UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

[X]  Annual report  pursuant to Section 13 or 15(d) of the  Securities  Exchange
     Act of 1934 for the fiscal year ended September 27, 1997 or

[ ]  Transition  report  pursuant  to  Section  13 or  15(d)  of the  Securities
     Exchange Act of 1934

                         Commission file number 0-17885

                        BEI MEDICAL SYSTEMS COMPANY, INC.
                                formerly known as
                              BEI ELECTRONICS, INC.
             (Exact name of Registrant as specified in its charter)

           Delaware                                           71-0455756
           --------                                           ----------
(State or other jurisdiction of                            (I.R.S. Employer 
 incorporation or organization)                            Identification No.)

                                83 Hobart Street
                                ----------------
                          Hackensack, New Jersey 07601
               --------------------------------------------------
               (Address of principal executive offices) (Zip code)

                                 (201) 488-4960
               --------------------------------------------------
              (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, $.001 par value
                          -----------------------------

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 proxy or information statements incorporated
by reference  in Part III of this Form 10-K or any  amendment to this Form 10-K.
[ ]

The   approximate   aggregate   market   value  of  the  voting  stock  held  by
non-affiliates  of the Registrant as of December 8, 1997 was $24,369,434 (A). As
of  December  8,  1997,  7,556,534  shares of  Registrant's  Common  Stock  were
outstanding.

(A) Based upon the closing sale price of the Common Stock on December 8, 1997 as
reported on the NASDAQ  National  Market System.  Excludes  1,557,904  shares of
Common  Stock held by  directors,  executive  officers  and  stockholders  whose
ownership  exceeds ten percent of Common Stock  outstanding on December 8, 1997.
Exclusion of shares held by any person  should not be construed to indicate that
such person  possesses  the power,  direct or  indirect,  to direct or cause the
direction of the  management or policies of  Registrant,  or that such person is
controlled by or under common control with Registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Registrant's  Proxy  Statement  with  respect  to its  1998  Annual  Meeting  of
Stockholders  to be  filed  with  the  Securities  and  Exchange  Commission  is
incorporated by reference into Part III, Items 10, 11, 12 and 13 of this Report.

                                        1

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<TABLE>
                                                  TABLE OF CONTENTS

<CAPTION>
                                                                                                               Page
                                                                                                               ----
<S>                        <C>                                                                                   <C>
PART I
         Item 1.           Business.......................................................................        3

         Item 2.           Properties.....................................................................       21

         Item 3.           Legal Proceedings..............................................................       22

         Item 4.           Submission of Matters to a Vote of Security Holders............................       22

PART II
         Item 5.           Market for Registrant's Common Equity and
                           Related Stockholder Matters....................................................       23

         Item 6.           Selected Financial Data........................................................       24

         Item 7.           Management's Discussion and Analysis of
                           Financial Condition and Results of Operations..................................       25

         Item 8.           Financial Statements and Supplementary Data....................................       29

         Item 9.           Changes in and Disagreements With Accountants
                           on Accounting and Financial Disclosure.........................................       50

PART III
         Item 10.          Directors and Executive Officers
                           of the Registrant..............................................................       50

         Item 11.          Executive Compensation.........................................................       50

         Item 12.          Security Ownership of Certain Beneficial
                           Owners and Management..........................................................       50

         Item 13.          Certain Relationships and Related Transactions.................................       50

PART IV
         Item 14.          Exhibits, Financial Statement Schedules,
                           and Reports on Form 8-K........................................................       51

Signatures                 ...............................................................................       57
</TABLE>

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PART I

Except for the historical information contained herein, the following discussion
contains forward-looking  statements that involve risks and uncertainties.  When
used  herein,  the words,  "intend",  "anticipate",  "believe",  "estimate"  and
"expect" and similar  expressions  as they relate to the Company are intended to
identify  such  forward-looking   statements.   The  Company's  actual  results,
performance or achievements  could differ  materially from those discussed here.
Factors that could cause or contribute to such differences  include, but are not
limited  to,  those  discussed  in  Item  1,  "Business"  as  well  as  Item  7,
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations."


ITEM 1.  BUSINESS

Background

Prior to September 27, 1997, BEI Electronics,  Inc. was a diversified technology
based manufacturing company which historically conducted its business in several
operating segments.  On July 2, 1997, the Company announced a plan to form a new
company,  BEI  Technologies,  Inc.  ("Technologies"),  consisting  of all of the
non-medical  business of BEI Electronics,  Inc. and to distribute  shares in the
new company pro rata to the existing shareholders of BEI Electronics,  Inc. (the
"Distribution").   The  Distribution  took  place  on  September  27,  1997,  to
shareholders  of record on September 24, 1997. The sole  continuing  business of
BEI Electronics, Inc. was thereafter that of its subsidiary, BEI Medical Systems
Company, Inc. BEI Medical Systems Company, Inc. was subsequently merged into BEI
Electronics,  Inc. on November 4, 1997 and the name of the combined  company was
changed to BEI Medical Systems Company,  Inc. (hereafter,  "Medical Systems", or
"the  Company",  or  "BEI").  For more  information,  see  Notes 2 and 10 to the
Consolidated Financial Statements.

The Company was originally  incorporated  in Delaware in 1974, as a successor to
Baldwin  Electronics,  Inc., and became a publicly-owned  company in 1989. BEI's
principal  executive  offices are located at 83 Hobart Street,  Hackensack,  New
Jersey,  07601 and its  telephone  number at that  location  is (201)  488-4960.
Unless  the  context  indicates  otherwise,  "Medical  Systems",  "BEI"  and the
"Company"  refer to BEI  Medical  Systems  Company,  Inc.  and its  consolidated
subsidiaries.  BEI and its triangular  design are a registered  trademark of the
Company.

For more information on BEI Technologies, Inc., see its Form 10-K for the fiscal
year ended September 27, 1997 (File No. 0-22799).

Introduction

Medical  Systems  designs,  manufactures,  and/or  sells  electrosurgery  units,
various  endoscopes,   surgical   instruments  and   surgical-procedure-specific
intervention products and kits. It also assembles endoscopic illuminators, video
imaging systems and laparascopic and hysteroscopic  insufflation systems.  Prior
to the Distribution of September 27, 1997, the Company also produced non-medical
items such as sensors,  engineered subsystems and associated components used for
the  control of  precision  machinery  and  equipment  in  industrial,  medical,
automotive,  aerospace and military  applications and rocket-propelled  ordnance
subsystems  for  military  use in fiscal  1997  (see Note 3 to the  Consolidated
Financial Statements regarding the spin-off of the non-medical businesses of the
Company).

                                        3

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BEI  Electronics,  Inc.  conducted  its fiscal  1997  operations  through  three
segments,  BEI Medical Systems  Company,  Inc., BEI Sensors and Systems Company,
Inc.  ("Sensors") and Defense Systems  Company,  Inc.  ("Defense").  Sensors and
Defense are now shown in the  Company's  financial  statements  as  discontinued
operations  and were  spun-off  from the Company at year end.  See Note 3 to the
Consolidated  Financial  Statements.  The Company has  continuing  operations in
California and New Jersey. For a discussion of factors relating to the Company's
risks, see "Risk Factors" below.

Business Strategy

The Company intends to become a leading medical device  manufacturer  focused on
serving  women's  healthcare  and the specific  needs of the  gynecologist.  Its
special  emphasis is on the diagnosis,  manipulation  and treatment of disorders
and conditions of the cervix,  uterus and fallopian  tubes. A particular goal is
to offer alternatives to hysterectomies for the physician and patient.

         The key components of the Company's strategy are as follows:

         Broaden its existing  gynecological product line. The Company currently
         markets  over 500 medical  products to its  existing  base of customers
         worldwide. The Company intends to develop or acquire additional product
         lines.  The Company acquired  Zinnanti  Surgical  Instruments,  Inc. in
         February  1993,  and further  broadened  its product  lines through the
         acquisition  of the  product  lines of OvaMed  Corporation  in February
         1996.

         Develop and commercialize innovative medical technologies.  The Company
         is currently directing product development efforts at commercialization
         of its  HydroThermAblator(R)  (HTA(R)) system, now undergoing U.S. Food
         and Drug  Administration  (FDA)  Phase II clinical  trials.  The HTA is
         intended  to provide a  minimally  invasive  alternative  treatment  to
         hysterectomy for abnormal or excessive uterine bleeding.

         Acquire complementary technologies.  The Company intends to continue to
         expand  its  product  line  through  selective  business  acquisitions,
         licensing,  joint  ventures,  and internal  development.  In 1993,  the
         Company  acquired  exclusive  rights to use the  Goldrath  patents that
         cover  endometrial   ablation.   In  1996,  the  Company  acquired  the
         GyneSys(R)  Dx System for cervical and  fallopian  tube  diagnosis  and
         treatment. In 1997, the Company acquired exclusive rights to distribute
         a specialized patented bipolar  electrosurgery  system for treatment of
         abnormal cervical tissue and benign uterine fibroids.

         Expand  global  sales  and  distribution.  The  Company  also  plans to
         increase sales through the expansion of its marketing activities to the
         over  33,000  gynecologists  practicing  in the  United  States.  A key
         component of this strategy is to increase the  Company's  complementary
         direct sales  through the use of  manufacturers'  representatives,  the
         internal  sales  team  and  a  niche  specialty   direct  catalogue  to
         gynecologists  in the U.S. The sales  effort has also been  expanded to
         select international areas through a network of distributors.

         Expand key  relationships  with  leading  clinicians.  The  Company has
         developed working  relationships  with key clinicians on the evaluation
         and use of  innovative  products and  procedures  that address  women's
         healthcare disorders. To further enhance this activity, the Company has
         formed a  Scientific  Advisory  Committee  to review and  evaluate  new
         products and procedures for future  development and  commercialization.
         This committee will be chaired by Stephen L. Corson,  M.D., a Professor
         of Obstetrics and Gynecology at Thomas Jefferson Medical  University in
         Philadelphia and the Director of the Philadelphia Fertility Institute.

                                        4

<PAGE>


Existing Base Products

         The Company currently sells a line of specialty instruments,  procedure
kits,  disposables  and equipment for  physicians  and surgeons in the fields of
gynecology, female reproductive healthcare and gastroenterology.

         The Company's products for the diagnosis and treatment of conditions of
the cervix include such  equipment as  Gyne-Tech(TM)  colposcopes  for magnified
visualization;  PLUS II(TM) electrosurgical generators for removal of tissue and
coagulation of bleeding;  and Gyne-Tech  cryosurgery  systems for destruction of
lesions.  Disposable single patient use items include electrosurgical electrodes
and the LLETZ-Plus(TM)  procedure-specific  sterile kits. The Company's products
for the  diagnosis  and  treatment  of  conditions  of the uterus  include  such
equipment as laparoscopic and Corson(TM)  hysteroscopic  electronic insufflators
for the precise  control of  pressure  within body  cavities;  endoscopic  video
systems and light sources for looking inside body cavities;  and electrosurgical
systems for the removal of tissue and  coagulation  of bleeding in the treatment
of fibroids,  as well as  disposable  single  patient use items such as ZUMI(TM)
uterine manipulators and ZUI(TM) uterine injectors,  electrosurgical electrodes,
sterile tubing sets, and Z-Sampler(TM) endometrial biopsy devices.

         The  Company's  products for  procedures  requiring  the  diagnosis and
treatment  of  female  reproductive  problems  include  such  equipment  as  the
GyneSys(R) flexible hysteroscope and Corson Hysteroscopic  System(TM) for seeing
inside the uterine cavity and video systems and light sources for display of the
hysteroscopic image.  Disposable single patient use items include the GyneSys DX
Catheter  System for diagnosis and therapy for tubal  blockage.  For  procedures
requiring  diagnosis and treatment of  conditions  of the digestive  tract,  the
Company's  products include such equipment as the UGI-3000B(TM)  electrosurgical
system that combines  monopolar and bipolar output for the removal of tissue and
coagulation of bleeding;  and the EndoLav(R)  endoscopic lavage pump. Disposable
single patient use items include the bipolar BEST(TM) Probe.

         For  gynecological   oncology  procedures  and  pelvic   reconstructive
surgery,   the   Company   provides   procedure-specific   instrumentation   for
laparoscopically  assisted vaginal  hysterectomy,  including the Soderstrom LAVH
Manipulator(TM);  Z-Clamps(TM)  and  Z-Scissors(TM)  for  pelvic  reconstructive
procedures;  and MIYA Hooks(TM) and the  Nichols-Veronikis  Ligature Carrier(TM)
for sacrospinous suspension of vaginal prolapse.

         The  Company  also  produces a variety of  electrosurgical  generators,
laparoscopic  insufflators,  endoscopic light sources, and associated disposable
products  designed  for use in various  medical / surgical  procedures  and sold
under OEM labeling arrangements.

New Products and Technology

The Company has developed,  licensed and acquired new technologies that it plans
to phase into future product offerings or has recently introduced to the market.
These include:

1.       A rigid and  flexible  hysteroscopy  system for  viewing  the  internal
         surface of the uterus.
2.       The patented HydroThermAblator system for treatment of abnormal uterine
         bleeding.
3.       A specialized  proprietary bipolar electrosurgery system for removal of
         benign uterine fibroids and treatment of cervical disorders.
4.       The patented GyneSys catheter system for access to and treatment of the
         uterus and fallopian tubes.

                                        5

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These new products and their potential are more fully discussed below:

1.       Hysteroscopy Systems
         The need to provide a definitive diagnosis of uterine abnormalities led
to the development of diagnostic and operative hysteroscopy.  A gynecologist may
look inside the uterus with a  hysteroscope,  a thin  telescope-equipped  device
that is inserted  through the cervix.  The  hysteroscope  is attached to a light
source and camera allowing the gynecologist to view the endometrial  lining on a
video monitor,  identify various  pathology,  make directed biopsies and perform
minimally invasive therapeutic procedures.

         The  Company  has  developed a rigid  hysteroscopy  system  offering an
integrated system of telescope,  sheaths,  accessory instruments,  hysteroscopic
insufflator,  and combination video  camera/light  source and monitor/VCR.  This
system  offers the  physician  the  flexibility  of gas or  continuous  flow for
distention of the uterus.

         The Company acquired its flexible  HysteroSys(TM)  hysteroscopy  system
from OvaMed Corporation.  The flexible systems offer a reusable 1.3mm fiberoptic
image guide and handle with a reposable 3.7 mm steerable sheath with 110(degree)
tip deflection for panoramic  viewing and accessory  control.  The system allows
1mm endoscopic instruments to be utilized under direct visual control.

         The Company believes that its hysteroscopy  systems offer the following
advantages:
         o        choice between rigid and flexible systems.
         o        flexibility  of CO2 or continuous  flow for  distention of the
                  uterus.
         o        modular  design that reduces  initial  investment and provides
                  for future expansion of system capability.
         o        availability of a line of diagnostic and therapeutic sheaths.
         o        availability of a line of instrumentation to biopsy, grasp and
                  cut.

2.       The HydroThermAblator System
         Approximately  2.5  million  women each year in the United  States seek
medical treatment from a gynecologist for abnormal uterine bleeding.  Also, many
of the nearly 2 million  women who  receive  hormonal  therapy or  dilation  and
curettage (D&C) fail to have satisfactory resolution of their menstrual bleeding
problem.

         Hysterectomy,  the  surgical  removal of the uterus  with  accompanying
risks  of post  surgical  complications,  has  historically  been  the  ultimate
solution  offered  for long term relief to women who  continue to bleed  despite
hormonal therapy or D&C. Of the approximately 600,000  hysterectomies  performed
annually in the United States,  it has been estimated that more than 150,000 are
performed for the relief of heavy bleeding from benign causes.

         The  Company  has  developed  the  patented  HydroThermAblator  ("HTA")
technology as an alternative to hysterectomy,  to other  traditional  treatments
for  abnormal  menstrual  bleeding  and to other  proposed  ablation  treatments
currently  under  development  or  evaluation.  Other  companies  currently have
endometrial  ablation  products under  development  and in various stages of FDA
clinical trials. One such product developed by Gynecare, a subsidiary of Johnson
and Johnson, recently received FDA clearance for marketing.

                                        6

<PAGE>


         The  Company  believes  that  its HTA  offers  the  following  distinct
advantages  compared to existing  and  emerging  ablation  technologies  for the
treatment of abnormal menstrual bleeding:
         o        Should not require extensive training prior to use.
         o        Clinical  outcome  is not  dependent  on  user  experience  or
                  variation in technique.
         o        Freely  circulating  heated  saline  allows even and  complete
                  treatment of the entire endometrium.
         o        Variation in uterine size and shape is easily  accommodated by
                  freely circulating heated saline.
         o        Integral hysteroscope provides confirmation of uterine anatomy
                  and  instrument  position,  as well as continuous  observation
                  during treatment.

         The  HydroThermAblator  has been designed to offer the  gynecologist  a
minimally-invasive,  nonsurgical  method to treat abnormal menstrual bleeding in
an outpatient setting. The HTA consists of a mobile treatment unit incorporating
microprocessor   control  of  fluid  circulation,   closed-loop  volume  of  the
circulating saline, and fluid temperature regulation. The mobile unit provides a
drawer for procedure  supplies,  and a shelf to house the  Company's  Integrated
Video  System(TM)  for display of the  hysteroscopic  image on a video  monitor.
Precisely-heated  saline is circulated  within the patient's  uterus,  under the
direct visual control of the gynecologist, for sufficient time to cause ablation
of the entire  endometrial  lining. The digital displays of the HTA control unit
guide the user through the steps of the HTA  procedure,  providing  step-by-step
prompts designed for ease of use and consistent results. During the procedure an
automated  microprocessor  system controls the ablating temperature and monitors
fluid volume to measure and reduce possibilities of fluid absorption or loss. At
any time,  the  gynecologist  can interrupt the treatment  and, if desired,  the
circulation of room temperature  saline will rapidly cool the fluid  circulation
system and the patient's  uterus. As a result of the ablation of the endometrial
lining of the uterus,  in most cases the  regeneration  of the  endometrium  and
resulting  periodic  menstrual  bleeding  are  either  significantly  reduced or
eliminated.

         The  Company  completed  FDA-required  Phase I clinical  trials with 20
patients in April  1996.  The  Company  began  Phase II clinical  trials with 20
patients in late 1996.  The HTA may not be marketed in the United  States  until
the Company has completed Phase III clinical trials and filed for and received a
Pre-Marketing  Authorization  (PMA) from the FDA. There can be no assurance that
the FDA will  permit  the  Company  to  proceed  to Phase III  clinical  trials.
Moreover,  there can be no assurance that any data obtained from such trials, if
they are  permitted,  will  support  the  safety and  effectiveness  of the HTA.
Failure on the part of the  Company to proceed to Phase III  clinical  trials or
failure of the data to support  the  safety and  effectiveness  of the HTA would
have a material adverse effect on the Company's  business,  financial  condition
and results of operations.  Certain  international  markets will require similar
approvals.  International  sales of the HTA system to date have been limited. In
February 1997, the Company  selectively  initiated  delivery of units in some of
those countries where regulatory authorities permit sales. In addition,  certain
clinical  sites in  international  markets  have  received  units for use in the
accumulation of additional clinical data.

3.       Bipolar Therapy System
         The newly licensed proprietary bipolar  electrosurgical therapy systems
will be utilized by gynecologists for the treatment of the cervix as well as for
treating  benign  uterine  fibroids of the  uterus.  The  bipolar  LLETZ  system
consists of a bipolar  generator and  accessories  for removing  tissue from the
cervix and the coagulation of any bleeding vessels.  The bipolar fibroid removal
system  consists of a generator  and  accessories  for  laparoscopic  removal of
fibroids as well as removal through a cervical approach.

                                        7

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4.       The GyneSys Catheter System
         The  Company  has  developed  a catheter  system for use by a physician
attempting to diagnose whether female infertility is caused by a blockage of the
fallopian   tubes.   The   current    diagnostic    procedure   of   choice   is
hysterosalpingography  ("HSG"),  a  hospital-based  procedure  that involves the
injection of an x-ray contrast media (or dye) transcervically into the uterus to
allow  the  physician  to  observe  and  evaluate  the flow of dye  through  the
fallopian tubes under fluoroscopy (imaging x-ray). This procedure is reported to
be  highly  inaccurate,  with  false-positive  results  in as  many  as  40%  of
HSG-diagnosed cases of proximal tubal occlusion ("PTO").

         The Company believes that its GyneSys Dx System of catheters  overcomes
the limitations of  conventional  HSG and may obviate the need and inherent risk
of exploratory  laparoscopy  in the diagnosis of PTO. The Company  believes that
the use of its  GyneSys Dx catheter  system,  rather  than the  traditional  HSG
catheter,  can improve the  diagnostic  accuracy of HSG procedures by adding the
ability to direct fluid flow to the opening of each  fallopian  tube  (selective
salpingography),  or even  direct a guidewire  and  catheter  into the  proximal
fallopian  tube  (proximal  tubal  cannulation)  to dislodge a  blockage.  While
fluoroscopy is the prevalent imaging modality for HSG, the Company believes that
the proliferation of ultrasound  equipment in gynecologists'  offices,  combined
with  nationwide  pressure  from  third  party  reimbursement  agencies  to move
procedures out of the hospital  environment into outpatient and office practice,
and the ease of use of the GyneSys Dx system will  create a  significant  market
opportunity  for the  GyneSys  Dx system as the first step in the  diagnosis  of
tubal occlusion in the work-up of female infertility patients.

         The  American  Society  for  Reproductive   Medicine   recommends  that
selective  salpingography  be performed,  following  positive HSG  indication of
proximal  tubal  occlusion,  before  use  of  more  invasive  techniques.  It is
estimated that, of the approximately 1 million potential HSG procedures,  30% of
all patients will require  selective  salpingography,  and that 10% will require
proximal tubal cannulation.

         BEI's Cervical Access  Catheter(TM)  (CAC(TM)) with its  non-allergenic
balloon  technology and patented locking  mechanism  provides safety and ease of
use for inserting additional catheters and devices. The Cervical Access Catheter
is designed  for the  routine  introduction  of  contrast  media or dye into the
uterine   cavity  for   hysterosalpingography,   sonohysterosalpingography   and
chromopertubation. Well suited to visualization using fluoroscopy or ultrasound,
the larger center lumen is designed for the  introduction  of other catheters or
instruments.

         The high false  positive rates  associated  with  conventional  HSG for
fallopian  tube  obstruction  under  both  fluoroscopy  and  ultrasound,  can be
significantly reduced with selective salpingography using the BEI Uterine Ostial
Access Catheter(TM) (UOAC(TM)).  With direct examination of the tubal ostia, the
physician  can  easily  distinguish   tubocornual  spasm  from  true  mechanical
obstruction.  The pre-formed  atraumatic distal tip of the UOAC advances through
the CAC in the  direction  of the  tactile  indicator  to provide  access to the
uterine ostia.

         If obstruction of the proximal fallopian tube is observed,  the GyneSys
System  also  accommodates  the  Uterine  Cornual  Access  Catheter  (UCAC)  and
guidewire,  with which the  physician  may dislodge  mucous or cellular  debris,
thereby opening the fallopian tube without the need for laparoscopic surgery.

Significant Customers and Markets

         Medical Systems' products are sold to a variety of customers  primarily
for the gynecology  market.  Other markets served include  gastroenterology  and
general surgery. In the U.S., Medical Systems utilizes

                                        8

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a system of  independent  manufacturers'  representative  organizations,  inside
sales  personnel  and regional  managers to market its products  directly to end
users, hospitals,  surgical centers and doctors' offices. Products are also sold
through a network of domestic and international distributors. In fiscal 1997 and
1996, international sales were 14% of Medical Systems' sales, compared to 10% in
fiscal 1995.  The Company's  international  sales are dependent on the marketing
efforts  of,  and  sales  by,  distributors.   The  Company  may  also  rely  on
distributors  to  assist  it in  obtaining  reimbursement  approvals  from  both
government and private insurers in certain  international  markets.  The Company
does not currently have  distributors  in a number of significant  international
markets that it has targeted and will need to establish additional international
distribution  relationships in order to sell to those markets.  Additionally,  a
variety  of  products  are  manufactured  by Medical  Systems  for sale by third
parties  under  various OEM  agreements.  In fiscal 1997,  OEM sales were 17% of
Medical Systems' sales, compared to 15% in fiscal 1996 and 21% in fiscal 1995.

Backlog

         Backlog is not currently a significant factor for Medical Systems.  The
Company  typically  ships  instruments  within one to two weeks of receipt of an
order  and  electronic  products  within  30 days  after  receipt  of an  order.
Disposable  products  are normally  shipped  within one day of receipt of order.
Products of OEM customers that require special  development,  design,  packaging
and testing are  generally  shipped  within four to six months after an order is
received.

Competition

         The Company  operates  in a highly  competitive  industry.  Many of the
Company's existing  competitors have significantly  greater financial  resources
and manufacturing capabilities,  are more established, have larger marketing and
sales organizations and larger technical staffs.

         The Company  believes that its products  compete  primarily on basis of
price, design, performance, reliability, delivery service and support.

         The   Company's   principal    competitors   include   Imagyn   Medical
Technologies,  Inc.; Gynecare, a subsidiary of Ethicon/Johnson & Johnson,  Inc.;
Conceptus,  Inc.; Karl Storz; Richard Wolf; Olympus; Circon Corp.-Cabot;  FemRx,
Inc.; Utah Medical Products,  Inc.; Leisegang;  Wallach;  CooperSurgical,  Inc.;
Valleylab, a subsidiary of Pfizer Inc.; and Microvasive,  a subsidiary of Boston
Scientific.  Other large healthcare companies may enter the market for minimally
invasive diagnostic and surgical gynecological products in the future. Competing
companies  may  succeed  in  developing   technologies  and  products  that  are
efficacious or more cost effective than those  currently  offered or that may be
developed by the Company.

         The Company believes that its ability to compete effectively depends on
its ability to continue  to develop  proprietary  products  that  fulfill  unmet
gynecological  market needs and to anticipate changing  marketplace  demands, to
continue  to  attract  and  retain  highly  qualified  personnel,  to obtain the
required regulatory  approvals,  and to continue to manufacture and successfully
market high quality  products.  See "Risk Factors - Competition;  Uncertainty of
Technology Change".

Manufacturing

         Medical  Systems'  manufacturing  operations  consist  primarily of the
manufacture and assembly of equipment such as electrosurgery  units,  endoscopic
illuminators, endoscopes and electronic insufflators.

                                        9

<PAGE>


Some component fabrication and assembly of various non-electrical products, both
disposable and reusable,  is performed by the manufacturing group. During fiscal
1996, Medical Systems' manufacturing  facilities received ISO 9001 certification
from Lloyds Register Quality Assurance (LRQA).  LRQA conducts  semiannual audits
in Hackensack, New Jersey and annual audits in Chatsworth,  California. The most
recent audit for both  facilities was in September 1997 and the audit report did
not include any negative  observations  or identify any areas of  noncompliance.
Additionally,  the Company's  facilities  and  documentation  procedures for the
manufacture  of medical  devices are  required to conform to the Quality  System
Regulations  ("QSR")  which are  issued  and  enforced  by the FDA  through  its
facilities  inspection  program.  The  Company's  manufacturing   facilities  in
Chatsworth,  California were most recently inspected by the FDA in November 1997
for compliance with the QSR and the facility in Hackensack,  New Jersey was most
recently  inspected  by the FDA in January  1996 for  compliance  with GMP (Good
Manufacturing Practices).  The GMP regulation was replaced by the QSR regulation
effective  October,  1996.  Future  inspections  by the  FDA  of the  Hackensack
facility will be based on determining  compliance  with the QSR. Upon completion
of the inspections, the FDA did not issue a Notice of Adverse Findings at either
facility.  Withdrawal  of QSR  compliance  status would have a material  adverse
effect on the Company's business, financial condition and results of operations.

         In  order to  commercialize  the HTA  successfully,  the  Company  must
manufacture  or assemble the HTA itself or through  third  parties in accordance
with FDA requirements,  in commercial quantities,  at high quality levels and at
reasonable  costs.  The  Company  has not yet  produced  the HTA in  substantial
quantities,  but expects that its  manufacturing  experience  with other medical
electronic  systems and consumable medical products will be transferrable to the
HTA. Failure of the Company to produce the HTA in commercial  quantities at high
quality  levels  and at  commercially  reasonable  prices  would have a material
adverse  effect on the Company's  business,  financial  condition and results of
operations.

Research and Development

         The Company's  principal  development effort has focused on proprietary
devices  for  minimally  invasive   procedures  in  gynecology.   The  Company's
internally funded research and development  expenditures were $1.9 million, $1.3
million and $1.0 million for the fiscal years 1997, 1996 and 1995, respectively.
Products that have been under development include the HydroThermAblator intended
to be an alternative to existing treatment for abnormal menstrual bleeding,  the
GyneSys  DX  Diagnostic  Catheter  System for the  diagnosis  and  treatment  of
fallopian tube obstruction,  and the flexible HysteroSys Diagnostic Hysteroscope
as a cost effective solution suitable for the physician's  office.  Although the
HydroThermAblator  technology  has not yet  received  FDA approval in the United
States, it has been approved for use and sold in several foreign countries. This
international  distribution  is  based on  continued  compliance  with  ISO-9001
standards,   as  certified  by  the  Company's  notified  body,  LRQA.  Domestic
distribution  of developed  products is contingent upon compliance with the QSR,
most specifically  Section  820.30-Design  Controls.  Additionally,  the Company
continues  development  efforts  to  improve  and  enhance  its  disposable  and
instrument  product lines for both outpatient and office  applications.  Through
strategic  alliances,  the Company also  continues  to develop new  applications
related to fibroid  resection for its bipolar  electrosurgical  generators.  The
Company  also  works  with  several  OEM  customers  for the  adaptation  of its
proprietary technology to various private label requirements.

                                       10

<PAGE>


Employees

         As of September 27, 1997, the Company had 94 employees, including 13 in
research,  development  and  engineering,  29  in  marketing  and  sales,  39 in
operations and 13 in administration.

Patents and Licenses

         The Company primarily relies upon trade secrets and know-how to develop
and maintain its competitive  position.  The Company holds 19 U.S. patents and 6
foreign patents with  expiration  dates ranging from April 2001 to October 2014.
Because many of these patents relate to technology  that is important to certain
of the Company's products, the Company considers these patents to be significant
to its  business.  There can be no  assurance,  however,  that any  patent  will
provide adequate protection for the technology or product it covers.

Risk Factors

Limited Operating History; History of Losses and Possible Future Losses

         The Company has a limited medical device  operating  history upon which
an evaluation of its prospects can be made. Such prospects must be considered in
light of the risks, expenses and difficulties frequently encountered by entrants
into the medical device industry which is characterized by an increasing  number
of participants,  intense competition and a high failure rate. Historically, the
Company has  incurred  significant  losses in its medical  device  business  and
expects losses to continue for at least the next several years. In addition, the
Company expects that it will continue to expend substantial resources in funding
clinical trials in support of regulatory and reimbursement approvals,  expansion
of marketing and sales  activities and research and  development.  The Company's
future revenues will depend upon, among other factors,  the Company's ability to
cost-effectively  commercialize  the  HydroThermAblator  and  any  other  of the
Company's new products. There can be no assurance that the HTA or such other new
products will be  successfully  commercialized  or that the Company will achieve
significant  revenues  from  either  international  or  domestic  sales  of such
products.  In addition,  there can be no assurance that the Company will achieve
or  sustain  profitability  in the  future.  See  "Management's  Discussion  and
Analysis of Financial  Condition  and Results of  Operations"  and  "Business --
Products."

FDA Approval of HTA

         The Company is  conducting  clinical  trials of the HTA  pursuant to an
investigational  device exemption  ("IDE") which has been deemed approved by the
Food  and  Drug  Administration.  The  Company  has  completed  a Phase I safety
feasibility  study of the HTA and is currently  conducting a Phase II study. The
Phase II study is an efficacy  feasibility study limited to twenty patients.  If
data from the Phase II study supports the  effectiveness of the HTA, the Company
will be required to conduct a full-scale Phase III efficacy study to obtain data
necessary  to  support  the  submission  of a PMA  application.  There can be no
assurance that the FDA will permit the Company to proceed to a full-scale  Phase
III efficacy study.  Moreover,  there can be no assurance that any data obtained
from  such  studies,  if  they  are  permitted,  will  support  the  safety  and
effectiveness of the HTA. Failure on the part of the Company to proceed to Phase
III  clinical  studies  or  failure  of the  data  to  support  the  safety  and
effectiveness  of the HTA would have a material  adverse effect on the Company's
business,  financial condition and results of operations.  See "Business -- Risk
Factors - Government Regulation."

                                       11

<PAGE>


Uncertainty of Market Acceptance

         The  Company's  success is  dependent  upon  acceptance  by the medical
community of the HTA and, to a lesser extent,  other new products  introduced by
the Company as  reliable,  safe and  cost-effective  treatments  for the medical
conditions they are intended to treat. There can be no assurance that the HTA or
such other products will gain any significant  degree of market acceptance among
physicians,  patients and healthcare payers, even if the necessary international
and United States regulatory  approvals are obtained.  The Company believes that
recommendations  and  endorsements  by  physicians  will be essential for market
acceptance  of the HTA and such other  products,  and there can be no  assurance
that any such  recommendations  or  endorsements  will be obtained.  The Company
believes that physicians  will not use the HTA unless they  determine,  based on
clinical  data  and  other  factors,  that  the HTA is an  attractive  treatment
alternative  for excessive and abnormal  menstrual  bleeding and offers clinical
utility in a cost-effective  manner.  Although the Company believes that the HTA
will not require  extensive  physician  training prior to use,  acceptance among
physicians  will depend upon the Company's  ability to train  potential users of
the HTA in interventional techniques, and the willingness of such users to learn
these new  techniques.  Failure of the  Company to  achieve  significant  market
acceptance  of the HTA and other new products  introduced  by the Company  would
have a material adverse effect on the Company's  business,  financial  condition
and results of operations. See "Business -- Products".

Fluctuations in Operating Results

         The  Company   expects  that  its  operating   results  will  fluctuate
significantly  from quarter to quarter in the future and will depend on a number
of factors,  many of which are  outside the  Company's  control.  These  factors
include actions relating to regulatory and reimbursement  matters, the extent to
which the  Company's  products  gain market  acceptance,  the timing and size of
international  and  domestic  distributor  purchases  and the  timing of product
approvals.  See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

Scale-up Risk

         In  order to  commercialize  the HTA  successfully,  the  Company  must
manufacture  or  assemble  by itself or  through  third  parties,  the HTA it is
developing in accordance with FDA requirements in commercial quantities, at high
quality  levels  and  at  commercially  reasonable  costs.  The  Company  has no
experience in manufacturing and assembling the HTA in commercial quantities. The
Company has not yet produced the HTA in commercial  quantities  at  commercially
reasonable  costs,  and there can be no assurance that it will be able to do so.
Failure of the  Company  to produce  the HTA in  commercial  quantities  at high
quality  levels  and at  commercially  reasonable  prices  would have a material
adverse  effect on the Company's  business,  financial  condition and results of
operations.

Limited Direct Sales Experience

         The  Company  has only  limited  experience  in direct  field sales and
marketing of the HTA and other products both  domestically and  internationally.
The  Company  intends to  establish a direct  field  sales force of  independent
manufacturers'  representatives  to market and sell the HTA (if  approved by the
FDA)and other products. Achieving market acceptance for the HTA will require the
Company to establish marketing and direct sales capability sufficient to support
sales in  commercial  quantities.  Establishing  such  capability  will  require
significant  resources  and there can be no  assurance  that the Company will be
able to recruit and retain additional  qualified  marketing  personnel or direct
sales  personnel or that future sales efforts of the Company will be successful.
Additionally, the Company intends to establish partnership relationships with

                                       12

<PAGE>


international distributors to market the HTA. There can be no assurance that the
Company will be successful in establishing  such  partnership  relationships  on
commercially  reasonable terms, if at all. The failure to establish and maintain
an effective distribution channel for the HTA and other products or to establish
and retain  qualified and effective sales personnel to support  commercial sales
of the Company's HTA and other products, would have a material adverse effect on
the  Company's  business,  financial  condition and results of  operations.  See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations.

Reliance on Patents and Protection of Proprietary Technology

         The Company's ability to compete effectively will depend  substantially
on  its  ability  to  develop  and  maintain  the  proprietary  aspects  of  its
technology.  There can be no assurance that any of the Company's issued patents,
or any future patents that may be issued, will offer any degree of protection to
the Company's products against competitive  products.  There can be no assurance
that any  patents  that may be issued or  licensed  to the Company or any of the
Company's   patent   applications   will  not  be  challenged,   invalidated  or
circumvented  in  the  future.  In  addition,  there  can be no  assurance  that
competitors,  many of whom have substantial  resources and have made substantial
investments  in  competing  technologies,  will not seek to apply for and obtain
patents that will  prevent,  limit or interfere  with the  Company's  ability to
make, use or sell its products  either in the United States or in  international
markets.

         The  medical  device  industry  has  been  characterized  by  extensive
litigation regarding patents and other intellectual property disputes,  and some
companies in the industry have employed intellectual property litigation to gain
a competitive advantage.  There can be no assurance that the Company will not in
the future  become  subject to patent  infringement  claims  and  litigation  or
interference  or other  proceedings  in the United  States  Patent and Trademark
Office  ("USPTO").  The defense and prosecution of intellectual  property suits,
USPTO  proceedings  and related legal and  administrative  proceedings  are both
costly and time consuming. Litigation may be necessary to enforce patents issued
or licensed to the Company,  to protect the Company's  trade secrets or know-how
or to determine the enforceability, scope and validity of the proprietary rights
of others.

         Any litigation or USPTO  proceedings  involving the Company will result
in substantial expense to the Company and significant diversion of effort by the
Company's  technical  and  management  personnel.  An adverse  determination  in
litigation  or USPTO  proceedings  to which the Company may become a party could
subject the Company to  significant  liabilities to third parties or require the
Company  to  seek  licenses  from  third  parties.   Although  some  patent  and
intellectual  property  disputes  in the medical  device area have been  settled
through   licensing  or  similar   arrangements,   costs  associated  with  such
arrangements may be substantial and could include substantial ongoing royalties.
Furthermore,  there  can  be no  assurance  that  necessary  licenses  would  be
available  to  the  Company  on   satisfactory   terms,   if  at  all.   Adverse
determinations in a judicial or  administrative  proceeding or failure to obtain
necessary  licenses could prevent the Company from manufacturing and selling its
products,  which would have a material adverse effect on the Company's business,
financial condition and results of operations.

         Legislation  is pending in  Congress  that,  if enacted in its  present
form,  would limit the ability of medical device  manufacturers in the future to
obtain patents on surgical and medical  procedures that are not performed by, or
as a part of, devices or compositions which are themselves patentable. While the
Company cannot predict  whether the  legislation  will be enacted,  or precisely
what  limitations  will  result  from  the law if  enacted,  any  limitation  or
reduction in the patentability of medical and surgical methods and procedures

                                       13

<PAGE>


could have a material  adverse  effect on the  Company's  ability to protect its
proprietary methods and procedures.

         In  addition  to  patents,  the  Company  relies on trade  secrets  and
proprietary  know-how,  which it seeks to protect,  in part, through appropriate
confidentiality  and  proprietary  information   agreements.   These  agreements
generally provide that all confidential  information  developed or made known to
an individual by the Company during the course of the individual's  relationship
with the Company is to be kept  confidential  and not disclosed to third parties
or utilized by the individual, except in specific circumstances.  The agreements
also generally  provide that all  inventions  conceived by the individual in the
course of rendering  services to the Company shall be the exclusive  property of
the  Company.   There  can  be  no  assurance  that  the  Company's  proprietary
information  will not be misused or  confidentiality  agreements with employees,
consultants and others will not be breached,  that the Company will become aware
of such breach,  have  adequate  remedies for any breach,  or that the Company's
trade secrets will not otherwise become known to or  independently  developed by
competitors.  See  "Business  -- Research and  Development"  and "-- Patents and
Licenses."

Uncertainty Relating to Third-Party Reimbursement

         In the  United  States,  hospitals,  physicians  and  other  healthcare
providers that purchase  medical devices  generally rely on third-party  payers,
such as private  health  insurance  plans,  to reimburse all or part of the cost
associated  with  the  treatment  of  patients.   Although   reimbursement   for
therapeutic  and  diagnostic  procedures  to  treat  uterine  disorders  such as
excessive menstrual bleeding have generally been available in the United States,
reimbursement  for diagnostic and therapeutic  procedures for  infertility  have
generally not been available. Even though certain procedures have generally been
reimbursable  there  is no  assurance  that it  will  continue  to be the  case.
Furthermore,  there can be no  assurance,  even if the  Company's  products  are
cleared by the FDA for new clinical  applications,  that full reimbursement will
be available for such procedures.  The Company could also be adversely  affected
by changes in reimbursement policies of government or private healthcare payers,
particularly  to the  extent  that any such  changes  affect  reimbursement  for
therapeutic  or  diagnostic  catheterization  procedures  in which the Company's
products  are used.  Failure by  physicians,  hospitals  and other  users of the
Company's products to obtain sufficient reimbursement from healthcare payers for
procedures  in which the  Company's  products  are used,  or adverse  changes in
government and private  third-party  payers' policies toward  reimbursement  for
such procedures, could have a material adverse effect on the Company's business,
financial condition and results of operations.

         Market  acceptance of the Company's  products in international  markets
may  be  dependent  in  part  upon  the  availability  of  reimbursement  within
prevailing  healthcare  payment systems.  Reimbursement  and healthcare  payment
systems in international markets vary significantly by country, and include both
government  sponsored  and  private  healthcare  insurance.  While  users of the
Company's  products for  falloposcopy  in Australia have obtained  reimbursement
both to the physician and to the hospital,  there can be no assurance that other
countries in which the Company seeks to market its technology  for  falloposcopy
will approve reimbursement for the Company's falloposcopy products. Although the
Company will seek additional international  reimbursement  approvals,  obtaining
such  approvals  can  require  12 to 18  months  or  longer  and there can be no
assurance that any such  approvals  will be obtained in a timely  manner,  if at
all. Failure to receive additional  international  reimbursement approvals could
have a material adverse effect on market acceptance of the Company's products in
the  international  markets in which the Company is seeking  approvals and could
have a material adverse effect on the Company's  business,  financial  condition
and results of operations.

                                       14

<PAGE>


Risks Associated with International Sales

         The Company  markets and sells its products  internationally  through a
network of distributors.  The Company's  international  sales are dependent upon
the marketing efforts of, and sales by, these distributors. The Company may also
rely on these  distributors  to assist it in obtaining  reimbursement  approvals
from both government and private insurers in certain  international  markets. In
general,  the Company has chosen to operate  through  small  distribution  firms
because of its belief  that these  firms will devote  greater  attention  to the
Company's products. The use of small distributors increases the risks associated
with  financial  instability  of  distributors,  which  includes  the risk  that
distributors  will  cease  operations  or will be  unable to  satisfy  financial
obligations  to the Company.  If a distributor  were to fail to invest  adequate
capital promoting the Company's products or were to cease operation, the Company
would  likely  be unable  to  achieve  significant  sales in the  territory.  In
addition,  because the Company has only recently commenced  international sales,
it has only limited sell-through  experience with many of its distributors.  The
Company also does not currently  have  distributors  in a number of  significant
international markets that it has targeted and will need to establish additional
international  distribution  relationships.  There can be no assurance  that the
Company will engage  qualified  distributors in a timely manner.  The failure to
engage  such  distributors  or the  failure  of  such  distributors  to  arrange
significant sales of the Company's products would have a material adverse effect
on the Company's business, financial condition and results of operations.

         A number of other risks are inherent in  international  operations  and
transactions.  International sales and operations may be limited or disrupted by
the imposition of government controls,  export license  requirements,  political
instability,  trade restrictions,  changes in tariffs,  difficulties in managing
international  operations and fluctuations in foreign  currency  exchange rates.
There  can be no  assurance  that  the  Company  will be  able  to  successfully
commercialize  any of its  existing  or  future  products  in any  international
market.  See  "Management's  Discussion and Analysis of Financial  Condition and
Results of Operations".

Competition; Uncertainty of Technology Change

         The medical device industry is highly  competitive and characterized by
innovation  and  technological  change.  There  are many  large  companies  with
significantly greater financial,  manufacturing,  marketing,  distribution,  and
technical resources and clinical experience than the Company. Such companies are
developing  and  marketing  devices  for  surgical  treatment  or removal of the
uterus, uterine fibroids, the endometrial lining of the uterus and other uterine
tissue or  non-surgical  methods such as drug therapy.  Additionally,  there are
smaller companies developing alternative methods of uterine tissue ablation that
compete with the Company.  There can be no assurance  that these  companies will
not succeed in developing technologies and products that are more effective than
any which have been or are being  developed  by the Company or that would render
the Company's technologies or products obsolete or not competitive.  The Company
also competes with such other  companies for clinical  sites to conduct  trials.
Such competition could have a material adverse effect on the Company's business,
financial  condition and results of operations.  The Company expects competition
for devices and services to treat excessive menstrual bleeding to increase.
See "Business -- Competition."

Possible Future Capital Requirements

         The  Company's  capital   requirements   depend  on  numerous  factors,
including  the  progress  of  the  Company's   clinical   research  and  product
development programs,  the receipt of and the time required to obtain regulatory
clearances and approvals and the resources the Company devotes to developing,

                                       15

<PAGE>


manufacturing  and marketing its products.  The Company's  capital  requirements
also depend on the  resources  required to hire and develop a direct sales force
in the  United  States,  the  resources  to expand  manufacturing  capacity  and
facilities  requirements,  the extent to which the Company's  products  generate
market acceptance and demand,  and other factors.  The timing and amount of such
capital  requirements cannot accurately be predicted.  The Company believes that
its current  cash,  together  with  operating  revenues,  will provide  adequate
funding for its capital  requirements for the next twenty-four months. There can
be no assurance,  however,  that the Company will not require additional funding
or that  such  additional  funding,  if  needed,  will  be  available  on  terms
attractive to the Company,  or at all. Any  additional  equity  financing may be
dilutive  to  stockholders,  and  debt  financing,  if  available,  may  involve
restrictive  covenants.  See "Management's  Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."

Product Liability Risk; Limited Insurance Coverage

         The medical device industry has  historically  been litigious,  and the
Company  faces an  inherent  business  risk of  financial  exposure  to  product
liability  claims in the event that the use of its products  results in personal
injury. Although the Company has not experienced any claims to date, the Company
plans to market new  technology  and there can be no assurance  that the Company
will not experience  losses due to product  liability claims in the future.  The
Company  currently   maintains  liability  insurance  with  coverage  limits  of
$1,000,000  per  occurrence  and  $2,000,000 in the  aggregate.  There can be no
assurance that the coverage limits of the Company's  insurance  policies will be
adequate.  Such  insurance  is  expensive,  difficult  to obtain  and may not be
available in the future on acceptable  terms,  or at all. Any claims against the
Company,  regardless of their merit or eventual  outcome,  could have a material
adverse effect upon the Company's  business,  financial condition and results of
operations.

Government Regulation

         The medical devices to be marketed and  manufactured by the Company are
subject to extensive  regulation by the FDA and, in some  instances,  by foreign
and state governments.  Pursuant to the Federal Food, Drug, and Cosmetic Act, as
amended,  and the regulations  promulgated  thereunder (the "FDC Act"),  the FDA
regulates the clinical testing, manufacture,  labeling, sale, distribution,  and
promotion of medical  devices.  Before a new device can be  introduced  into the
market,  the manufacturer must obtain market clearance through either the 510(k)
premarket  notification  process  or  the  lengthier  PMA  application  process.
Noncompliance with applicable requirements,  including QSR, can result in, among
other  things,  fines,  injunctions,  civil  penalties,  recall  or  seizure  of
products,  total or partial suspension of product,  failure of the government to
grant  premarket  clearance or premarket  approval  for devices,  withdrawal  of
marketing  approvals,  and criminal  prosecution.  The FDA has the  authority to
request repair,  replacement or refund of the cost of any device manufactured or
distributed by the Company.

         The  Company  manufactures  and  markets a number of general  surgical,
obstetric  and  gynecological  devices  for which  510(k)  clearances  have been
obtained.  Included  among the products that the Company  currently  markets are
electrosurgical  systems,  endosurgical systems,  irrigation and lavage systems,
integrated  video  systems,  laparoscopic  insufflation  systems,  intra-uterine
manipulators and injectors,  endometrial  sampling systems,  hysterectomy clamps
and scissors and various biopsy instruments.  Any modifications to the Company's
currently  marketed  devices  that could  significantly  affect  their safety or
efficacy  or that  constitute  a major  change to the  intended  use require new
510(k)  submissions.  There can be no assurance  that the Company has  submitted
510(k) notices for all such modifications and that the FDA would not

                                       16

<PAGE>


require the Company to cease  distribution of the modified  products pending the
submission and review of a 510(k) notice for such products.

         In addition,  the Company manufactures and markets products,  including
ZSI gynecological  products,  Meditron medical devices and OvaMed products,  the
rights to which it obtained  through the  acquisition  of other  medical  device
companies.  There  can be no  assurance  that  the  acquired  companies  were in
compliance  with  applicable FDA  regulations at the time they were acquired and
that any  noncompliance  on the part of the  acquired  companies  would not have
regulatory consequences for the Company. As a result,  noncompliance on the part
of the acquired  companies could have a material adverse effect on the Company's
business, financial condition and results of operations.

         Developments  such as the enactment of the Safe Medical  Devices Act of
1990 and increased  enforcement  actions  reflect a trend toward more  stringent
product  regulation  by the FDA.  One result is an increase in the typical  time
elapsed between the filing of an application and the receipt of FDA clearance or
approval of commercial  release of a medical device. In addition,  the FDA often
requires  clinical data with such  applications,  which can increase the cost of
obtaining such clearance to market. Furthermore,  rigorous regulatory action may
be taken in  response to  deficiencies  noted in  inspections  or to any product
performance problems.

         Medical  device laws are also in effect in many  countries  outside the
U.S. in which  Medical  Systems does  business.  These range from  comprehensive
device approval requirements to requests for product data or certifications. The
number  and  scope of these  requirements  are  increasing.  This  trend  toward
increasing  product  regulation is evident in the European Union,  where efforts
are under way to harmonize  the  regulatory  systems.  Such  regulatory  systems
include ISO 9000, IEC 601 and CE marks.

         Political, economic and regulatory influences are subjecting the health
care  industry  in  the  United  States  to  fundamental   change.  The  Company
anticipates  that  Congress and state  legislatures  will continue to review and
assess alternative health care delivery and payment systems.  Legislative debate
is  expected to continue in the  future,  and the Company  cannot  predict  what
impact the adoption of any federal or state health care reform measure or future
private sector reform may have on its business.

Dependence on Key Employees

         The Company is dependent  upon a number of key management and technical
personnel.  The loss of the services of one or more key  employees  would have a
material  adverse  effect on the Company.  The  Company's  ability to manage its
transition to commercial-scale operations, and hence its success, will depend on
the efforts of these individuals.  The Company's success will also depend on its
ability to  attract  and  retain  additional  highly  qualified  management  and
technical  personnel.  The  Company  faces  intense  competition  for  qualified
personnel,  and  there  can be no  assurance  that the  Company  will be able to
attract  and retain such  personnel.  The Company  does not  currently  have key
person insurance on the life of any employee.

Anti-Takeover   Effects  of  Delaware  Law  and  Certain   Charter   Provisions;
Stockholder Rights Plan

         The  Company's  Board of  Directors  has the  authority  to issue up to
2,000,000  shares  of  Preferred  Stock  and to  determine  the  price,  rights,
preferences and privileges of those shares without any further vote or action by
the  Company's  stockholders.  The  rights of  holders  of Common  Stock will be
subject to, and may be  adversely  affected by, the rights of the holders of any
Preferred Stock that may be issued in the

                                       17

<PAGE>


future.  While the Company has no present intention to issue shares of Preferred
Stock, such issuance,  while providing desirable  flexibility in connection with
possible  acquisitions  and other corporate  purposes,  could have the effect of
making  it more  difficult  for a third  party  to  acquire  a  majority  of the
outstanding voting stock of the Company. In addition,  the Company is subject to
the anti-takeover  provisions of Section 203 of the Delaware General Corporation
Law  (the  "Delaware  Law"),  and the  Company's  Certificate  of  Incorporation
contains a fair price  provision,  the combined  effect of which  prohibits  the
Company  from  engaging  in  a  "business   combination"   with  an  "interested
stockholder"  for a period of three years after the date of the  transaction  in
which  the  person  became  an  interested  stockholder,   unless  the  business
combination is approved in a prescribed  manner.  The application of Section 203
and the fair price  provision  could have the effect of delaying or preventing a
change of control of the Company.  The Company's  Certificate  of  Incorporation
provides  for  staggered  terms for the members of the Board of  Directors.  The
staggered  Board of Directors  and certain  other  provisions  of the  Company's
Certificate  of  Incorporation  and Bylaws may have the  effect of  delaying  or
preventing  changes  in  control  or  management  of the  Company,  which  could
adversely  affect the market price of the Company's  Common Stock.  Furthermore,
the Board of Directors of the Company has adopted a Stockholder Rights Plan that
has  certain  anti-takeover  effects.  Rights  issued  under the plan will cause
substantial  dilution to a person or group that  attempts to acquire the Company
on terms not approved by the Company's Board of Directors.

                                       18

<PAGE>


EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY

The  executive  officers  and  directors  of the  Company  and their  ages as of
December 1, 1997 are as follows:


Name                         Age    Position
--------------------------------------------------------------------------------
Charles Crocker   (2)        58    Chairman of the Board of Directors
Richard W. Turner            51    President and Chief Executive Officer
Thomas W. Fry                53    Vice President, Finance and Administration,
                                   Secretary and Treasurer
Gary D. Wrench  (1)          64    Director
Dr. Ralph M. Richart  (1)    63    Director
Dr. Lawrence A. Wan  (2)     59    Director
--------------------------------------------------------------------------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee


Mr.  Crocker,  a founder of the Company,  has served as Chairman of the Board of
Directors of the Company since October 1974. Mr.  Crocker  assumed the positions
of President and Chief Executive Officer, effective October 1, 1995. Mr. Crocker
served as President of Crocker Capital  Corporation (a Small Business Investment
Company),  from 1970 to 1985, and as General  Partner of Crocker  Associates,  a
venture capital investment  partnership,  from 1970 to 1990. He currently serves
as a director of BEI Technologies,  Inc., Fiduciary Trust Company International,
Pope & Talbot,  Inc. and  KeraVision.  Mr.  Crocker  holds a B.S.  from Stanford
University and an M.B.A. from the University of California, Berkeley.

Mr.  Turner  began  Medical in 1991 as a  subsidiary  of what is now BEI Medical
Systems  Company,  Inc.  Previously  President of the  Healthcare  Group for the
Cooper  Companies,  Mr. Turner has held  executive  leadership  positions in the
medical industry for over 20 years,  including President and Director of Cooper-
LaserSonics, Inc., President of CooperVision Inc., President and Chief Executive
Officer/Director  for  Pancretec,  Inc. and President of Kay  Laboratories.  Mr.
Turner holds a B.S. from Old Dominion  University and an M.B.A.  from Pepperdine
University.

Mr. Fry served as Vice  President,  Finance and  Administration  of Medical from
October  1992 until the merger of Medical  into the  Company in  November  1997.
Prior to that  time,  Mr. Fry was  employed  by GTE from 1970 to 1979 in various
accounting and financial  roles  including  three years as the Controller of GTE
Sylvania  in Caracas,  Venezuela.  Mr. Fry was  employed by  Cheeseborough-Ponds
International  as Manager of Profit Planning and  Manufacturing  Controller from
1979 to  1986,  by  Cavitron,  Inc./CUSA,  a  medical  device,  engineering  and
manufacturing  company,  as Controller/CFO from 1986 to 1989, and by Disctronics
Ltd.  as  Corporate  Controller  from 1989 to 1992.  Mr.  Fry holds a B.S.  from
Southeast Missouri State University and an M.B.A. with academic honors from Pace
University.

Mr. Wrench served as Senior Vice  President and Chief  Financial  Officer of the
Company from July 1993 to September 1997, and as a Director of the Company since
February 1986.  From April 1985 to July 1993, he served as Vice President of the
Company and President and Chief  Executive  Officer of Motion  Systems  Company,
Inc.,  then a wholly owned  subsidiary  of the Company that is now a part of BEI
Technologies,  Inc.  Previous  experience  includes  twenty  years  with  Hughes
Aircraft  Company  including an assignment as President of  Spectrolab,  Inc., a
Hughes subsidiary.  He currently serves as a director of BEI Technologies,  Inc.
Mr. Wrench holds a B.A. from Pomona College and an M.B.A. from the University of
California, Los Angeles.

                                       19

<PAGE>


Dr.  Richart is Professor of Pathology  and  Obstetrics  and  Gynecology  at the
Columbia   University  College  of  Physicians  and  Surgeons  and  Director  of
Gynecological  Pathology  and  Cytology at the Sloane  Hospital for Women in New
York City.  He served as a Career  Research  Development  Awardee at the Medical
College of Virginia  before moving to  Columbia-Presbyterian  Medical  Center in
1963.  His   professional   interests  have  centered  around   obstetrical  and
gynecological  pathology and cytology with  particular  emphasis on the study of
cervical   neoplasia  and,  more  recently,   the   relationship  of  the  human
papillomavirus to lower genital tract neoplasia. He is the past President of the
International  Gynecologic  Cancer Society.  He received his medical training at
the University of Rochester School of Medicine and Dentistry,  and completed his
pathology residency in the Harvard Hospitals system.

Dr. Wan served as Vice President and Chief Technical Officer of BEI Electronics,
Inc. from July 1990 to September 1997, and is currently Vice President and Chief
Technical Officer of BEI Technologies, Inc., and President of SiTek, Inc., a BEI
Technologies'  subsidiary.  From 1984 until 1990,  he served as Vice  President,
Engineering,  of  Systron  Donner  Corporation,  and  also  held  various  other
technical and general  management  positions with that company  between 1979 and
1984.  From 1968 through  1979,  he was founder and Chief  Executive  Officer of
Sycom,  Inc., a commercial  electronics  company.  Prior to that,  he worked for
Hughes Aircraft  Company where he headed the Radar Systems Section of the Hughes
Ground Systems Group. In 1962, Dr. Wan and two other  professors  established an
Engineering School at the University of California, Santa Barbara, where he also
taught  Engineering.  Dr. Wan holds B.S., M.S. and Ph.D.  degrees in Engineering
and Applied Sciences from Yale University.

The Company has a classified  Board of  Directors,  which may have the effect of
deterring  hostile takeovers or delaying changes in control or management of the
Company. For purposes of determining their term of office, directors are divided
into three classes,  with the term of office of the first class to expire at the
1998 annual meeting of stockholders,  and the term of office of the second class
to expire at the 1999 annual meeting of  stockholders  and the term of office of
the third class to expire at the 2000 annual meeting of stockholders.

Class I  consists  of Mr.  Turner;  Class II  consists  of Mr.  Crocker  and Dr.
Richart;  and Class III consists of Mr. Wrench and Dr. Wan. Directors elected to
succeed those directors whose term expires will be elected for a three year term
of  office.  All  directors  hold  office  until  the  next  annual  meeting  of
stockholders,  at which their term expires, and until their successors have been
duly elected and  qualified.  Executive  officers serve at the discretion of the
Board.  There  are  no  family  relationships  among  any of  the  officers  and
directors.

                                       20

<PAGE>


ITEM 2.           PROPERTIES

The Company's  principal executive offices are located in leased office space in
Hackensack,  New  Jersey,  under a lease  which  expires  in 1998.  The  Company
operates  two other  facilities  that relate to Medical  Systems  and  maintains
office space in various  locations  throughout  the United  States for sales and
technical support. The Company's principal facilities are as follows:



Location                        Description of Facility
--------------------------------------------------------------------------------
Hackensack, New Jersey          Leased   10,100   square   foot   manufacturing,
                                engineering, and administrative facility.

Chatsworth, California          Leased  6,400  square  foot   manufacturing  and
                                administrative facilities.

Chatsworth, California          Leased  4,300  square  foot  administrative  and
                                marketing facility.

                                       21

<PAGE>


ITEM 3.           LEGAL PROCEEDINGS

CooperSurgical, Inc. vs. BEI Medical Systems Company, Inc. et al.

In October 1993,  CooperSurgical,  Inc., a subsidiary  of The Cooper  Companies,
filed a claim for unspecified damages alleging unfair competition due to actions
by Medical Systems and its president  Richard  Turner,  a former employee of The
Cooper  Companies,  and others.  On January 31, 1996,  the Court issued a ruling
which affirmed the legal basis for Medical Systems to assert a counterclaim  for
damages against CooperSurgical regarding the parties' electrosurgical  generator
contract.

CooperSurgical's  original damage claims were for approximately $11 million.  In
June  1996,  more  than one year  after  expert  discovery  closed  in May 1995,
CooperSurgical's  counsel sent to the Company's  counsel a letter  purporting to
supplement CooperSurgical's previous responses to interrogatories. The June 1996
letter indicated that CooperSurgical's  damages for one particular aspect of the
claim  were  between  $24 and $50  million  with  respect  to a claim  for which
CooperSurgical's  experts had previously  estimated damages of $3.4 million. The
Company  will  vigorously  oppose  any  CooperSurgical   attempt  whatsoever  to
introduce  at trial any  evidence  of a damage  claim  based  upon its June 1996
purported supplement.

Management has vigorously  defended its rights in this action and believes after
discussion with legal counsel that the CooperSurgical claims are exaggerated. In
1995,  expert witnesses for the Company prepared a formal response to the damage
computations  CooperSurgical  previously submitted. The Company's experts stated
that if CooperSurgical were entitled to damages,  those damages would total less
than $100,000,  and would be more than offset by Medical Systems'  counterclaims
against CooperSurgical, if Medical Systems were successful in its counterclaims.

The trial  started in October  1997,  and is  currently  ongoing in the Superior
Court of New Jersey for Bergen County,  Chancery Division.  While the outcome of
this matter cannot be determined at this time, management believes, taking known
factors into account and after consultation with legal counsel, that this matter
will not result in a material  adverse  impact on the financial  position of the
Company.  However,  any  settlement  of this case on a basis that  results in an
unfavorable  outcome for the Company could have a material adverse effect on the
results of operations of any quarterly or annual reporting period.

Other
The Company has pending  various legal  actions  arising in the normal course of
business.  Management  believes  that none of these  legal  actions  will have a
material effect on the Company's operating results or financial condition.


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

                  None.

                                       22

<PAGE>


PART II

ITEM 5.           MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
                  STOCKHOLDER MATTERS

BEI's common stock was  initially  offered to the public in July 1989 and traded
on the NASDAQ  national market system under the NASDAQ symbol "BEII" from August
1, 1989  through the fiscal year end of September  27,  1997.  During the period
from  October 3 to October 7, 1997,  the stock  traded  under the NASDAQ  symbol
"BEIIV".  After October 7, 1997, the Company's  common stock began trading under
the NASDAQ  symbol  "BMED." Set forth  below are the high and low  closing  sale
prices on the National Market System for the periods indicated.  Such quotations
do not reflect retail markups, markdowns or commissions.

1997 Fiscal Year                                      Cash  Dividend
(ended 9/27/97)            High             Low             Declared
--------------------------------------------------------------------------------
Fourth Quarter          $   14.50       $   10.38       $   0.02
Third Quarter           $   11.00       $    8.00       $   0.02
Second Quarter          $   12.38       $   10.38       $   0.02
First Quarter           $   11.25       $    9.25       $   0.02
--------------------------------------------------------------------------------

1996 Fiscal Year
(ended 9/28/96)
--------------------------------------------------------------------------------
Fourth Quarter          $   11.00       $   8.50        $   0.02
Third Quarter           $   13.50       $   8.55        $   0.02
Second Quarter          $    9.00       $   6.75        $   0.02
First Quarter           $    7.63       $   6.25        $   0.02
--------------------------------------------------------------------------------


On  September  27,  1997,  having  transferred  all  of its  non-medical  device
businesses  to  Technologies  in exchange for all of  Technologies'  outstanding
common  stock,  Electronics  distributed  that  stock to its  stockholders  in a
tax-free spin-off of Technologies.  As a result of the spin-off of Technologies,
whose business represented the majority of Electronic's assets and revenues, the
market price of the Company's stock adjusted to account for the Distribution. On
November 4, 1997, BEI Electronics,  Inc. merged with its subsidiary, BEI Medical
Systems Company, Inc., and changed its name to BEI Medical Systems Company, Inc.
The closing price of BEI Medical Systems common stock was $4.0625 on December 8,
1997.  For further  information  see "Business -  Background"  and Note 1 to the
Consolidated Financial Statements.

As of December 8, 1997, there were approximately  1,300 holders of record of the
Company's  common stock. The Board of Directors has declared and the Company has
paid  quarterly cash dividends of $.02 per share of common stock in each quarter
of fiscal 1996 and 1997.  There are no restrictions on the Company's  ability to
pay dividends;  however, it is currently the intention of the Board of Directors
to retain any and all earnings for use in the Company's business and the Company
does not anticipate paying cash dividends in the foreseeable  future. Any future
determination  as to the payment of dividends will depend,  among other factors,
upon  the  earnings,  capital  requirements,  operating  results  and  financial
condition of the Company.

                                       23

<PAGE>


ITEM 6.           SELECTED FINANCIAL DATA

The selected financial data for the five fiscal years presented below is derived
from the audited  Consolidated  Financial  Statements  of the Company.  The data
should  be read in  conjunction  with  the  Consolidated  Financial  Statements,
related notes and other financial information included herein.

The data and the accompanying analysis in "Management's  Discussion and Analysis
of Financial  Condition  and Results of  Operations"  cover periods in which the
Company's  operations  include  business  segments  which  are now  operated  by
Technologies   and  include  the  results  of  those   business   statements  as
discontinued operations by the Company. Continuing operations of the Company are
comprised  of  the  medical  device   business   carried  on  by  the  Company's
majority-owned  subsidiary  BEI  Medical  Systems  Company,  Inc.  prior  to the
Distribution,  which  subsequent  to  the  Distribution  comprised  all  of  the
Company's  operations.  For further  information see Note 1 to the  Consolidated
Financial  Statements,  Technologies'  Form 10 General Form for  Registration of
Securities, as amended (File No. 0-22799) and the Technologies Form 10-K for the
fiscal year ended September 27, 1997 (File No. 0-22799).


<TABLE>
(in thousands, except per share amounts)
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                                  Year Ended
                                                 -----------------------------------------------------------------------------------
                                                 September 27      September 28     September 30        October 1        October 2
                                                         1997              1996             1995             1994             1993
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>              <C>              <C>              <C>              <C>      
Statement of Operations Data:
Net sales                                             $  10,005        $   9,357        $   8,847        $   8,678        $   7,204
Loss from continuing operations                          (4,348)          (2,682)          (2,350)          (2,458)          (1,150)
Income (loss) from discontinued
   operations                                             4,583            4,571           (2,041)             714            4,928
Net income (loss)                                           235            1,889           (4,391)          (1,744)           3,778
Loss from continuing operations per
   common and common equivalent
   share                                              $   (0.60)       $   (0.38)       $   (0.35)       $   (0.37)       $   (0.17)
Earnings (loss) from discontinued
   operations per common and
   common equivalent share                                 0.64             0.64            (0.30)            0.11             0.73
Earnings (loss) per common and
   common equivalent share                                 0.03             0.27            (0.65)           (0.26)            0.56
Cash dividends per common share                       $    0.08        $    0.08        $    0.08        $    0.08        $    0.08
Weighted average shares
   outstanding                                            7,203            7,108            6,759            6,657            6,783

Balance Sheet Data:
Working capital                                       $  11,085        $  38,102        $  35,923        $  40,189        $  35,667
Total assets                                             22,584          115,011          113,738          112,432          108,528
Long-term debt (excluding current
   portion)                                                  22              212              392              560            1,231
Stockholders' equity                                     17,660           55,972           53,319           57,829           59,606
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

                                                                 24

<PAGE>


ITEM 7.           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                  AND RESULTS OF OPERATIONS

Except for the historical information contained herein, the following discussion
contains  forward-looking  statements that involve risks and uncertainties.  The
Company's  actual results could differ  materially  from those  discussed  here.
Factors that could cause or contribute to such differences  include, but are not
limited to, those discussed in this section and in "Business".

<TABLE>
The following table sets forth, for the fiscal periods indicated, the percentage
of  net  sales  represented  by  certain  items  in the  Company's  Consolidated
Statements of Operations.

<CAPTION>
                                                                                                    Year Ended
------------------------------------------------------------------------------------------------------------------------------------
                                                                                     1997                1996                 1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                  <C>                 <C>                 <C>   
Net sales                                                                            100.0%              100.0%              100.0%
Cost of sales                                                                         59.7                61.9                59.7
------------------------------------------------------------------------------------------------------------------------------------
Gross profit                                                                          40.3                38.1                40.3
Operating expenses:
Selling, general and administrative expenses                                          78.8                69.6                68.9
Research, development and related expenses                                            18.6                14.2                11.3
------------------------------------------------------------------------------------------------------------------------------------

Loss from operations                                                                 (57.1)              (45.7)              (39.9)
Other income                                                                           1.3                 3.5                 2.0
Interest expense                                                                       0.7                 1.2                 1.7
------------------------------------------------------------------------------------------------------------------------------------
Loss before income taxes                                                             (56.5)              (43.4)              (39.6)
Income taxes (benefit)                                                               (13.0)              (14.8)              (13.1)
------------------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations                                                      (43.5)              (28.6)              (26.5)
Income (loss) from discontinued operations                                            45.8                48.8               (23.1)
------------------------------------------------------------------------------------------------------------------------------------
Net income (loss)                                                                      2.3%               20.2%              (49.6)%
====================================================================================================================================
</TABLE>


Net Sales
Fiscal years 1997, 1996, 1995

In fiscal 1997,  the Company's net sales from  continuing  operations  increased
6.9% to $10.0  million  from $9.4  million  in fiscal  1996.  The  increase  was
primarily due to increased  sales of existing  gynecology  instruments  and to a
lesser  extent  increased  sales of OEM products and initial sales of the HTA in
international markets.

The  Company's  sales  increased  5.8% to $9.4  million in fiscal 1996 from $8.8
million in fiscal  1995.  The increase  was  primarily  due to sales of existing
gynecology instruments.

The Company's sales to international  customers were approximately  14.3%, 13.8%
and  10.1%  of  the  Company's  net  sales  for  fiscal  1997,  1996  and  1995,
respectively.  International  sales can vary  significantly  as a percentage  of
sales depending on the timing of shipments and size of orders.

Cost of Sales and Gross Profit

Cost of sales as a percentage of net sales was 59.7%,  61.9% and 59.7% in fiscal
1997, 1996 and 1995, respectively.

                                       25

<PAGE>


The decrease in cost of sales as a  percentage  of net sales in fiscal 1997 from
fiscal 1996 resulted primarily from improved overhead absorption  resulting from
higher sales volume.

The  increase in the cost of sales as a  percentage  of net sales in fiscal 1996
from fiscal 1995 was primarily due to increased costs for regulatory compliance.

Selling, General and Administrative Expenses

Selling,  general and administrative  expenses as a percentage of net sales were
78.8%, 69.6% and 68.9% in fiscal 1997, 1996 and 1995, respectively.

Fiscal 1997 selling,  general and administrative expenses increased $1.4 million
from $6.5 million in fiscal 1996 to $7.9 million resulting from expansion of the
domestic sales force, and higher marketing and promotional expenses. Fiscal 1997
expenses  also  included  higher   administrative   and  legal  costs  primarily
associated with the  Distribution of the common stock of BEI Technologies to the
shareholders of Electronics.

Fiscal 1996 selling,  general and administrative expenses increased $0.4 million
from $6.1  million in fiscal  1995 to $6.5  million  due to higher  amortization
expenses and increased support for new products.

Research, Development and Related Expenses

The Company's internally funded research,  development and related expenses as a
percentage  of net sales were 18.6%,  14.2% and 11.3% for fiscal 1997,  1996 and
1995, respectively.

Research  and  development  expenses in fiscal 1997  increased  from fiscal 1996
primarily because of increased spending for the development of the HTA and other
new products and clinical trials of the HTA.

Research  and  development  expenses in fiscal 1996  increased  from fiscal 1995
primarily as a result of new product development and clinical trials.

The Company believes that the continued  timely  development of new products and
enhancements   to  its  existing   products  is  essential  to  maintaining  its
competitive  position.  Accordingly,  the Company anticipates that such expenses
will increase in absolute amount, but may fluctuate as a percentage of sales.

Interest Expense and Other Income

Interest  expense as a  percentage  of net sales in fiscal  1995,  1996 and 1997
decreased  slightly  from 1.7% to 1.2% and from 1.2% to 0.7%,  respectively,  as
existing debt was paid down and no new debt incurred.

Other income in fiscal 1997,  1996,  and 1995 was  comprised of interest  income
earned on highly liquid investments. Other income in fiscal 1997 as a percentage
of sales decreased from 3.5% in fiscal 1996 to 1.3% in fiscal 1997.  Total other
income in fiscal  1996  increased  slightly  from  prior  year due to  increased
interest on a higher level of cash balances held during the year.

Income Tax Provision

The  Company's  effective tax rate from  operations  was (23.0%),  (34.0%),  and
(33.1%),  for fiscal 1997, 1996 and 1995,  respectively.  The effective tax rate
reflects the statutory federal tax rate and the weighted average tax rate of the
states in which the Company conducts  business.  The fiscal 1997 tax rate varies
from the

                                       26

<PAGE>


statutory  federal  income tax rate as a result of an increase in the  valuation
allowance due to substantial  uncertainties  regarding  realizability of certain
deferred tax assets.

Deferred Income Taxes

At September 27, 1997,  the Company had net deferred tax  liabilities of $58,000
composed of deferred tax assets of $1,951,000 net of the valuation  allowance of
$1,784,000, and deferred tax liabilities of $225,000.

The  valuation  allowance was  established  to reflect  uncertainties  regarding
realizability  of deferred tax assets related to certain  intangibles  and state
net operating loss carryovers.  Management intends to evaluate the realizability
of  deferred  tax  assets on a  quarterly  basis by  assessing  the need for any
additional valuation allowance.

Discontinued Operations

Income  (loss) for  business  segments  now  operated by  Technologies  was $4.6
million,  $4.6  million  and  ($2.0)  million  in  fiscal  1997,  1996 and 1995,
respectively.  The net loss in  fiscal  1995 as  compared  to the net  income of
fiscal  1996 and 1997 is  primarily  related to a royalty  expense  incurred  in
fiscal 1995 of $3.5 million  before taxes and, to a lesser  extent,  lower gross
profit from sales in fiscal 1995.

Liquidity and Capital Resources

The Company's capital  requirements  depend on numerous  factors,  including the
progress of the Company's  clinical research and product  development  programs,
the timing and receipt of regulatory clearances and approvals, and the resources
the Company devotes to developing, manufacturing and marketing its products. The
Company's capital requirements also depend on the resources required to hire and
develop a direct  sales force in the United  States and to expand the  Company's
manufacturing  capacity,  and the extent to which the  Company's  products  gain
market acceptance and sales. The timing and amount of such capital  requirements
cannot be predicted accurately.  Consequently, although the Company believes its
existing cash balances  together with operating  revenues will provide  adequate
funding to meet its capital  requirements for the next twenty-four  months,  the
Company may need to raise additional  funds through public or private  financing
or other  arrangements.  There can be no  assurance  that the  Company  will not
require additional funding or that such additional  funding,  if needed, will be
available on terms attractive to the Company,  or at all. Any additional  equity
financing may be dilutive to stockholders, and debt financing, if available, may
involve restrictive covenants.

During fiscal 1997,  operating  activities of  continuing  operations  used $4.1
million in cash,  excluding  cash  provided by  discontinued  operations of $5.7
million.  The loss from operations of $4.3 million,  plus inventory purchases of
$0.9 million and increases in accounts  receivables,  other  current  assets and
deferred  taxes of $0.3 million,  $0.1 million and $0.3  million,  respectively,
were partially  offset by non-cash  charges for depreciation and amortization of
$0.3  million  and $1.4  million  respectively,  and a net  increase  in accrued
expenses, accounts payable and other liabilities of $0.2 million.

Investing  activities,  which used approximately $0.4 million in cash, consisted
primarily of purchases of $0.3 million in capital  equipment and $0.2 million in
patents and licenses.

                                       27

<PAGE>


Cash used in financing  activities  of $1.7 million  included  proceeds from the
issuance  of common  stock of $0.9  million  offset  by  principal  payments  on
long-term debt of $0.7 million,  stock  repurchases of $1.3 million and dividend
payments of $0.6 million.

The Company had no material  capital or other  commitments at September 27, 1997
except  as  discussed  in  Note  13 to the  Consolidated  Financial  Statements,
"Contingencies and Litigation."

Effects of Inflation

Management  believes  that, for the periods  presented,  inflation has not had a
material effect on the Company's operations.

                                       28

<PAGE>


ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED BALANCE SHEETS
BEI Medical Systems Company, Inc. and Subsidiaries

--------------------------------------------------------------------------------
                                                    September 27,  September 28,
dollars in thousands except share amounts                    1997          1996
--------------------------------------------------------------------------------
ASSETS
Current assets
Cash and cash equivalents                                  $  9,271     $  9,128
Trade receivables, less allowance for doubtful accounts
(1997--$112; 1996--$236)                                      1,958        1,713

Inventories--Note 4                                           2,939        2,085
Refundable income taxes                                          10         --
Other current assets                                            286          144
Deferred income taxes--Note 8                                     0          406
Current assets of discontinued operations--Note 3              --         55,549
--------------------------------------------------------------------------------
Total current assets                                         14,464       69,025


Plant and equipment
Equipment                                                     1,461        1,209
Leasehold improvements                                          130          126
--------------------------------------------------------------------------------
                                                              1,591        1,335

Less allowances for depreciation and amortization               780          518
--------------------------------------------------------------------------------
                                                                811          817

Other assets
Tradenames, patents and related assets, less amortization
(1997--$4,142; 1996--$3,776)                                  3,708        4,638
Goodwill, less amortization (1997--$ 1,251; 1996--$975)       3,595        3,835
Non-current assets of discontinued operations--Note 3          --         36,672
Other                                                             6           24
--------------------------------------------------------------------------------
                                                              7,309       45,169
--------------------------------------------------------------------------------
                                                           $ 22,584     $115,011
================================================================================
See notes to consolidated financial statements.

                                       29

<PAGE>


<TABLE>
CONSOLIDATED BALANCE SHEETS
BEI Medical Systems Company, Inc. and Subsidiaries


<CAPTION>
                                                                                                  September 27,        September 28,
dollars in thousands except share amounts                                                                 1997                  1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                                   <C>                 <C>      
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Trade accounts payable                                                                                $     346           $     683
Accrued expenses and other liabilities--Note 6                                                            2,785               2,332
Current portion of long-term debt--Note 7                                                                   190                 184
Deferred income taxes                                                                                        58                --
Current liabilities of discontinued operations -- Note 3                                                   --                27,724

------------------------------------------------------------------------------------------------------------------------------------
Total current liabilities                                                                                 3,379              30,923


Long-term debt, less current portion--Note 7                                                                 22                 212

Deferred income taxes--Note 8                                                                              --                   725

Other liabilities                                                                                          --                   561

Non-current liabilities of discontinued operations                                                         --                25,100

Commitments and contingencies--Notes 12 and 13

Minority interest in consolidated subsidiary--Note 2                                                      1,523               1,518

Stockholders' equity--Notes 2, 9, and 10
Preferred stock
  ($.001 par value; authorized 2,000,000 shares; none issued)                                              --                  --
Common stock
  ($.001 par value; authorized 20,000,000 shares; issued
  and outstanding; 1997--7,114,513 shares; 1996--9,469,008 shares)                                           10                   9
Additional paid-in capital                                                                               14,204              25,773
Retained earnings                                                                                         3,446              43,055
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                         17,660              68,837
Less: Treasury stock, at cost (1997--none; 1996--2,455,372 shares)                                         --               (11,947)
          Unearned restricted stock--Note 10                                                               --                  (918)
------------------------------------------------------------------------------------------------------------------------------------

Total stockholders' equity                                                                               17,660              55,972
------------------------------------------------------------------------------------------------------------------------------------

                                                                                                      $  22,584           $ 115,011
====================================================================================================================================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>

                                                                 30

<PAGE>


<TABLE>
CONSOLIDATED STATEMENTS OF OPERATIONS
BEI Medical Systems Company, Inc. and Subsidiaries


<CAPTION>
                                                                                                   Year Ended
                                                                                ---------------------------------------------------
                                                                              September 27,       September 28,       September 30,
dollars in thousands except per share amounts                                          1997                1996                1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                             <C>                 <C>                 <C>        
Net sales -- Note 2                                                             $    10,005         $     9,357         $     8,847
Cost of sales -- Note 2                                                               5,972               5,792               5,282
                                                                                ---------------------------------------------------
Gross profit                                                                          4,033               3,565               3,565
                                                                                ---------------------------------------------------
Selling, general and administrative expenses                                          7,883               6,517               6,100
Research, development and related expenses                                            1,864               1,328                 999
                                                                                ---------------------------------------------------
                                                                                      9,747               7,845               7,099
                                                                                ---------------------------------------------------
Loss from operations                                                                 (5,714)             (4,280)             (3,534)

3Other income                                                                            136                 324                 177
Interest expense                                                                        (70)               (110)               (154)
                                                                                ---------------------------------------------------
Loss before income taxes                                                             (5,648)             (4,066)             (3,511)

Income taxes (benefit) -- Note 8                                                     (1,300)             (1,384)             (1,161)
                                                                                ---------------------------------------------------
Loss from continuing operations                                                      (4,348)             (2,682)             (2,350)

Income (loss) from discontinued operations, net of taxes
     of $1,788, $1,412, and ($600) for 1997, 1996 and
     1995, respectively                                                               4,583               4,571              (2,041)
                                                                                ---------------------------------------------------
Net income (loss)                                                               $       235         $     1,889         $    (4,391)
                                                                                ===================================================
Loss from continuing operations per common and
     common equivalent share                                                    $     (0.60)        $     (0.38)        $     (0.35)
Earnings (loss) from discontinued operations per common
     and common equivalent share                                                       0.64                0.64         $     (0.30)
                                                                                ---------------------------------------------------
Earnings (loss) per common and common equivalent
     share -- Note 2                                                            $      0.03         $      0.27         $     (0.65)
                                                                                ===================================================

Weighted average shares outstanding -- Note 2                                     7,203,448           7,107,818           6,758,745
                                                                                ===================================================

Dividends per common share -- Note 2                                            $      0.08         $      0.08         $      0.08
                                                                                ===================================================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>

                                                                 31

<PAGE>


<TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
BEI Medical Systems Company, Inc. and Subsidiaries                                                    Year Ended
<CAPTION>
                                                                                    ------------------------------------------------
                                                                                    September 27,    September 28,    September 30,
dollars in thousands                                                                         1997             1996             1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                       <C>              <C>              <C>     
Cash flows from operating activities:
Loss from continuing operations                                                           $(4,348)         $(2,682)         $(2,350)
Adjustments to reconcile net loss to net cash provided
   by operating activities:
Depreciation                                                                                  269              217              154
Amortization                                                                                1,356            1,530            1,273
Provision for losses on trade receivables                                                      57               39               26
Loss on sale of assets                                                                       --               --                  7
Deferred income taxes                                                                        (261)             (26)              92
Changes in operating assets and liabilities, net of
   acquisitions and dispositions:
Trade receivables                                                                            (302)            (187)             204
Inventories                                                                                  (854)            (267)             (35)
Other current assets                                                                         (142)             192             (145)
Trade accounts payable, accrued expenses and other liabilities                                164           (3,955)           3,134
------------------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities of
   continuing operations                                                                   (4,061)          (5,139)           2,360
------------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:

Purchases of property, plant and equipment                                                   (263)            (316)            (387)
Purchases of patents and licenses                                                            (186)            (136)            --
Other                                                                                          18             (297)            --

------------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities of continuing operations                               (431)            (749)            (387)

Cash flows from financing activities:
Borrowings on short-term debt                                                                --               --              6,000
Payments on short-term debt                                                                  --               --             (6,000)
Proceeds from sale of minority interest                                                      --              1,488             --
Principal payments on long-term debt and other liabilities                                   (715)            (678)          (1,391)
Proceeds from issuance of common stock, net                                                   872            1,067              319
Repurchase of stock                                                                        (1,303)            (154)            (133)
Payment of cash dividends                                                                    (563)            (555)            (541)
------------------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities of continuing
   operations                                                                              (1,709)           1,168           (1,746)
------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by discontinued operations--Note 3                                        6,344            4,825            7,693
------------------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents                                                     143              105            7,920
Cash and cash equivalents at beginning of year                                              9,128            9,023            1,103
------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year                                                  $ 9,271          $ 9,128          $ 9,023
====================================================================================================================================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>

                                                                 32

<PAGE>


<TABLE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
BEI Medical Systems Company, Inc. and Subsidiaries


<CAPTION>
                                                                   Additional                                Unearned
                                                     Common         paid-in      Retained      Treasury     restricted
dollars in thousands                                  stock         capital      earnings       stock         stock         Total
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>           <C>           <C>           <C>           <C>           <C>     
Balances at October 1, 1994                          $      9      $ 23,533      $ 46,653      $(11,660)     $   (706)     $ 57,829

Net loss for 1995                                                                  (4,391)                                   (4,391)
Stock options exercised                                                  65                                                      65
Employee Stock Purchase Plan
     offering--Note 11                                                  254                                                     254
Restricted Stock Plan--Note 10                                          260                                       (24)          236
Purchase of treasury stock-
     (19,500 shares at $6.80 average
     per share)                                                                                    (133)                       (133)
Cash dividends                                                                       (541)                                     (541)
------------------------------------------------------------------------------------------------------------------------------------
Balances at September 30, 1995                              9        24,112        41,721       (11,793)         (730)       53,319

Net income for 1996                                                                 1,889                                     1,889
Stock options exercised                                                 842                                                     842
Employee Stock Purchase Plan
     offering--Note 11                                                  225                                                     225
Restricted Stock Plan--Note 10                                          594                                      (188)          406
Purchase of treasury stock-
     (15,000 shares at $10.27
     average per share)                                                                            (154)                       (154)
Cash dividends                                                                       (555)                                     (555)
------------------------------------------------------------------------------------------------------------------------------------
Balances at September 28, 1996                              9        25,773        43,055       (11,947)         (918)       55,972
------------------------------------------------------------------------------------------------------------------------------------
Net income for 1997                                                                   235                                       235
Stock options exercised                                     1           866                                                     867
Restricted Stock Plan--Note 10                                          815                                      (475)          340
Purchase of treasury stock-
     (135,000 shares at $9.67
     average per share)                                                                          (1,303)                     (1,303)
Cash dividends                                                                                                                 (563)
Retirement of treasury stock                                        (13,250)         (563)       13,250                          --
------------------------------------------------------------------------------------------------------------------------------------
Balances at September 27, 1997
     before Distribution                                   10        14,204        42,727          --          (1,393)       55,548
Distribution                                                                      (39,281)                      1,393       (37,888)
------------------------------------------------------------------------------------------------------------------------------------
Balances at September 27, 1997                       $     10      $ 14,204      $  3,446      $   --        $   --        $ 17,660
====================================================================================================================================

<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>

                                                                 33

<PAGE>


Notes to Consolidated Financial Statements
BEI Medical Systems Company, Inc. and Subsidiaries
September 27, 1997

Note 1 -- Basis of Presentation

On September 27, 1997,  BEI  Electronics,  Inc.  ("Electronics")  distributed to
holders  of  Electronics   common  stock  one  share  of  common  stock  of  BEI
Technologies,  Inc. ("Technologies"),  a newly formed subsidiary, for each share
of  Electronics  common  stock held ("the  Distribution").  On November 4, 1997,
Electronics  merged with its  subsidiary,  BEI  Medical  Systems  Company,  Inc.
("Medical"),   and  became  one  company  with   Electronics  as  the  surviving
corporation (the "Merger").  After the Merger,  Electronics  changed its name to
BEI Medical Systems Company, Inc. (the "Company").

In connection with the Distribution, Electronics transferred to Technologies all
of the assets,  liabilities and operations of its BEI Sensors & Systems Company,
Inc.  ("Sensors")  and  Defense  Systems  Company,   Inc.  ("Defense")  business
segments.  Accordingly,  the results of  operations  of the  segments  have been
presented as discontinued  operations for all periods  presented and the related
assets and liabilities have been segregated in the consolidated  balance sheets.
See Note 3 -- Discontinued Operations for a description of the Distribution.

Note 2 -- Summary of Significant Accounting Policies

Operations: The Company is a manufacturer of diagnostic and therapeutic products
focused on  gynecology  and  women's  health  issues.  In the U.S.,  the Company
utilizes independent manufacturers' representative  organizations,  direct sales
representatives,  telemarketers and domestic distributors to market its products
directly  to end  users,  hospitals,  surgical  centers  and  doctors'  offices.
Products  are  also  sold  through  a  network  of  international  distributors.
Medical's  operations  consist of Zinnanti  Surgical  Instruments in Chatsworth,
California  and Xylog  Corporation,  Meditron  Devices,  Inc.,  and BEI  Medical
Systems International, Inc. in Hackensack, New Jersey.

The Company believes its existing cash balances together with operating revenues
will  produce  adequate  funding to meet its capital  requirements  for the next
twenty-four  months.  The Company  may need to raise  additional  funds  through
public or private  financing  or other  arrangements.  There can be no assurance
that the Company  will not require  additional  funding or that such  additional
funding,  if needed, will be available on terms attractive to the Company, or at
all. Any additional  equity financing may be dilutive to stockholders,  and debt
financing if available, may involve restrictive covenants.

Acquisitions:  On February 2, 1996,  Medical  acquired all outstanding  stock of
OvaMed  Corporation  ("OvaMed"),  for the purpose of acquiring  OvaMed's product
line and merging it into Zinnanti  Surgical  Instruments' operations.  The total
purchase price of OvaMed was $375,000 and 6,336 shares of Medical stock. Product
and patent related  intangible  assets acquired amounted to $1.4 million and are
being amortized over ten years for trade names and over their  respective  lives
for patents.

Minority  Interest:  Concurrent  with the  closing  of the  OvaMed  transaction,
Johnson & Johnson  Development  Corporation  ("J&J")  purchased 50,016 shares of
Series B Preferred  Stock of Medical for  $1,500,000.  Also  concurrent with the
OvaMed  transaction  and the sale of Series B Preferred  Stock,  Medical entered
into an agreement with J&J whereby J&J was granted a right of first  negotiation
for the exclusive right to

                                       34

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

manufacture and distribute  certain products  intended for use in the gynecology
field for endometrial  ablation,  that were acquired or developed by Medical. In
the  event  the  Company  and  J&J  are  unable  to  agree  on  the  terms  of a
manufacturing  or  distribution  arrangement,  the  Company  has  the  right  to
manufacture  or distribute  any such  products  itself or to arrange for a third
party to  manufacture or distribute  such products  provided that any such third
party arrangement is not materially less favorable to the Company than the terms
offered by J&J.

<TABLE>
At September 27, 1997 Medical had authorized 2,000,000 shares of $.001 par value
Common  Stock and 959,000  shares of $.001 par value  Preferred  Stock  (859,000
shares of series A and 100,000  shares of Series B) at September  27, 1997.  The
table  below  shows the  ownership  of  Medical  for the two years  prior to the
Distribution and Merger.


<CAPTION>
                                                                            Medical Shares Outstanding
                                            ----------------------------------------------------------------------------------------
                                                         September 27, 1997                             September 28, 1996
                                            ----------------------------------------------------------------------------------------
                                            Series A         Series B         Common         Series A        Series B        Common
                                            Preferred       Preferred         Stock         Preferred       Preferred        Stock
                                            ----------------------------------------------------------------------------------------
<S>                                          <C>              <C>            <C>             <C>              <C>                <C>
BEI Electronics, Inc.                        859,000          33,344         397,471         859,000          33,344             100

Johnson & Johnson                               --            50,016           2,115            --            50,016            --

Management                                      --              --            12,650            --              --            15,150

Others                                          --              --            15,721            --              --            10,003
                                            ----------------------------------------------------------------------------------------
Total                                        859,000          83,360         427,957         859,000          83,360          25,253
                                            ========================================================================================
</TABLE>


After year end and prior to the  merger,  the  Series A and  Series B  Preferred
stock were converted to Medical common stock on a share-for-share basis.

As a result of the Merger  effective  November 4, 1997,  Medical was merged into
Electronics,  and Medical ceased to exist as a separate entity. Each outstanding
share of  common  stock of  Medical  at that date  (other  than  shares  held by
Electronics)  was  automatically  converted  into the right to  receive  5.51615
shares of Electronics  common stock.  Certificates for Electronics  common stock
will be issued,  rounded down to the nearest whole number of shares.  Fractional
shares of  Electronics  common  stock that would have  otherwise  been issued in
connection  with the Merger have been redeemed by Electronics  pro rata based on
the last reported sale price of Electronics common stock on the last trading day
preceding the merger.

                                       35

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The following table shows the conversion of the 6% minority  interest in Medical
common stock to Electronics  common stock at a conversion rate of 5.51615 shares
of Electronics common stock for every one share of Medical Common stock held.

                                                       Shares
                                      ----------------------------------------
                                            Pre-Merger          Post-Merger
                                              Medical           Electronics
                                           Common Stock         Common Stock
                                      ----------------------------------------
Johnson & Johnson                                  52,131              287,561

Management                                         12,650               69,778

Others                                             15,721               86,716
                                      ----------------------------------------
                                                   80,502              444,055
                                      ========================================


Fiscal Year: The Company's  fiscal year ends on the Saturday  nearest  September
30. Fiscal years 1997, 1996 and 1995 each contained 52 weeks.

Consolidation: The consolidated financial statements include the accounts of the
Company  and  its  wholly  and  majority  owned  subsidiaries.  All  significant
intercompany accounts and transactions have been eliminated.

Cash and Cash Equivalents:  The Company considers all highly liquid  investments
with a maturity of three months or less when purchased to be cash equivalents.

Concentration  of Credit Risk:  The  Company's  products are sold to  commercial
customers  throughout the United States and in various  foreign  countries.  The
Company  performs  ongoing credit  evaluations  of its commercial  customers and
generally  does not require  collateral.  The  Company  maintains  reserves  for
potential  credit  losses.  Historically,  such  losses  have  been  within  the
expectations of management.

Use of Estimates:  The  preparation of financial  statements in conformity  with
generally accepted  accounting  principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
the accompanying notes. Actual results could differ from these estimates.

Revenue Recognition:  Revenue is recognized as units are shipped.

Inventories: Inventories are carried principally at the lower of cost (first-in,
first-out method) or market.

Depreciation  and  Amortization:  Plant  and  equipment  are  recorded  at cost.
Depreciation and amortization are provided in amounts sufficient to amortize the
cost of such assets over their estimated useful lives, which range from three to
thirty  years,  using the  straight-line  method for  structures  and  leasehold
improvements and by accelerated or straight-line methods for equipment.

                                       36

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Long-Lived  Assets:  The Company  accounts for any  impairment of its long-lived
assets  using  Financial  Accounting  Standards  Board  Statement  of  Financial
Accounting  Standards No. 121 ("FAS No. 121")  "Accounting for the Impairment of
Long-Lived  Assets to be  Disposed  of."  This  category  consists  of plant and
equipment;  patents,  and trade names,  related  non-competition  agreements and
goodwill  acquired  in  purchase   acquisitions.   Patents  and  non-competition
agreements are being amortized over their terms.  Trade names are amortized over
ten to twenty years.  Goodwill consists of the excess of cost over fair value of
net tangible assets acquired in purchase acquisitions.  Goodwill is amortized by
the  straight-line  method over twenty years.  The carrying  value of long-lived
assets will be reviewed if the facts and circumstances  suggest that they may be
impaired.  Impairment is determined based on undiscounted future cash flows over
the amortization  period.  Generally,  if impairment is indicated,  the carrying
value of long-lived assets would be reduced by the estimated short-fall based on
discounted future cash flows.

Earnings  (loss) Per Share:  Earnings (loss) per share are computed based on the
weighted  average  number  of  shares  of common  stock  (less  treasury  stock)
outstanding during the year, adjusted for the effect of common stock equivalents
attributable to dilutive stock options (using the treasury stock method).

Research and Development Costs:  Company-sponsored product development costs are
charged to expense when incurred.

Advertising  Costs:  Advertising costs are charged to expenses when incurred and
were  approximately  $412,000,  $423,000 and $326,000 in fiscal years 1997, 1996
and 1995, respectively.

Recent Accounting  Pronouncements:  Statement of Financial  Accounting Standards
No. 123 ("FAS 123"),  "Accounting for Stock-Based  Compensation,"  established a
fair-value  based method of accounting for  stock-based  compensation  plans and
requires  additional  disclosures for those companies who elect not to adopt the
new  method  of  accounting.   The  Company  has  adopted  the   disclosure-only
alternative  as described in FAS 123 in fiscal year 1997.  The Company  accounts
for employee  stock awards using the intrinsic  value method in accordance  with
APB Opinion No. 25,  "Accounting  for Stock Issued to Employees" and accordingly
recognizes no expense upon the granting of options.

In February 1997, the Financial  Accounting  Standards Board issued Statement of
Financial Accounting Standards No. 128 ("FAS 128"),  "Earnings per Share", which
is required to be adopted for the quarter  ending  December  27,  1997.  At that
time,  the  Company  will be  required  to change the method  currently  used to
compute  earnings  per share and to  restate  earnings  (loss) per share for all
prior  periods.  Had the Statement  been  implemented  for fiscal years 1997 and
1996, the impact on the  calculation of earnings (loss) per share would not have
been material.

In June 1997, the Financial  Accounting Standards Board issued Statement No. 130
"Reporting Comprehensive Income," ("FAS 130"), and Statement No. 131 "Disclosure
about  Segments of an  Enterprise  and Related  Information"  ("FAS  131").  The
Company is  required  to adopt these  statements  in fiscal  year 1999.  FAS 130
establishes new standards for reporting and displaying  comprehensive income and
its components.  FAS 131 requires  disclosure of certain  information  regarding
operating  segments,  products and services,  geographic  areas of operation and
major  customers.  Adoption of these Statements is expected to have no impact on
the Company's  consolidated  financial  position,  results of operations or cash
flows.

                                       37

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Reclassifications:  Certain  reclassifications have been made to the fiscal 1996
and 1995 financial statements to conform to the fiscal 1997 presentation.

Note 3 -- Discontinued Operations

Technologies  was  incorporated on June 30, 1997 in the State of Delaware,  as a
wholly owned  subsidiary  of  Electronics.  On September  27, 1997,  Electronics
distributed to holders of Electronics  common stock one share of common stock of
Technologies  for each share of  Electronics  common stock held on September 24,
1997.  In  connection  with  the   Distribution,   Electronics   transferred  to
Technologies  all of the assets,  liabilities  and operations of its Sensors and
Defense business  segments.  Accordingly,  the financial position and results of
operations of Sensors and Defense are shown as  discontinued  operations for all
periods presented.

Note 4 -- Inventories


(dollars in thousands)                                   1997               1996
--------------------------------------------------------------------------------
Finished products                                      $1,843             $1,268
Work in process                                           230                182
Materials                                                 866                635
--------------------------------------------------------------------------------
Inventories                                            $2,939             $2,085
================================================================================


Note 5 -- Bank Credit Agreements

At September  18, 1997 and  September  28,  1996,  the Company had a $15 million
unsecured  credit line with a bank.  There were no borrowings  under the line at
these dates.  On September  19, 1997,  the credit line  agreement was amended to
allow  borrowings  only by Sensors,  then a subsidiary of the Company.  Prior to
year-end,  Sensors was spun-off  and the  obligations  under the amended  credit
agreement  transferred  with it. The  Company had no bank  credit  agreement  at
September 27, 1997.

Note 6 -- Accrued Expenses and Other Liabilities


(dollars in thousands)                                        1997          1996
--------------------------------------------------------------------------------
Insurance reimbursement                                     $  946        $ --
Noncompetition contract                                        562           531
Professional fees                                              205           344
Employee compensation                                          202           499
Returns                                                        136            85
Taxes                                                          136           137
Vacation                                                       135           224
Commissions                                                    127           177
Royalties and related costs                                    102            98
Other                                                          234           237
--------------------------------------------------------------------------------
Accrued Expenses and Other Liabilities                      $2,785        $2,332
================================================================================

                                       38

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

<TABLE>
Note 7 -- Long-Term Debt


<CAPTION>
(dollars in thousands)                                                                         1997             1996
--------------------------------------------------------------------------------------------------------------------
<S>                                                                                            <C>              <C> 
Note payable to the previous owner of Zinnanti Surgical Instruments,
Inc. with interest at 5.0%; payable in monthly installments of $10,883
through 1998                                                                                   $147             $266

Note  payable to a related  party with  interest at the lessor of 1.0% below the
Bank of America  reference  rate or 8.0% (5.0% at September 27, 1997);  due in
annual installments of $60,000 plus interest through 1998                                        60              120

Asset purchase agreement with zero interest; payable in monthly
installments through 1998                                                                         5               10
--------------------------------------------------------------------------------------------------------------------
                                                                                                212              396
Less current portion                                                                            190              184
--------------------------------------------------------------------------------------------------------------------
Long-term debt                                                                                  $22             $212
====================================================================================================================
</TABLE>


Annual  maturities  of  long-term  debt are as follows:  fiscal  1998--$190,000;
1999--$22,000.

Interest of  approximately  $11,000,  $31,000 and $63,000 was paid on  long-term
debt by Medical  during fiscal 1997,  1996 and 1995,  respectively.  Interest of
approximately   $50,000,   $96,000  and  $124,000  was  paid  on  noncompetition
agreements  by Medical  during  fiscal  1997,  1996 and 1995,  respectively.  In
connection with the Distribution,  Technologies assumed Electronics' obligations
related to the service  and  repayment  of $22.4  million in Senior  Notes.  The
interest  expense related to the notes was allocated to Technologies  for fiscal
years 1996 and 1997.

Note 8
Income Taxes

Deferred  income  taxes  reflect  the net tax effects of  temporary  differences
between  carrying  amounts of assets and  liabilities  for  financial  reporting
purposes and amounts used for income tax purposes.

                                       39

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Significant  components of the Company's  deferred tax liabilities and assets as
of September 27, 1997 and September 28, 1996 are as follows (in thousands):


Deferred tax liabilities                                          1997     1996
--------------------------------------------------------------------------------
   Depreciation and property basis difference                   $   12   $    7
   Intangibles                                                    --        548
   Prepaid expenses                                               --         32
   Accrued expenses                                                213       32
--------------------------------------------------------------------------------
      Total deferred tax liabilities                               225      619
--------------------------------------------------------------------------------

Deferred tax assets
   Intangibles                                                     536     --
   Accrued expenses                                                 98      140
   Inventory valuation                                              85      124
   State net operating loss carryovers                           1,177      929
   Allowance for bad debt                                           55       36
--------------------------------------------------------------------------------
      Total deferred tax assets                                  1,951    1,229
    Valuation allowance for deferred tax assets                  1,784      929
--------------------------------------------------------------------------------
    Net deferred tax liabilities                                $   58   $  319
================================================================================

The valuation allowance for deferred tax assets increased by $855,000 during the
year ended  September 27, 1997. The valuation  allowance was adjusted to reflect
uncertainties  regarding realizability of deferred tax assets related to certain
intangibles and state net operating loss  carryovers.  As of September 27, 1997,
the Company has net operating loss  carryforwards  for state income tax purposes
of approximately  $12.5 million which expire from 2001 through 2003. The Company
has no net operating loss carryforwards for federal income tax purposes.

<TABLE>
Significant  components  of  the  provision  (benefit)  for  income  taxes  from
continuing operations are as follows:


<CAPTION>
                                                                                             1997             1996             1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                       <C>              <C>              <C>     
Current (credit)
     Federal                                                                              ($1,039)         ($1,358)         ($1,071)
     State                                                                                   --               --               (182)
------------------------------------------------------------------------------------------------------------------------------------
     Total Current                                                                         (1,039)          (1,358)          (1,253)
Deferred (credit)
     Federal                                                                                 (261)             (23)              72
     State                                                                                   --                 (3)              20
------------------------------------------------------------------------------------------------------------------------------------
     Total Deferred                                                                          (261)             (26)              92
------------------------------------------------------------------------------------------------------------------------------------
 Total income tax expense (benefit)                                                       ($1,300)         ($1,384)         ($1,161)
====================================================================================================================================
</TABLE>

                                                                 40

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


<TABLE>
A  reconciliation  of the  statutory  federal  income tax rate to the  Company's
effective rate from continuing operations is presented below.


<CAPTION>
                                                                                             1997             1996             1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                       <C>              <C>              <C>     
Income tax (credit) at the statutory rate of 34%                                          $(1,920)         $(1,382)         $(1,194)
Federal income tax effect of state income taxes                                              --                  1              (55)
Goodwill amortization                                                                          81               81               82
Increase in federal valuation allowance                                                       607             --               --
Other                                                                                         (68)             (81)             168
------------------------------------------------------------------------------------------------------------------------------------
Federal income taxes (credit)                                                              (1,300)          (1,381)            (999)
State income taxes (credit), net of increase in state
    valuation allowance                                                                      --                 (3)            (162)
------------------------------------------------------------------------------------------------------------------------------------
Provision(credit) for income taxes                                                        $(1,300)         $(1,384)         $(1,161)
====================================================================================================================================
</TABLE>


Note 9
Stockholders' Equity

The  Company's  preferred  stock may be issued  from time to time in one or more
series.  The Board of Directors is authorized to establish from time to time the
number of shares to be included in each series,  and to  designate  the dividend
rights,  dividend rate,  conversion rights,  voting rights,  rights and terms of
redemption, redemption price or prices and liquidation preferences.

During  fiscal 1992 and 1990,  the Board of Directors of the Company  authorized
the purchase from time to time in open market  transactions of up to 300,000 and
500,000 shares of common stock, respectively. During fiscal year 1996, the Board
approved an additional repurchase of up to 200,000 shares on the open market. At
the end of fiscal year 1997,  934,424  shares had been  repurchased at a cost of
$6,969,178  under this program.  The treasury  stock shares were then retired at
September 27, 1997.


Note 10
Stock Option and Restricted Stock Plans

In 1982,  the Company's  stockholders  voted to adopt an incentive  stock option
plan.  The plan provided for option prices based on the fair market value of the
stock on the date the option is granted. The Incentive Stock Option Plan of 1982
terminated December 15, 1991. The remaining outstanding options in the plan were
exercised  during fiscal year 1997. No shares were  outstanding or available for
grant at September 27, 1997.

                                       41

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


<TABLE>
Transactions  relating to the Incentive Stock Option Plan of 1982 are summarized
as follows:


<CAPTION>
                                                               Number of       Exercise Price            Weighted
                                                           common shares            per share       average price
                                                                                                        per share
-----------------------------------------------------------------------------------------------------------------
<S>                                                               <C>                   <C>                 <C>  
Options outstanding at October 1, 1994                            28,000                $3.75               $3.75
Exercised                                                             --                                       --
-----------------------------------------------------------------------------------------------------------------
Options outstanding at September 30, 1995                         28,000                $3.75               $3.75
Exercised                                                         (4,000)               $3.75               $3.75
-----------------------------------------------------------------------------------------------------------------
Options outstanding at September 28, 1996                         24,000                $3.75               $3.75
Exercised                                                        (24,000)               $3.75               $3.75
-----------------------------------------------------------------------------------------------------------------
Options outstanding at September 27, 1997                             --                   --                  --
=================================================================================================================
</TABLE>


In  November  1987,  the  Company's  stockholders  voted to adopt an  additional
incentive stock option plan and a supplemental (nonqualified) stock option plan.
The  incentive  stock option plan  provides for option  prices based on the fair
market value of the stock on the date the option is granted,  as  determined  by
the Board of  Directors.  The  supplemental  stock option plan requires that the
exercise  price of each  option  shall not be less  than 50% of the fair  market
value on the date the  option is  granted.  Under  both  plans the  options  are
generally  exercisable in three approximately equal installments  commencing one
year from the date of grant with accumulation privileges.

In January 1997,  the Board combined the Incentive and  Supplemental  Plans into
one plan,  and  amended it to change the name to the Amended  1987 Stock  Option
Plan (the  "Amended  Plan"),  provide  for the  granting of both  incentive  and
non-statutory stock options,  provide for grants to non-employee  consultants to
the Company, and increase the share reserve for option grants by 100,000 so that
shares issued pursuant to options granted under these two plans shall not exceed
1,350,000 in the aggregate.

As a result of the Distribution, all the outstanding options for common stock of
the Company,  vested and non-vested,  were converted to options for common stock
of Technologies,  at a rate of approximately 1.07 options for Technologies stock
for every 1.0  Electronics  option held.  The exercise  price of the options was
also adjusted so that the  aggregate  value of all  outstanding  options was the
same after the Distribution as before.

See Note 1 -- Basis of Presentation for more information.

                                       42

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

<TABLE>
Transactions  relating to the Amended 1987 Stock Option Plan are  summarized  as
follows:


<CAPTION>
                                                              Number of                            Weighted Average
                                                                 Common             Exercise         Exercise Price
                                                                 Shares      Price Per Share              Per Share
-------------------------------------------------------------------------------------------------------------------
<S>                                                           <C>              <C>                            <C>  
Options outstanding at October 1, 1994                          667,465        $2.88 - $9.13                  $5.88

   Granted                                                       31,000                $5.00                  $5.00
   Exercised                                                    (16,814)       $2.88 - $4.38                  $3.85
   Terminated                                                   (71,256)       $4.38 - $9.13                  $7.41
-------------------------------------------------------------------------------------------------------------------
Options outstanding at September 30, 1995                       610,395        $2.88 - $9.13                  $5.71
   Granted                                                       11,000        $6.00 - $7.13                  $6.42
   Exercised                                                   (115,922)       $2.88 - $9.13                  $6.27
   Terminated                                                   (48,511)       $5.00 - $9.13                  $7.80
-------------------------------------------------------------------------------------------------------------------
Options outstanding at September 28, 1996                       456,962        $2.88 - $9.13                  $5.36
   Exercised                                                   (137,866)       $2.88 - $7.25                  $5.33
   Terminated                                                    (3,500)       $3.75 - $9.13                  $7.95
-------------------------------------------------------------------------------------------------------------------
   Options outstanding prior to Distribution                    315,596        $2.88 - $9.13                  $5.35
Distribution conversion to Technologies options                (315,596)       $2.88 - $9.13                  $5.35
-------------------------------------------------------------------------------------------------------------------
Options outstanding at September 27, 1997                            --                   --                     --
===================================================================================================================
</TABLE>


As of September 27, 1997, no options were  outstanding  and 792,915  shares were
available for grant under the Amended Plan.

In July 1995, Medical's  stockholders adopted an incentive stock option plan and
a supplemental (nonqualified) stock option plan for Medical stock. The incentive
stock  option plan  provided for option  prices  based on Medical's  fair market
value of the stock on the date the option is granted, as determined by Medical's
Board of  Directors.  The  supplemental  stock  option  plan  required  that the
exercise  price of each  option  shall not be less  than 85% of the fair  market
value on the date the option is granted.

                                       43

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

<TABLE>
Transactions  related to the  incentive  and  supplemental  Medical stock option
plans of 1995 are summarized as follows:

<CAPTION>
                                                                 Number of                             Weighted Average
                                                                    Common              Exercise         Exercise Price
                                                                    Shares       Price Per Share              Per Share
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>                    <C>                    <C>  
Options outstanding at October 1, 1994                                  --               $    --                $    --
    Granted                                                         85,500                 $1.72                  $1.72
    Exercised                                                           --               $    --                $    --
    Terminated                                                          --               $    --                $    --
-----------------------------------------------------------------------------------------------------------------------
Options outstanding at September 30, 1995                           85,500                 $1.72                  $1.72
    Granted                                                         34,800          $3.00 - 3.85                  $3.48
    Exercised                                                           --               $    --                $    --
    Terminated                                                          --               $    --                $    --
-----------------------------------------------------------------------------------------------------------------------
Options outstanding at September 28, 1996                          120,300          $1.72 - 3.85                  $2.23
    Granted                                                          2,500                $20.65                 $20.65
    Exercised                                                       (9,000)                $1.72                  $1.72
    Terminated                                                      (5,800)                $3.00                  $3.00
-----------------------------------------------------------------------------------------------------------------------
Options outstanding at September 27, 1997                          108,000         $1.72 - 20.65                  $2.66
=======================================================================================================================
</TABLE>


On  November 4, 1997,  Medical and  Electronics  merged into one  company,  with
Electronics as the surviving  legal entity.  As a result of the Merger,  options
outstanding  under the Medical  Stock  Option  Plans of 1995 were  converted  to
Electronics  options at a rate of approximately  5.51615 Electronics options for
every one Medical option outstanding. Electronics' outstanding options increased
to  595,739  after the Merger  from zero  outstanding  at  September  27,  1997.
Medical's  outstanding  options  decreased to zero and the Medical  Stock Option
Plans of 1995 were cancelled as a result of the Merger.


                                               Number of Shares
                               -------------------------------------------------
                                      Medical Options        Electronics Options
                               ----------------------   ------------------------
September 27, 1997                            108,000                         --
November 4, 1997                                   --                    595,739


<TABLE>
<CAPTION>
                                                                    Weighted          Weighted
                                                                Average Remaining      Average
                                                       Options    Contractual       Exercise Price        Number
Exercise Prices                                      Outstanding  Life (Years)        Per Share         Exercisable
---------------                                      -----------  ------------        ---------         -----------
<S>                                                    <C>            <C>               <C>               <C>    
$0.31 ..........................................       421,982        7.8               $0.31             421,982
$0.54 ..........................................        52,403        8.3               $0.54              13,101
$0.70 ..........................................       107,564        8.6               $0.70              26,891
$3.74 ..........................................        13,790        9.4               $3.74               --
-----                                                  -------        ---               -----             -------
$0.31 - $3.74 ..................................       595,739        8.0               $0.48             461,974
=============                                          =======        ===               =====             =======
</TABLE>

                                                        44

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

As of September 27, 1997,  83,750 Medical  options were  exercisable  and 24,000
shares were  available  for stock  option  grants  under the 1995 plans.  If the
Merger and  conversion  to  Electronics  options  had taken  place at that date,
options  exercisable and available for grant would have been 461,978 and 132,388
shares,  respectively,  based  on the  conversion  rate of  5.51615  Electronics
options for every Medical option.

In February 1992, the Company's Board of Directors  approved the 1992 Restricted
Stock Plan (the "Restricted  Plan"),  ratified by the Company's  shareholders in
February  1993,  and authorized up to 350,000 shares to be issued to certain key
individuals  subject to forfeiture if employment  terminated prior to the end of
prescribed periods. In January 1997, the Restricted Plan was amended to increase
the shares  reserved for issuance under the plan from 350,000 to 700,000.  As of
September 27, 1997, 419,926 shares had been granted and of these, 354,250 shares
were   outstanding  and  are  included  in  the  Company's  total  common  stock
outstanding.  Of the  outstanding  shares,  129,195 had fully vested.  There are
345,750  shares  reserved  for issue.  The market  value at the date of grant of
shares  awarded  under the plan is recorded as unearned  restricted  stock.  The
market value of shares  granted is amortized  to  compensation  expense over the
periods of vesting.  No compensation  expense for Medical was recorded in fiscal
1997, 1996 or 1995.

The impact of the  calculation  required by FAS No. 123 on  proforma  results of
operations  and earnings  (loss) per share was  determined to be immaterial  for
fiscal years 1997 and 1996.

Note 11
Employee Benefit Plans

The Company has a defined  contribution  retirement  plan for the benefit of all
eligible  employees.  The plan  qualifies  under Section  401(k) of the Internal
Revenue  Code  thereby  allowing  eligible  employees  to  make  tax  deductible
contributions to the plan. Non-discretionary employer contributions are based on
a fixed percentage of total eligible  employee  compensation and a formula based
matching of the participant's contribution to the plan. Additional contributions
are at the discretion of the Board of Directors.  The Company's contributions to
the plan for fiscal  1997,  1996 and 1995 for the  benefit of the  employees  of
continuing   operations  were  approximately   $62,000,   $54,000,  and  $43,000
respectively.

The  Company  also has an  employee  stock  purchase  plan.  The  purchase  plan
qualifies as an employee  stock  purchase plan under Section 423 of the Internal
Revenue Code.  Under the purchase plan, the Board of Directors may authorize the
participation by employees  (excluding certain highly compensated  employees) in
offerings of its common stock. Under the purchase plan, employees may have up to
10% of their salary  withheld to be used to purchase shares of common stock at a
price  equal to not  less  than 85% of the  fair  market  value of the  stock at
specified  applicable  dates.  The purchase  plan was  suspended as of August 1,
1996,  due to efforts to  simplify  the  Company's  equity  accounts  to support
analysis of various  organizational  alternatives.  At that date, 459,174 shares
had been issued and 140,826  shares were reserved for purchase over the ten year
life of the purchase plan.

                                       45

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 12
Lease Commitments

Operating leases consist  principally of leases for structures and land. Certain
of the operating  leases contain  various options for renewal and/or purchase of
the related assets for amounts approximating their fair market value at the date
of exercise of the option.  The future  minimum  payments for  operating  leases
consisted of the following at September 27, 1997:


(dollars in thousands)
-----------------------------------------------------
1998                                             $184
1999                                                9
2000                                                7
2001                                                2
Thereafter                                         --
-----------------------------------------------------
Total minimum lease payments                     $202
=====================================================


There are no minimum capital lease payments beyond fiscal 1996.

Total rental expense  attributable to property,  plant and equipment amounted to
approximately  $268,000,  $228,000,  and $198,000 for fiscal 1997, 1996 and 1995
respectively.

Note 13
Contingencies and Litigation

CooperSurgical, Inc. vs. BEI Medical Systems Company, Inc. et al.

In October 1993,  CooperSurgical,  Inc., a subsidiary  of The Cooper  Companies,
filed a claim for unspecified damages alleging unfair competition due to actions
by Medical and its president  Richard  Turner,  a former  employee of The Cooper
Companies,  and others.  On January 31,  1996,  the Court  issued a ruling which
affirmed  the legal  basis for  Medical  to assert a  counterclaim  for  damages
against  CooperSurgical   regarding  the  parties'   electrosurgical   generator
contract.

CooperSurgical's  original damage claims were for approximately $11 million.  In
June  1996,  more  than one year  after  expert  discovery  closed  in May 1995,
CooperSurgical's  counsel sent to the Company's  counsel a letter  purporting to
supplement CooperSurgical's previous responses to interrogatories. The June 1996
letter indicated that CooperSurgical's  damages for one particular aspect of the
claim  were  between  $24 and $50  million  with  respect  to a claim  for which
CooperSurgical's  experts had previously  estimated damages of $3.4 million. The
Company  will  vigorously  oppose  any  CooperSurgical   attempt  whatsoever  to
introduce  at trial any  evidence  of a damage  claim  based  upon its June 1996
purported supplement.

                                       46

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Management has vigorously  defended its rights in this action and believes after
discussion with legal counsel that the CooperSurgical claims are exaggerated. In
1995,  expert witnesses for the Company prepared a formal response to the damage
computations  CooperSurgical  previously submitted. The Company's experts stated
that if CooperSurgical were entitled to damages,  those damages would total less
than  $100,000,  and would be more than  offset by the  Company's  counterclaims
against CooperSurgical, if the Company were successful in its counterclaims.

The trial started in October 1997 and is currently ongoing in the Superior Court
of New Jersey for Bergen County,  Chancery  Division.  While the outcome of this
matter  cannot be  determined at this time,  management  believes,  taking known
factors into account and after consultation with legal counsel, that this matter
will not result in a material  adverse  impact on the financial  position of the
Company.  However,  any  settlement  of this case on a basis that  results in an
unfavorable  outcome for the Company could have a material adverse effect on the
results of operations of any quarterly or annual reporting period.

Other
The Company has pending  various legal  actions  arising in the normal course of
business.  Management  believes  that none of these  legal  actions  will have a
material impact on the Company's operating results or financial condition.

Note 14
Sales

Net sales from continuing  operations to customers in foreign countries amounted
to  $1,430,000,   $1,287,000  and  $895,000  in  fiscal  1997,  1996  and  1995,
respectively. In fiscal 1997, 1996 and 1995, foreign sales did not exceed 10% of
consolidated net sales in any individual geographic area.

                                       47

<PAGE>


                        BEI MEDICAL SYSTEMS COMPANY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 15
Quarterly Results of Operations (Unaudited)

<TABLE>
The tables below present unaudited  quarterly  financial  information for fiscal
1997 and 1996:


<CAPTION>
(dollars in thousands except per share amounts)
-------------------------------------------------------------------------------------------------------------------------
                                                                             Three months ended
-------------------------------------------------------------------------------------------------------------------------
                                                           December 28,       March 29,       June 28,    September 27,
                                                                   1996            1997           1997             1997
-------------------------------------------------------------------------------------------------------------------------
<S>                                                              <C>             <C>            <C>              <C>   
Net sales                                                        $2,584          $2,550         $2,472           $2,399
Gross profit                                                      1,152           1,090            938              853
Loss from continuing operations                                    (746)           (833)        (1,136)          (1,633)
Income from discontinued operations                                  35           1,452          1,696            1,400
Net income (loss)                                                  (711)            619            560             (233)
Loss from continuing operations
   per common and common equivalent share                        $(0.11)         $(0.12)        $(0.16)          $(0.23)
Earnings from discontinued operations per
   common and common equivalent share                            $ 0.00          $ 0.20         $ 0.24           $ 0.20
Earnings (loss) per common share                                 $(0.10)         $ 0.09         $ 0.08           $(0.03)


-------------------------------------------------------------------------------------------------------------------------
                                                           December 30,       March 30,       June 29,    September 28,
                                                                   1995            1996           1996             1996
-------------------------------------------------------------------------------------------------------------------------
Net sales                                                        $2,153          $2,446         $2,336           $2,422
Gross profit                                                        761             925            926              953
Loss from  continuing operations                                  (536)           (489)          (817)            (840)
Income from  discontinued operations                                888           1,102          1,593              988
Net income                                                          352             613            776              148
Loss from continuing operations per
   common and common equivalent share                            $(0.08)         $(0.07)        $(0.11)          $(0.12)
Earnings from discontinued operations per
   common and common equivalent share                            $ 0.13          $ 0.16         $ 0.22           $ 0.14
Earnings per common share                                        $ 0.05          $ 0.09         $ 0.11           $ 0.02
</TABLE>

                                                            48

<PAGE>


                Report of Ernst & Young LLP, Independent Auditors


The Board of Directors and Stockholders
BEI Medical Systems Company, Inc.

We have  audited the  accompanying  consolidated  balance  sheets of BEI Medical
Systems Company, Inc. (formerly BEI Electronics,  Inc.) as of September 27, 1997
and September 28, 1996, and the related  consolidated  statements of operations,
stockholders'  equity and cash  flows for each of the three  years in the period
ended September 27, 1997. These financial  statements are the  responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all  material  respects,  the  consolidated  financial  position  of BEI Medical
Systems  Company,  Inc. at September 27, 1997 and  September  28, 1996,  and the
consolidated  results of their  operations  and their cash flows for each of the
three years in the period ended  September 27, 1997 in conformity with generally
accepted accounting principles.


                                                         Ernst & Young LLP

San Francisco, California
November 7, 1997

                                       49

<PAGE>


ITEM 9.           CHANGES IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS ON ACCOUNTING
                  AND FINANCIAL DISCLOSURE

                  None.


                                    PART III

ITEM 10.          DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

                  Certain  information  with respect to directors  and executive
                  officers  is set  forth in Part I of this  Report.  Additional
                  information  required by this Item is  incorporated  herein by
                  reference  to the section  entitled  "Compliance  with Section
                  16(a) of the  Securities  Exchange  Act of 1934" of the  Proxy
                  Statement  related to the  Company's  1998  Annual  Meeting of
                  Stockholders  to be filed by the Company  with the  Securities
                  and Exchange Commission (the "Definitive Proxy Statement").


ITEM 11.          EXECUTIVE COMPENSATION

                  The information  required by this Item is incorporated  herein
                  by  reference  to  the  sections  entitled   "Compensation  of
                  Executive   Officers"  and  "Certain   Transactions"   of  the
                  Company's Definitive Proxy Statement.


ITEM 12.          SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
                  The information  required by this Item is incorporated  herein
                  by reference to the section  entitled  "Security  Ownership of
                  Certain  Beneficial  Owners and  Management"  of the Company's
                  Definitive Proxy Statement.


ITEM 13.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

                  The information  required by this Item is incorporated  herein
                  by reference to the sections entitled  "Certain  Transactions"
                  and "Compensation Committee Interlocks and Insider
                  Participation" of the Definitive Proxy Statement.

                                       50

<PAGE>


                                     PART IV

ITEM 14.          EXHIBITS,  FINANCIAL STATEMENT SCHEDULES,  AND REPORTS ON FORM
                  8-K

<TABLE>
The following documents are filed as part of this Form 10-K.

<CAPTION>
                                                                                                                          Form
                                                                                                                          10-K
(a)(1)      Index to Consolidated Financial Statements.                                                                   Page
                                                                                                                          Number
                                                                                                                          ------
<S>                                                                                                                         <C>
            The following Consolidated Financial Statements of BEI Medical Systems
            Company, Inc. (formerly BEI Electronics, Inc.) are filed as part of this Form
            10-K:

            Report of Ernst & Young LLP, Independent Auditors                                                               49

            Consolidated Balance Sheets -
               Years ended September 27, 1997 and September 28, 1996                                                        29

            Consolidated Statements of Operations -
               Years ended September 27, 1997, September 28, 1996
               and September 30, 1995                                                                                       31

            Consolidated Statements of Cash Flows -
               Years ended September 27, 1997, September 28, 1996
               and September 30, 1995                                                                                       32

            Consolidated Statements of Stockholders' Equity -
               Years ended September 27, 1997, September 28, 1996
               and September 30, 1995                                                                                       33

            Notes to Consolidated Financial Statements -
              September 27, 1997                                                                                            34

(a)(2)      Index to Financial Statement Schedule.
            The following Consolidated Financial Statement Schedule of BEI Medical
            Systems Company, Inc. (formerly BEI Electronics, Inc.) for each of the years
            ended September 27, 1997, September 28, 1996 and September 30, 1995 is filed
            as part of this Form 10-K:
            Schedule II                            Valuation and Qualifying Accounts                                       S-1

                                                   Report of Ernst & Young LLP, Independent                                S-2
                                                   Auditors as to Schedule

                                                   Consent of Ernst & Young LLP, Independent
                                                   Auditors                                                                S-3
</TABLE>

                                                                51

<PAGE>


Schedules not listed above have been omitted  because they are not applicable or
are not required or the information required to be set forth therein is included
in the  Consolidated  Financial  Statements or Notes thereto.  

<TABLE>
(a)(3)      Listing of Exhibits

<CAPTION>
            Exhibit Numbers                 Description                                        Footnote
            ---------------                 -----------                                        --------
<S>                              <C>                                                           <C>
                 2.1             Distribution Agreement between BEI Electronics,
                                 Inc. and BEI Technologies, Inc. dated September
                                 26, 1997                                                        (xix)

                 2.2             Corporate Services Agreement between BEI
                                 Technologies, Inc. and BEI Electronics, Inc. dated
                                 as of September 26, 1997                                        (xix)

                 2.3             Tax Allocation and Indemnity Agreement between
                                 BEI Electronics, Inc. and BEI Technologies, Inc.
                                 dated as of September 26, 1997                                  (xix)

                 2.4             Assumption of Liabilities and Indemnity
                                 Agreement between BEI Electronics, Inc. and BEI
                                 Technologies, Inc. dated as of September 26, 1997               (xix)

                 2.5             Technology Transfer and License Agreement by
                                 and between BEI Electronics, Inc. and BEI
                                 Technologies, Inc. dated as of September 26, 1997               (xix)

                 2.6             Trademark Assignment and Consent Agreement
                                 by and between BEI Electronics, Inc. and BEI
                                 Technologies, Inc. dated as of September 26, 1997               (xix)

                 2.7             Agreement Regarding Certain Representations
                                 and Covenants by and between BEI Electronics,
                                 Inc. and BEI Technologies, Inc. dated as of                     (xix)
                                 September 26, 1997

                 3.1             Restated Certificate of Incorporation                             (i)

                 3.2             Amended Bylaws of the Company as of June 30,
                                 1997                                                          (xviii)

                 3.3             Certificate of Designation of Series A Junior
                                 Participating Preferred Stock                                 (xviii)

                 4.1             Reference is made to exhibits 3.1, 3.2 and 3.3

                 4.2             Form of Rights Certificate                                    (xviii)

                                                   52

<PAGE>


                 4.3             Summary of Rights to Purchase Preferred Shares                (xviii)

                10.2  *          Registrant's 1987 Incentive Stock Option Plan, as
                                 amended and standard option grant form used in
                                 connection with the plan                                        (iii)

                10.3  *          Additional standard option grant form used in
                                 connection with Registrant's 1987 Incentive Stock
                                 Option Plan, as amended                                          (ii)

                10.4  *          Registrant's 1987 Supplemental Stock Option
                                 Plan, as amended November 12, 1990, and
                                 standard option grant form used in connection                     (v)
                                 with the plan

                10.5  *          Option grant forms used in connection with
                                 options granted to certain employees on May 1,                    (i)
                                 1989

                10.6  *          Description of Management Incentive Bonus Plan                    (i)

                10.7  *          Consulting Agreement, dated July 3, 1990,
                                 between BEI Electronics, Inc. and George S.                      (iv)
                                 Brown

                10.8  *          Registrant's 1992 Restricted Stock Plan and
                                 standard form of restricted stock agreement used
                                 in connection with the plan                                      (vi)

                10.10            Credit Agreement, dated June 1, 1993, between
                                 BEI Electronics, Inc., Defense Systems Company,
                                 Inc., Motion Systems Company, Inc., New SD,
                                 Inc., BEI Medical Systems Company, Inc. and
                                 Canadian Imperial Bank of Commerce                             (viii)

                10.11  *         Personal Service Contract, dated June 14, 1993,
                                 between BEI Electronics, Inc. and William G.
                                 Howard, Jr.                                                    (viii)

                10.12            First Amendment to Credit Agreement, dated
                                 September 23, 1993, between  BEI Electronics,
                                 Inc., Defense Systems Company, Inc., Motion
                                 Systems Company, Inc., New SD, Inc., BEI
                                 Medical Systems Company, Inc. and Canadian
                                 Imperial Bank of Commerce                                        (ix)

                10.14            1989 Employee Stock Purchase Plan, adopted
                                 June 1, 1989, as Amended through November 18, 1993               (ix)

                                                   53

<PAGE>


                10.15            Second Amendment to Credit Agreement, dated
                                 April 1, 1994, between BEI Electronics, Inc.,
                                 Defense Systems Company, Inc., Motion Systems
                                 Company, Inc., New SD Inc., BEI Medical
                                 Systems Company, Inc. and Canadian Imperial                        (x)
                                 Bank of Commerce

                10.17            Third Amendment to Credit Agreement, dated
                                 September 30, 1994, between BEI Electronics,
                                 Inc., Defense Systems Company, Inc., BEI
                                 Sensors & Systems Company, Inc., BEI Medical
                                 Systems Company, Inc. and Canadian Imperial
                                 Bank of Commerce                                                  (xi)

                10.19            Fourth Amendment to Credit Agreement, dated
                                 June 1, 1995, between BEI Electronics, Inc., BEI
                                 Sensors & Systems Company, Inc., Defense
                                 Systems Company, Inc., BEI Medical Systems
                                 Company, Inc. and Canadian Imperial Bank of                      (xii)
                                 Commerce

                10.20            Fifth Amendment to Credit Agreement, dated June
                                 1, 1996 between BEI Electronics, Inc., BEI
                                 Sensors & Systems Company, Inc.,  Defense
                                 Systems Company, Inc., BEI Medical Systems
                                 Company, Inc. and Canadian Imperial Bank of                      (xiv)
                                 Commerce.

                10.21  *         Extension to Consulting Agreement, effective
                                 June 30, 1996, between BEI Electronics, Inc. and
                                 George S. Brown.                                                  (xv)

                10.22            Sixth Amendment to Credit Agreement, dated
                                 October 31, 1996, between BEI Electronics, Inc.,
                                 BEI Sensors & Systems Company, Inc.,  Defense
                                 Systems Company, Inc., BEI Medical Systems
                                 Company, Inc. and Canadian Imperial Bank of
                                 Commerce.                                                         (xv)

                10.24            Seventh Amendment to Credit Agreement, dated
                                 February 28, 1997 between BEI Electronics, Inc.,
                                 BEI Sensors & Systems Company, Inc., Defense
                                 Systems Company, Inc., BEI Medical Systems
                                 Company, Inc. and CIBC Inc., and Canadian
                                 Imperial Bank of Commerce.                                       (xvi)

                                                   54

<PAGE>


                10.25            Eighth Amendment to Credit Agreement, dated
                                 July 31, 1997, between BEI Electronics, Inc., BEI
                                 Sensors & Systems Company, Inc., Defense
                                 Systems Company, Inc., and CIBC Inc. and
                                 Canadian Imperial Bank of Commerce.                             (xvii)

                10.26            Ninth Amendment to Credit Agreement, dated  
                                 September 19, 1997, between BEI Electronics,
                                 Inc., BEI Sensors & Systems Company, Inc.,  
                                 Defense Systems Company, Inc., and CIBC Inc.
                                 and Canadian Imperial Bank of Commerce.     

                10.27            Rights Agreement dated June 30, 1997 among BEI
                                 Electronics, Inc. and ChaseMellon Shareholder
                                 Services, LLC.                                                 (xviii)

                11.1             Statement regarding computation of per share
                                 earnings

                21.1             Subsidiaries of the Registrant

                23.1             Consent of Ernst & Young, LLP, Independent
                                 Auditors

                24.1             Power of Attorney

                27.1             Financial Data Schedule (EDGAR only)


<FN>
     *         Indicates   management   contracts  or   compensatory   plans  or
               arrangements filed pursuant to Item 601(b)(10) of regulation S-K.

     (i)       Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's   Registration  Statement  on  Form  S-1  (File  No.
               33-29032).

     (ii)      Incorporated  by  reference.  Previously  filed as an  exhibit to
               Amendment  No. 1 to the  Registrant's  Registration  Statement on
               Form S-1 (File No. 33-29032).

     (iii)     Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-Q, dated December 30, 1989.

     (iv)      Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-Q, dated June 30, 1990.

     (v)       Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-K, dated September 29, 1990.

     (vi)      Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's   Registration  Statement  on  Form  S-8  (File  No.
               33-46766).

     (viii)    Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-Q, dated July 3, 1993.

                                       55

<PAGE>


     (ix)      Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-K, dated October 2, 1993.

     (x)       Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-Q, dated April 2, 1994.

     (xi)      Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-K, dated October 1, 1994.

     (xii)     Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-Q, dated July 1, 1995.

     (xiii)    Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-K, dated September 30, 1995.

     (xiv)     Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-Q, dated June 29, 1996.

     (xv)      Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-K, dated September 28, 1996.

     (xvi)     Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-Q, dated March 29, 1997.

     (xvii)    Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Report on Form 10-Q, dated June 30, 1997.

     (xviii)   Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's Current Report on Form 8-K, dated July 30, 1997.

     (xix)     Incorporated by reference.  Previously filed as an exhibit to the
               Registrant's  Current  Report on Form 8-K,  dated  September  27,
               1997.
</FN>
</TABLE>


(b)(1)         A Form 8-K dated  July 2, 1997,  contained  the  Company's  press
               release   announcing   the  formation  of  a  new  company,   BEI
               Technologies,  and  outlining  the  reasons for and manner of the
               proposed  distribution of all the common stock of the new company
               to the holders of the Company's stock.

(b)(2)         A Form 8-K dated June 30, 1997,  was filed to report the adoption
               of a Share  Purchase  Rights Plan and the  description,  term and
               form of the Rights.

               The Company also reported its press release of July 2, 1997,  and
               its Amended and Restated Bylaws.

                                       56

<PAGE>


                                   SIGNATURES

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


                                               BEI Medical Systems Company, Inc.

                                        By:    /s/ Thomas W. Fry
                                               ---------------------------------
                                               Thomas W. Fry
                                               Vice President of Finance and
                                               Administration, Secretary & 
                                               Treasurer

                                               December 22, 1997

                                       57

<PAGE>


                                POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE  PRESENTS,  that each person whose  signature  appears
below  constitutes and appoints Charles Crocker and Gary D. Wrench,  and each of
them, as his true and lawful  attorneys-in-fact  and agents,  with full power of
substitution and  resubstitution,  for him and in his name, place, and stead, in
any and all  capacities,  to sign any and all  amendments  to this Report and to
file the same,  with all exhibits  thereto,  and other  documents in  connection
therewith,  with the  Securities  and Exchange  Commission,  granting  unto said
attorneys-in-fact  and agents,  and each of them, full power and authority to do
and perform each and every act and thing  requisite  and necessary to be done in
connection therewith,  as fully to all intents and purposes as he might or could
do in person,  hereby  ratifying and confirming all that said  attorneys-in-fact
and agents,  or any of them,  or their or his  substitute  or  substitutes,  may
lawfully do or cause to be done by virtue hereof.

<TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following  persons on behalf of the  Registrant and
in the capacities and on the dates indicated.


<CAPTION>
Signature                                       Title                                      Date
---------                                       -----                                      ----
<S>                                             <C>                                        <C>
/S/Charles Crocker                              Chairman of the Board of                   December 22 , 1997
--------------------------------------          Directors
(Charles Crocker)                     

/S/Thomas W. Fry                                Vice President of Finance and              December 22, 1997
--------------------------------------          Administration, Secretary
(Thomas W. Fry)                                 and Treasurer

/S/Ralph M. Richart                             Director                                   December 22 , 1997
--------------------------------------
(Ralph M. Richart)

/S/Richard W. Turner                            President, Chief Executive                 December 22 , 1997
--------------------------------------          Officer & Director
(Richard W. Turner)                   

/S/Lawrence A. Wan                              Director                                   December 22 , 1997
--------------------------------------
(Lawrence A. Wan)

/S/Gary D. Wrench                               Director                                   December 22 , 1997
--------------------------------------
(Gary D. Wrench)
</TABLE>

                                                        58

<PAGE>


<TABLE>
                                                                                                                         SCHEDULE II

                                                  BEI MEDICAL SYSTEMS COMPANY, INC.
                                                          ----------------
                                                  VALUATION AND QUALIFYING ACCOUNTS


<CAPTION>
 Column A                                               Column B                Column C                   Column D         Column E
-----------                                             ---------      ---------------------------        ----------        --------
                                                                               Additions
                                                                       ---------------------------
                                                        Balance at   Charged to          Charged to                          Balance
                                                        Beginning     Costs and            Other                           at End of
Description                                             of Period      Expenses           Accounts        Deductions          Period
-----------                                             ---------      --------           --------        ----------          ------
(in thousands)
<S>                                                       <C>           <C>               <C>               <C>               <C>   
Year ended September 27, 1997:
Deducted from asset accounts:
Allowance for doubtful accounts                           $  236        $   57            $ --              $  181(B)         $  112
Valuation allowances of deferred
    tax assets                                               929           855(A)           --                --               1,784
Valuation allowances of
    discontinued operations                                  701            75               (94)              682              --
                                                          ------        ------            ------            ------            ------
      Total                                               $1,866           987            $  (94)           $  863            $1,896
                                                          ======        ======            ======            ======            ======

Year ended September 28, 1996:
Deducted from asset accounts:
Allowance for doubtful accounts                           $   56        $   39            $  162(E)         $  (21)(B)        $  236

Valuation allowance for deferred
    tax assets                                             1,077                            (148)(D)                             929
Valuation allowances of
    discontinued operations                                  538           282               (49)               70               701
                                                          ======        ======            ======            ======            ======
      Total                                               $1,671        $  321            $ (197)           $  103            $1,866
                                                          ======        ======            ======            ======            ======

Year ended September 30, 1995:
Deducted from asset accounts:
Allowance for doubtful accounts                           $   83        $   26            $ --              $   53(C)         $   56
Valuation allowance for deferred
    tax assets                                               603           474              --                --               1,077
Valuation allowances of
    discontinued operations                                  315           262              --                  39               538
                                                          ------        ------            ------            ------            ------
      Total                                               $1,001        $  762            $ --              $   92            $1,671
                                                          ======        ======            ======            ======            ======

<FN>
(A)      Allowance  adjustment resulting from evaluation of the realizability of
         the related deferred tax assets

(B)      Uncollectible accounts written off

(C)      Miscellaneous adjustments to the allowance

(D)      Adjustment  based on evaluation of  uncertainties in the realization of
         state net operating loss carryovers

(E)      Purchased allowance from acquisition

</FN>
</TABLE>

                                                                 S-1

                                                                 59

<PAGE>


REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS, AS TO SCHEDULE


The Board of Directors and Shareholders
BEI Medical Systems Company, Inc.

We have audited the  consolidated  financial  statements of BEI Medical  Systems
Company,  Inc.  (formerly  BEI  Electronics,  Inc.) as of September 27, 1997 and
September  28,  1996,  and for  each of the  three  years  in the  period  ended
September 27, 1997,  and have issued our report  thereon dated November 7, 1997.
Our  audits  also  included  the  financial  statement  schedule  listed in Item
14(a)(2) of this Form 10-K. This schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits.

In our  opinion,  the  financial  statement  schedule  referred  to above,  when
considered  in  relation  to the basic  financial  statements  taken as a whole,
presents fairly in all material respects, the information set forth therein.


                                                          Ernst & Young LLP

San Francisco, California
November 7, 1997

                                       S-2

                                       60

<PAGE>


               CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS


We consent to the incorporation by reference in the Registration Statement (Form
S-8 No.  33-31459),  as amended,  pertaining to the 1982 Incentive  Stock Option
Plan,  the Amended 1987 Stock Option Plan,  and the 1989 Employee Stock Purchase
Plan of BEI Medical Systems Company,  Inc. (formerly BEI Electronics,  Inc.), of
our reports dated November 7, 1997, with respect to the  consolidated  financial
statements and schedule of BEI Medical  Systems  Company,  Inc.  included in the
Annual Report (Form 10-K) for the year ended September 27, 1997.


                                                           Ernst & Young LLP

San Francisco, California
December 19, 1997

                                       S-3

                                       61

<PAGE>


INDEX TO EXHIBITS


Exhibit
 Number  Description
 ------  -----------

 10.26   Ninth amendment to credit agreement

 11.1    Statement regarding computation of per share earnings

 21.1    Subsidiaries of the Registrant

 23.1    Consent of Ernst & Young LLP,  Independent  Auditors (Reference is made
         on page 61 within the 10-K)

 24.1    Power of Attorney (Reference is made on page 58 within the 10-K)

 27.1    Financial Data Schedule

                                       62