilities. Income Taxes. The provision for income taxes decreased by $2,370,000, or 93.2%, from $2,543,000 in fiscal 1999 to $173,000 in fiscal 2000 as a result of decreased taxable income. Income from Continuing Operations. As a result of the foregoing factors, income from continuing operations decreased by $3,650,000, or 91.6%, from $3,983,000 in fiscal 1999 to $333,000 in fiscal 2000. Discontinued Operations. Income from operations of a discontinued segment decreased by $541,000 from $1,371,000 in fiscal 1999 to $830,000 in fiscal 2000, net of tax. The loss on disposal of the discontinued segment of $4,965,000 is net of an estimated tax benefit of $3,367,000. Net Income (Loss). As a result of the foregoing factors, the Company incurred a net loss of $3,802,000 in fiscal 2000 versus net income of $5,354,000 in fiscal 1999. BUSINESS ENVIRONMENT AND FUTURE RESULTS The Company's future operating results may be affected by various trends in the healthcare industry as well as by a variety of other factors, some of which are beyond the Company's control. The healthcare industry is undergoing significant change as third-party payors attempt to control the cost, utilization and delivery of healthcare services. Substantially all of the Company's revenues are derived from Medicare, HMOs, commercial insurers and other third-party payors. Both government and private payment sources have instituted cost containment measures designed to limit payments made to healthcare providers by reducing reimbursement rates, limiting services covered, increasing utilization review of services, negotiating prospective or discounted contract pricing and seeking competitive bids. Revenue from the Company's Pacing operations during the last three fiscal years has been negatively impacted by Medicare reimbursement rate reductions. Reimbursement rate reductions applicable to the Company's Pacing procedures became effective on January 1, 1999 and had a negative effect on Pacing revenue for calendar year 1999. There was a slight increase in Medicare reimbursement rates effective January 1, 2000 and again effective January 1, 2001; however, a decrease is expected effective January 1, 2002. The Company cannot predict with any certainty 21 whether or when additional reductions or changes in Medicare or other third-party reimbursement rates or policies will be implemented. There can be no assurance that future changes, if any, will not adversely affect the amounts or types of services that may be reimbursed to the Company, or that future reimbursement of any service offered by the Company will be sufficient to cover the costs and overhead allocated to such service. From time to time, Congress considers legislation to reduce Medicare and Medicaid expenditures. Future legislation of this type could have a material adverse effect on the Company's business, financial condition and operating results. Governmental agencies promulgate regulations which mandate changes in the method of delivering services which could have a material adverse effect on the Company's business. An element of the Company's strategy is to expand, in part, through acquisitions and investments in complementary healthcare businesses. The implementation of this strategy may place significant strain on the Company's administrative, operational and financial resources and increase demands on its systems and controls. There can be no assurances that businesses acquired by the Company, in the future, will be integrated successfully and profitably into the Company's operations, that suitable acquisitions or investment opportunities will be identified, or that any such transactions can be consummated. Providers of healthcare services are subject to numerous federal, state and local laws and regulations that govern various aspects of their business. There can be no assurance that the Company will be able to obtain regulatory approvals that may be required to expand its services or that new laws or regulations will not be enacted or adopted that will have a material adverse effect on the Company's business, financial condition or operating results. The healthcare businesses in which the Company is engaged are highly competitive. The Company expects competition to increase as a result of ongoing consolidations and cost-containment pressures, among other factors. The trading price of the Company's Common Stock could be subject to wide fluctuations in response to quarterly variations in the Company's operating results, shortfalls in such operating results from levels forecasted by securities analysts and other events or factors. In addition, the stock market has, from time to time, experienced extreme price and volume fluctuations that have particularly affected the market prices of companies in the healthcare service industries and that have often been unrelated to the operating performance of the affected companies. Announcements of changes in reimbursement policies of third-party payors, legislative or regulatory developments, economic news and other external factors may have a significant impact on the market price of healthcare stocks. LIQUIDITY AND CAPITAL RESOURCES At September 30, 2001, the Company had working capital of $12,942,000, compared to $32,387,000 at September 30, 2000. At September 30, 2001, the Company had cash and temporary cash investments of $6,495,000. In connection with the settlement of the OIG investigation, the Company made payments of $1,500,000 through September 30, 2001. The Company batch-bills Medicare insurance carriers for most cardiac testing services performed during the first few months of each calendar year. This practice results in a temporary build-up of accounts receivable during the Company's second and third fiscal quarters, with the collection of these receivables occurring primarily during the subsequent fourth fiscal quarter. On December 15, 2000, the Company's line of credit agreement with two banks was amended to reduce the line of credit to $20,000,000 and to revise certain financial and other covenants and terms. The interest rate was changed to be based on LIBOR plus 275 basis points, or the bank's prime rate plus 50 basis points, at the option of the Company, and the date for repayment was extended to October 1, 2001. A new non-financial covenant was added under which any civil financial settlement in excess of $1,000,000 or any criminal charges relating to the ongoing OIG investigation would constitute an event of default. On March 16, 2001, the line of credit was further reduced to $14,900,000 in connection with the sale of the Company's HFHI subsidiary. 22 Consistent with the terms of the December 2000 amendment to the line of credit agreement, the line of credit was further reduced by $2,500,000 on June 30, 2001 to $12,400,000. At September 30, 2001, there was approximately $12,300,000 outstanding under the line of credit. The line matured on October 1, 2001 and, therefore, indebtedness outstanding under the line as of September 30, 2001 was classified as a current liability on the Company's balance sheet. In addition, at that date, the Company was in default of certain of its covenants under the credit agreement (including the new covenants relating to the disposition of the OIG investigation). In November 2001, the Company entered into a new two-year revolving credit facility with Healthcare Business Credit Corporation under which it may borrow up to $15,000,000. Loans under the facility will bear interest at prime plus 1% per annum and will be secured by accounts receivable, inventories, capital equipment and other assets of Raytel and certain of its subsidiaries and affiliated entities. Raytel used the proceeds of the new facility to repay outstanding indebtedness of approximately $12,300,000 under the bank credit line that matured on October 1, 2001. The Company's long-term capital requirements will depend on numerous factors, including the rate at which the Company develops new products and services and acquires other businesses, if any. The Company's ability to meet its working capital and capital expenditure needs for the next twelve months is dependent upon its ability to achieve profitability. The Company may require additional capital if, for example, it were to experience operating losses or if it were to pursue one or more business acquisitions. The Company cannot be certain that additional financing will be available when required, or at all. RCS' guilty plea pursuant to the settlement agreement entered into with the federal government in September 2001 could adversely affect Raytel's ability to obtain debt or equity financing in the future. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Raytel does not hold any marketable equity securities, foreign currencies, or derivative financial instruments in its investment portfolio. The Company is exposed to market risk from interest rate fluctuations because it uses variable rate debt to finance working capital requirements. The Company does not believe that there is any material market risk exposure with respect to other financial instruments that would require further disclosure under this item. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See the Index to Financial Statements on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable. PART III Certain information required by Part III is omitted from this report in that Raytel intends to file its definitive proxy statement pursuant to Regulation 14A (the "Proxy Statement") not later than 120 days after the end of the fiscal year covered by this report, and certain information therein is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is incorporated by reference to information set forth in the Proxy Statement under the heading "Proposal No. 1 -- Election of Directors -- Executive Officers and Directors." The information required by this Item with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference to information set forth in the Proxy Statement under the heading "Section 16(a) Beneficial Ownership Reporting Compliance." 23 ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to information set forth in the Proxy Statement under the heading "Executive Compensation and Other Matters." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference to information set forth in the Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference to information set forth in the Proxy Statement under the heading "Certain Relationships and Related Transactions." PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. FINANCIAL STATEMENTS: Report of Independent Public Accountants Consolidated Balance Sheets as of September 30, 2001 and 2000 Consolidated Statements of Operations for the Years Ended September 30, 2001, 2000 and 1999 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended September 30, 2001, 2000 and 1999 Consolidated Statements of Cash Flows for the Years Ended September 30, 2001, 2000 and 1999 Notes to Consolidated Financial Statements Supplementary Data: Quarterly Financial Data (unaudited) 2. FINANCIAL STATEMENT SCHEDULES: Report of Independent Public Accountants Schedule II -- Valuation and Qualifying Accounts 3. EXHIBITS: The exhibits which are filed with this report, or incorporated herein by reference, are set forth in the Exhibit Index, which immediately follows the financial statements. (b) REPORTS ON FORM 8-K DURING THE QUARTER ENDED SEPTEMBER 30, 2001 None. 24 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: December 28, 2001 RAYTEL MEDICAL CORPORATION By: /s/ RICHARD F. BADER ---------------------------------------------- Richard F. Bader Chairman of the Board of Directors and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated on the dates indicated.

25 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS

F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Raytel Medical Corporation: We have audited the accompanying consolidated balance sheets of Raytel Medical Corporation and Subsidiaries as of September 30, 2001 and 2000 and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the years in the three year period ended September 30, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Raytel Medical Corporation and Subsidiaries as of September 30, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the years in the three year period ended September 30, 2001 in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Hartford, Connecticut November 29, 2001 F-2 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2001 AND 2000

The accompanying notes are an integral part of these consolidated financial statements. F-3 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999

The accompanying notes are an integral part of these consolidated financial statements. F-4 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999

The accompanying notes are an integral part of these consolidated financial statements. F-5 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999

The accompanying notes are an integral part of these consolidated financial statements. F-6 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. ORGANIZATION AND DESCRIPTION OF THE COMPANY: Since 1990, Raytel Medical Corporation ("Raytel" or the "Company") or its predecessor companies, have been in the medical service business. The Company provides a range of services, focusing on the needs of patients with cardiovascular disease and is the leading provider in the United States of remote cardiac monitoring, testing and information services utilizing telephonic and Internet communication technology. Since 1990, the Company has acquired and disposed of various medical services businesses and entered into agreements with various medical service providers. Significant transactions occurring during the past five fiscal years are described below: (a) An agreement, with Granada Hills Community Hospital, became effective February 1, 1996 and provided for the creation of the Company's first integrated heart center, the Raytel Heart Center at Granada Hills ("RHCGH"). Under the agreement, which was amended in September 1998, the Company was responsible for the day-to-day operations of RHCGH, including administrative support and other non-medical aspects of the program. Effective March 27, 1999, the Company entered into a revised agreement with RHCGH, which resulted in significantly lower revenues and expenses than those recognized under the previous agreements. (b) Effective June 11, 1996, the Company acquired certain assets and assumed certain liabilities of Cardio Data Services, Inc. ("CDS"). CDS provides clinical transtelephonic pacemaker monitoring, cardiac event detection and Holter monitoring services. The purchase price of the transaction was $14,254,000 of which $13,985,000 was allocated to the acquisition of intangible assets, the majority of which is being amortized over 25 years. (c) On September 18, 1996, the Company acquired all of the non-medical assets of Southeast Texas Cardiology Associates, P.A. ("SETCA") and entered into a long-term management service agreement whereby the Company managed the non-medical aspects of the practice. The Company assumed responsibility for providing office space as well as billing and collection activities and other management services. Total consideration for the transaction was cash and transaction costs of $4,010,000, promissory notes of $2,289,000 and 40,689 shares of the Company's Common Stock to be delivered at future dates, valued at $852,000. The shares of Common Stock were valued at a discount from the then current trading price after considering all relevant factors, including, but not limited to, normal discounts for marketability due to the time delay in delivery of the shares. The recorded amounts for the aggregate number of shares of Common Stock to be delivered were discounted 40% from comparable cash sales of Common Stock. The scheduled issuance of the shares of Common Stock that the Company was committed to deliver was 28,483 in 2000 and 12,206 in 2001 (See (f) below). (d) On October 18, 1996, the Company entered into a long-term management service agreement whereby the Company managed the non-medical aspects of Comprehensive Cardiology Consultants, a Medical Group, Inc. ("CCMG"), a physician practice. Total consideration for the transaction was cash of $427,000, promissory notes of $620,000 and 4,792 shares of the Company's Common Stock to be delivered at future dates, valued, as described above, at $91,000. In November 1999, the Company filed a demand for arbitration against CCMG with JAMS/ Endispute, Inc. The demand for arbitration asserts that Raytel is entitled to rescission, restitution and/or damages as a result of CCMG's material breaches of the management services agreement. The arbitration was settled in fiscal 2001 with no material adverse effect to the Company. (e) On August 15, 1997, the Company acquired all of the outstanding capital stock of Cardiovascular Ventures, Inc. ("CVI"). CVI manages, owns and operates several cardiovascular diagnostic facilities F-7 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) in Texas, Louisiana and owned and managed a cardiovascular diagnostic facility and a multi-specialty clinic in Florida ("HFHI") (See (g) below). Total original consideration for the transaction was cash and transaction costs of approximately $16,980,000, 166,666 shares of the Company's Common Stock and contingent promissory notes in the aggregate principal amount of $820,000. During fiscal 1998 there were additional transaction costs of approximately $280,000 and an additional 15,556 shares of the Company's Common Stock was to be issued. Also, the $820,000 of contingent promissory notes were cancelled in accordance with the terms of the agreement. (f) In order to settle a dispute and avoid protracted litigation, initiated by SETCA, effective May 31, 2000, the Company's Board of Directors approved management's plan to sell SETCA. Effective May 31, 2000, the Company sold substantially all of the assets of Raytel Nuclear Imaging-Orange, L.P. and the Common Stock of Raytel Texas Physicians Services, Inc. in exchange for the cancellation of promissory notes in the aggregate principal amount of approximately $2,300,000 payable by the Company to the physicians and the physicians' agreement to cancel rights to receive 40,689 shares of Raytel's Common Stock. The loss on the disposal of $4,965,000, recorded June 30, 2000, was net of an estimated $3,367,000 tax benefit. Accordingly, the results of the operations of these entities have been accounted for as discontinued operations and the related operating results have been reported separately from the Company's continuing operations for all periods presented. Prior year operating results have been restated. Revenues applicable to the above discontinued segments for the years ended September 30, 2001, 2000 and 1999 were $0, $2,432,000 and $5,522,000, respectively. (g) In March 2001, effective January 1, 2001, the Company completed the sale of its wholly-owned subsidiary, HFHI, to a new company organized by physicians practicing at HFHI, including David Wertheimer, M.D., who had served as President of the subsidiary as well as an officer of Raytel and a member of Raytel's Board of Directors. Raytel received a cash purchase price of $8,311,000, net of transaction expenses, for all of the common stock of the subsidiary. Approximately $1,234,000 of the proceeds were used to pre-pay leases for equipment used at the HFHI facility, $5,100,000 was used to reduce the indebtedness under the Company's bank credit facility and the balance was used for working capital purposes. The Company reported the results of operations of HFHI and the loss on disposal as discontinued operations for all applicable periods presented. Prior year operating results have been restated. The loss on disposal of $19,353,000 represents a one-time non-cash charge, consisting primarily of the write-off of intangible assets. Due to the uncertainty of the ultimate tax benefit to be realized as a result of the loss, the Company has not provided for any tax benefit that may result from this transaction. Revenues applicable to this discontinued segment for the years ended September 30, 2001, 2000 and 1999 were $3,948,000, $17,629,000 and $15,951,000, respectively. (h) The Company's acquisitions have been accounted for as purchases in accordance with accounting principles generally accepted in the United States. Accordingly, acquired assets and assumed liabilities were recorded at their estimated fair values at the acquisition date. In certain acquisitions, there was an excess of the purchase price over the fair value of the net tangible assets acquired which was allocated to identifiable intangible assets and goodwill (See Note 5). NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (a) Principles of Consolidation -- The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. F-8 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) At September 30, 2001, the Company owned seven imaging centers and held interests in two others through investments in various joint ventures and limited partnerships (the "Ventures"). All Ventures are consolidated for financial reporting purposes, as the Company owns more than 50% of each of the Ventures and/or controls their assets and operations. At September 30, 2001, the Company held interests in four cardiovascular diagnostic facilities, through investments in various limited partnerships (the "Partnerships") and wholly-owned two others. All Partnerships are consolidated for financial reporting purposes, as the Company owns more than 50% of each of the Partnerships and/or controls their assets and operations as the Company is the general partner for the four facilities and, as such, makes strategic operating decisions for the partnerships. Minority interests in consolidated entities represent the investment of third-parties in certain consolidated Ventures and Partnerships. All significant intercompany accounts and transactions are eliminated in consolidation. (b) Revenue Recognition -- Net patient and service revenues are recognized at established rates when the services are provided. Contractual allowances are calculated for services provided at less than the established rates as approved by Medicare or other third-party payors and are recorded as deductions from revenue. Consolidated diagnostic imaging revenues principally represent fees for services provided to patients net of physician fees, contractual allowances and certain expenses. (c) Cash Equivalents -- For purposes of reporting cash flows, the Company considers temporary investments with original maturities of three months or less to be cash equivalents. The temporary investments are stated at cost, which approximates market. (d) Property and Equipment -- Property and equipment are stated at cost. Depreciation is provided on the straight-line method over the estimated useful lives of the assets which range from three to ten years. Capital leases are recorded at the present value of the future minimum lease payments. Capital leases are amortized over the terms of the related lease on a straight-line basis. (e) Intangible Assets -- Intangible assets principally consist of physician referrals and patient lists, non-compete covenants, capitalized debt issuance expense and goodwill. Amortization of capitalized debt issuance expense and goodwill is provided on a straight-line basis. Amortization of physician referrals and patient lists is provided based upon the ratio of expected annual revenues to expected total revenues to be generated over the estimated life of the asset. The amortization periods of the intangibles range from two to twenty-five years, with physician referrals and patient lists being amortized over fifteen years and goodwill being amortized over ten to twenty-five years. (f) Income Taxes -- The Company and its subsidiaries file consolidated federal and state income tax returns. The Company accounts for income taxes in accordance with the Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes. (g) Use of Estimates -- The preparation of the Company's financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the related disclosures. Actual results could differ from those estimates. (h) New Accounting Standards -- The Financial Accounting Standards Board ("FASB") issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, in July 2001 (effective for the Company's fiscal 2003). Statement No. 141 will not have an effect on the Company's results and the Company is currently assessing what effect, if any, Statement No. 142 will have on its results. F-9 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (i) Fair Value of Financial Instruments -- The carrying amounts of all financial instruments approximate fair value. (j) Long-Lived Assets -- The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In those circumstances, the Company estimates the net undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. If the undiscounted expected cash flows are lower than the carrying amount of the asset, an impairment loss would be recorded. NOTE 3. RECEIVABLES: Receivables consist of the following (in thousands):

NOTE 4. PROPERTY AND EQUIPMENT: Property and equipment consist of the following (in thousands):

Depreciation expense was $4,790,000, $4,768,000 and $4,701,000 for the years ended September 30, 2001, 2000 and 1999 respectively. NOTE 5. INTANGIBLE ASSETS: Intangible assets consist of the following (in thousands):

Amortization expense related to intangible assets totaled $1,695,000, $1,814,000 and $2,107,000 for the years ended September 30, 2001, 2000 and 1999; respectively. F-10 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 6. NOTES PAYABLE, LONG-TERM DEBT AND CAPITAL LEASES: Notes payable, long-term debt and capital leases consist of the following (in thousands):

--------------- (a) In August 1996, the Company entered into an agreement with two banks providing for a line of credit for $25,000,000. This agreement was amended in September 1997 to expand the line of credit to $45,000,000 and was further amended in July 1998 and July 1999 to revise certain terms and covenants. The Company's access to the line of credit was subject to the maintenance of certain financial covenants related to the Company's level of indebtedness and cash flow. The interest rate was based upon LIBOR plus 175 to 225 basis points, depending on the maintenance of a certain defined ratio, or the bank's prime rate plus 0 to 50 basis points, at the option of the Company. Borrowings under the line were collateralized by substantially all of the assets of the Company and its subsidiaries. On December 15, 2000, the agreement was amended to reduce the line of credit to $20,000,000 and to revise certain financial and other covenants and terms. The interest rate was changed to be based on LIBOR plus 275 basis points, or the bank's prime rate plus 50 basis points, at the option of the Company and the due date was extended to October 1, 2001. A new non-financial covenant was added under which any civil financial settlement in excess of $1,000,000 or any criminal charges relating to the ongoing OIG investigation would constitute an event of default. At September 30, 2001, there was approximately $12,300,000 outstanding under the line of credit. The line matured on October 1, 2001 and, therefore, was classified as a current liability on the Company's consolidated balance sheet. In November 2001, the Company entered into a new two year revolving credit facility with Healthcare Business Credit Corporation under which it may borrow up to $15,000,000. The interest rate is prime plus 1% per annum. Loans under the facility will be secured by accounts receivable, inventories, capital equipment and other assets of Raytel and certain of its subsidiaries and affiliated entities. Raytel used the proceeds of the facility to repay outstanding indebtedness of approximately $12,300,000 under the previous line of credit. The Company's access to the line of credit is subject to the maintenance of certain financial and other covenants. (b) Represents amount due under a settlement with the Federal Government (See Note 13). (c) Other debt includes nonrecourse notes and capital lease obligations with varying maturities at interest rates ranging from 7.25% to 11.71% per annum. The majority of these notes and leases are collateralized by the equipment purchased. Notes payable, long-term debt and capital lease obligations maturing within each of the five years subsequent to September 30, 2001 are as follows: 2002 -- $15,151,000; 2003 -- $2,901,000; 2004 -- $2,740,000; 2005 -- $2,206,000 and 2006 -- $2,006,000. F-11 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7. PREFERRED STOCK AND COMMON STOCK: The Company has 2,000,000 shares of undesignated Preferred Stock authorized for issuance. The Company's Board of Directors has the authority to issue such Preferred Stock in one or more series and to establish the terms of each series which may be greater than the rights of the Common Stock. As of September 30, 2001, no such shares had been issued. In August 1998, the Board of Directors adopted a Stockholder Rights Plan (the "Rights Plan"). Under the Rights Plan, each outstanding share of Raytel Common Stock held of record at the close of business on September 2, 1998 received one right to purchase one one-hundredth of a share of a new series of Preferred Stock for $30.00 per right when someone acquires 15 percent or more of Raytel's Common Stock or announces a tender offer which could result in such person owning 15 percent or more of the Common Stock. The rights expire on August 13, 2008. On May 9, 2001, the Company effected a one-for-three reverse split of the Company's Common Stock. The accompanying consolidated financial statements reflect such reverse stock split for all periods presented. There are 20,000,000 shares of Common Stock, $.001 par value, authorized. NOTE 8. STOCK OPTIONS AND WARRANTS: WARRANTS Upon completion of the Company's initial public offering (the "Offering") in December 1995, in accordance with the terms of a 1993 acquisition, the Company issued the seller warrants to purchase 77,066 shares of Common Stock at an exercise price of $25.20 per share. These warrants expired in December 2000, five years from the effective date of the Offering. STOCK OPTION PLANS The Company has options outstanding under the 1983 Incentive Stock Option Plan as Amended (the "1983 Option Plan") and the 1990 Stock Option Plan (the "1990 Option Plan"). Generally, the 1983 Option Plan and the 1990 Option Plan (together the "Plans") have similar terms. Terms for the option grants under the Plans, including exercise price, are set by the Board of Directors. The exercise price for incentive stock options must be at not less than the fair market value of the underlying stock at the date of grant. The exercise price for nonqualified options must be at not less than 85% of fair market value. Options granted under the Plans have a term of five to ten years from the date of grant. Vesting occurs ratably over a period ranging from two to four years beginning with the effective date of grant. In the event of a change in control, as defined, all options granted become exercisable. The Company's Outside Directors Stock Option Plan (the "Directors Plan") was approved by the stockholders in fiscal 1995. The Directors Plan provides for the grant of 2,000 nonstatutory stock options to nonemployee directors of the Company on the date on which the optionee first becomes a director of the Company. Thereafter, the annual grant could be a maximum of 2,000 shares, as defined. Total vesting occurs, based on a formula, no sooner than three years nor longer than five years. The exercise price per share of all options granted under the Directors Plan shall be equal to the fair market value of a share of the Company's Common Stock on the date of grant. In October 1995, SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS 123"), was issued. SFAS 123 requires the measurement of the fair value of stock options or warrants to be included in the statements of operations or disclosed in the notes to financial statements. The Company has determined that it will retain its existing method of accounting for stock options and has elected the pro forma footnote disclosure included in the tables below. Accordingly, SFAS 123 has no effect on the Company's consolidated financial position or results of operations. F-12 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company has computed the pro forma disclosures required under SFAS 123 for options granted in fiscal 2001, 2000 and 1999 using the Black-Scholes option pricing model prescribed by SFAS 123. The weighted average assumptions used are as follows:

Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant dates of awards under these plans consistent with the method of SFAS 123, the Company's net income (loss) and net income (loss) per common share would have decreased to the pro forma amounts indicated below (in thousands, except per share amounts):

A summary of the status of the Company's three stock option plans at September 30, 2001, 2000 and 1999 and changes during the years then ended is presented in the tables below:

F-13 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

At September 30, 2001, there were 157,666 shares available for future option grants. NOTE 9. LEASE COMMITMENTS: The Company leases its facilities and office space under various noncancelable agreements which expire at various dates through 2008. The Company also leases various equipment under noncancelable leases. All of the above are treated as operating leases. At September 30, 2001, the future minimum rental payments for each fiscal year thereafter under all noncancelable operating leases are as follows (in thousands):

NOTE 10. INCOME TAXES: The provision for income taxes consists of the following (in thousands):

At September 30, 2001 and 2000, the Company had $6,413,000 and $2,411,000, respectively, of deferred tax assets. The Company has recorded a 100% valuation allowance against these amounts. F-14 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The tax effect of the primary temporary differences giving rise to the Company's deferred tax assets and liabilities at September 30, 2001 and 2000 are as follows (in thousands):

Reconciliation of the federal statutory rate from continuing operations to the Company's effective tax rate is as follows (dollars in thousands):

At September 30, 2001, the Company had federal tax loss carryforwards of $195,000, state carryforwards of $3,253,000 and AMT credit carryforwards of $158,000. NOTE 11. EMPLOYEE BENEFIT PLANS: The Raytel Medical Corporation Pension Plan (the "Pension Plan") is a defined contribution benefit plan which covers substantially all employees. Contributions to the Pension Plan are based upon a percentage of an employee's covered compensation, as defined. Total expense under the Pension Plan amounted to $628,000, $619,000 and $599,000 for the years ended September 30, 2001, 2000 and 1999; respectively. The Company maintains a tax-qualified Retirement Savings Plan (the "401(k) Plan") which covers substantially all employees. Eligible employees may make salary deferral (before tax) contributions up to a specified maximum. The Company makes a matching contribution of 25% of the amount deferred. Total expense under the 401(k) Plan amounted to $182,000, $188,000 and $183,000 for the years ended September 30, 2001, 2000 and 1999; respectively. NOTE 12. PRINCIPAL CUSTOMERS: All services performed by the Company are performed in the United States. No one customer accounted for more than 10% of the Company's total net patient and service revenues. However, certain sources of F-15 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) payment for the services, such as Medicare, HMOs, commercial insurers and other third party payors, do or could account for more than 10% of payments received. NOTE 13. CONTINGENCIES: From June 2000 through June 2001, Raytel was the subject of a grand jury investigation of unspecified allegations concerning certain business practices of the trans-telephonic cardiac pacemaker monitoring business conducted by Raytel Cardiac Services, Inc., a wholly-owned subsidiary of the Company ("RCS"). The investigation did not involve Raytel's other healthcare services, such as RCS' cardiac event detection services or Raytel's diagnostic imaging services or other cardiac-related businesses. In connection with the investigation, Raytel has reviewed its compliance with Medicare billing and record-keeping requirements on a patient-by-patient basis. Pending such review, Raytel held Medicare reimbursement checks received subsequent to June 23, 2000 in payment of invoices for pacemaker monitoring services and established a special account for funds inadvertently deposited with respect to such services received since the date the investigation began. In addition, Raytel suspended billing for such services. Most of the checks have been deposited, most of the cash has been released from the special account, and new billings for services performed has commenced as most of the affected patients' records have been reviewed and found to be in compliance with applicable Medicare requirements. The total amount of such uncashed checks and funds deposited in such special account was approximately $400,000 as of September 30, 2001. Since Raytel recognizes revenue when patient services are provided, neither the special account arrangement nor the deferred billing has had a direct impact on Raytel's operating results. If the Company's review discloses any patient billings that have not been fully compliant with Medicare requirements, any resulting billing adjustments or reversals will be charged against operating results in that current period. In addition, the Company has incurred substantial legal fees and other expenses in connection with the investigation and has accrued a reserve of $4,600,000 to cover the estimated amounts of these expenses. Additional expenses, if any, will adversely affect operating results in future periods. As of September 30, 2001, the Company had incurred legal fees and other expenses of approximately $3,945,000 related to the investigation. The remaining balance is included in "accrued other liabilities" on the Company's balance sheet. These expenses include legal fees incurred by certain employees in connection with the on-going investigation which were reimbursed by the Company in accordance with the requirements of Delaware Law and the Company's By-Laws. In June 2001, RCS reached an agreement with the federal government to resolve the issues that were the subject of the investigation. In accordance with that agreement, on June 25, 2001 RCS plead guilty in U.S. District Court in Hartford, Connecticut to a charge of obstructing a criminal investigation arising out of the initial investigation in June 2000. In addition, in September 2001, the Company and RCS entered into an agreement with the government to resolve related civil claims. Under the criminal and civil settlements, RCS agreed to pay a total of $11,500,000 to the government over a five year period, with interest of 7% per annum on the unpaid balance, and Raytel guaranteed RCS' payment obligations. RCS also entered into a corporate integrity agreement under which it agreed that its ongoing operations would conform to specified guidelines. As of September 30, 2001, $1,500,000 had been paid to the government, and the next payment of $2,000,000 is due in June 2002. RCS' guilty plea did not constitute the type of conviction that would adversely affect its participation in the Medicare program or other federal healthcare programs. The investigation, the related internal compliance review and the settlement negotiations with the government diverted the efforts and attention of a number of Raytel's management and administrative personnel. The impact of this diversion reduced the efficiency of RCS' pacemaker monitoring operations during the last week of the quarter ended June 30, 2000 and adversely affected both revenues and operating expenses for that period as well as the quarter ended September 30, 2000, and throughout the fiscal year ended September 30, 2001. Although the investigation has been concluded, implementation of the corporate integrity agreement continues to require the time and attention of Raytel and RCS management and a number F-16 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) of RCS' administrative personnel. In addition, RCS' guilty plea entered into under its agreement with the government constituted a default under Raytel's bank credit facility. In November 2001, Raytel entered into a new revolving line of credit arrangement and repaid indebtedness under its bank facility. However, RCS' guilty plea could adversely affect Raytel's ability to obtain debt or equity financing in the future. The Company is from time to time a party to various other claims and disputes associated with various aspects of its ongoing business operations. In management's opinion, none of these other claims or disputes are expected, either individually or in the aggregate, to have a material adverse effect on the Company's financial position or results of operations. NOTE 14. NET INCOME (LOSS) PER SHARE: Those shares under commitments to be issued at specified future dates are considered as outstanding for per share calculations. For the years ended September 30, 2001, 2000 and 1999, the shares used in calculating diluted earnings per share were determined as follows (in thousands):

--------------- (a) Due to the loss for the period shown, dilutives are not included in the calculation. Certain options and warrants to purchase shares of common stock were outstanding during the years ended September 30, 2001, 2000 and 1999, but were not included in the computation of diluted earnings per share because their exercise prices were greater than the average market price of the common shares for the period. The options and warrants outstanding and their exercise prices are as follows:

NOTE 15. SEGMENT INFORMATION: The Company's reportable segments are strategic business units that offer different services. The Company has three reportable segments: Cardiac Information Services ("Information"), Diagnostic Imaging Services ("Imaging") and Heart Facilities and Other ("Facilities"). The Information segment provides remote cardiac monitoring and testing services utilizing telephonic and Internet communication technology. The Imaging segment operates a network of imaging centers throughout the United States. The Facilities segment provides diagnostic, therapeutic and patient management services primarily associated with cardiovascular disease. The accounting policies of the segments are the same as those described in the summary of significant accounting policies except that the Company does not allocate all interest expense, taxes or corporate overhead to the individual segments. The Company evaluates performance based on profit or loss from operations before income taxes and unallocated amounts. The totals per the schedules below will not and F-17 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) should not agree to the consolidated totals. The difference is due to corporate overhead and other unallocated amounts which are reflected in the reconciliation to consolidated earnings before income taxes and discontinued operations (in thousands):

F-18 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 16. SUBSEQUENT EVENT: In October 2001, the Company received notice from an investor group (of which the Chief Executive Officer of the Company is a member) that the investor group is evaluating the feasibility of entering into discussions regarding the possible acquisition of Raytel. The Board of Directors of the Company has appointed a Special Committee of the Board of Directors, and the Special Committee has engaged financial advisors and counsel to assist it in evaluating any proposals that might be received. The Special Committee has also received expressions of interest from other unaffiliated parties. At the present time there are no agreements between any party and the Company with regard to any acquisition transaction. F-19 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES SELECTED CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)

--------------- (1) Quarterly per share earnings do not necessarily equal the total per share earnings reported for the year as a result of the dilutive effect of common stock equivalents on the calculation of per share earnings. F-20 RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES PERCENTAGE OF CONSOLIDATED REVENUES BY SEGMENT (UNAUDITED)

F-21 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE II To the Board of Directors and Stockholders of Raytel Medical Corporation: We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated financial statements of Raytel Medical Corporation and Subsidiaries included in this Form 10-K, and have issued our report thereon dated November 29, 2001. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The accompanying schedule is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. The information reflected on the schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. /s/ ARTHUR ANDERSEN LLP Hartford, Connecticut November 29, 2001 F-22 SCHEDULE II RAYTEL MEDICAL CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999

--------------- (1) The decrease in fiscal 2001 is due primarily to the sale of HFHI. F-23 INDEX TO EXHIBITS

F-24

--------------- * Constitutes a management contract or compensatory plan required to be filed pursuant to Item 14(c) of Form 10-K. + Confidential treatment has been granted as to a portion of this Exhibit. (1) Incorporated by reference to identically numbered exhibit to the Registrant's Form 10-Q Report for the quarter ended December 31, 1995. (2) Incorporated by reference to Exhibit 4 to the Registrant's Form 8-K Report filed on October 23, 1998 (the "October 1998 Form 8-K"). (3) Incorporated by reference to the identically numbered exhibit to the Registrant's Form 10-Q Report for the quarter ended June 30, 2001. (4) Incorporated by reference to Exhibit 1 to the October 1998 Form 8-K. (5) Incorporated by reference to the identically numbered exhibit to the Registrant's Registration Statement on Form S-1, No. 33-97860, which became effective on November 30, 1995 (the "1995 Registration Statement"). (6) Incorporated by reference to identically numbered exhibits to the Registrant's Form 10-K Report for the year ended September 30, 1996. (7) Incorporated by reference to identically numbered exhibits to the Registrant's Form 10-K Report for the year ended September 30, 1997. (8) Incorporated by reference to Exhibit 2.1 to the March 1998 Form 10-Q. (9) Incorporated by reference to identically numbered exhibits to the Registrant's Form 10-K Report for the year ended September 30, 1998. (10) Incorporated by reference to identically numbered exhibits to the Registrant's Form 10-K Report for the year ended September 30, 1999. (11) Incorporated by reference to the identically numbered exhibits to the Registrant's Form 10-Q Report for the quarter ended December 31, 1999. F-25 (12) Incorporated by reference to Exhibit 10.59 to the Registrant's Form 10-Q Report for the quarter ended June 30, 2000 (the "June 2000 10-Q"). (13) Incorporated by reference to Exhibit 10.60 to the June 2000 10-Q. (14) Incorporated by reference to the identically numbered exhibit to the Registrant's Form 10-Q Report for the quarter ended December 31, 2000. (15) Incorporated by reference to the identically numbered exhibit to the Registrant's Form 10-Q Report for the quarter ended March 31, 2001. F-26

RAYTEL MEDICAL CORP 10-K