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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

         ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1997

                         Commission file number 0-27242

                    PHYSIO-CONTROL INTERNATIONAL CORPORATION
             (Exact name of registrant as specified in its charter)

          Washington                                          91-1673799
      (State or other jurisdiction of                       (I.R.S. Employer
      incorporation or organization)                       Identification No.)

    11811 Willows Road N.E., Redmond, WA                          98052
  (Address of principal executive offices)                      (Zip Code)

Registrant's telephone number, including area code: (425) 867-4000

        Securities registered pursuant to Section 12(b) of the Act: None

        Securities registered pursuant to Section 12(g) of the Act:

                   Common Stock, par value $0.01 per share
                                (Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.

                                    Yes  x     No
                                        ----      ----

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ( )

The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 2, 1998, at a closing sale price of $18.62 as reported
by the Nasdaq National Market was approximately $324,396,690.

As of March 2, 1998, the registrant had 17,558,625 shares of Common Stock,
par value $0.01 per share, outstanding.

                      Documents Incorporated by Reference

Portions of the Registrant's Proxy Statement to be used in connection with
the solicitation of proxies for the 1998 Annual Meeting to be held in May
1998 are incorporated by reference in Part III, Items 11-13.

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                    PHYSIO-CONTROL INTERNATIONAL CORPORATION

                       INDEX TO ANNUAL REPORT ON FORM 10-K

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                                                                                                    Page No.

                                                  PART I
<S>        <C>                                                                                      <C>
Item 1.    Business................................................................................     3
Item 2.    Properties..............................................................................    11
Item 3.    Legal Proceedings.......................................................................    11
Item 4.    Submission of Matters to a Vote of Security Holders.....................................    11

                                                 PART II

Item 5.    Market for the Registrant's Common Equity and Related Stockholder Matters...............     12
Item 6     Selected Financial Data.................................................................     13
Item 7.    Management's Discussion and Analysis of Financial Condition and
           Results of Operations...................................................................     15
Item 8.    Financial Statements and Supplementary Data.............................................     20
Item 9.    Changes in and Disagreements with Accountants on Accounting
           and Financial Disclosure................................................................     40

                                                PART III

Item 10.   Directors and Executive Officers of the Registrant......................................     41
Item 11.   Executive Compensation...................................................................     *
Item 12.   Security Ownership of Certain Beneficial Owners and Management...........................     *
Item 13.   Certain Relationships and Related Transactions...........................................     *

                                                 PART IV

Item 14.   Exhibits, Financial Statement Schedules and Reports on Form 8-K.........................     43

</TABLE>


*  Incorporated by reference to the Company's Proxy Statement which the
   Company will file with the Commission on or before April 3, 1998, pursuant
   to General Instruction 6(3) to Form 10-K.

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Business

Physio-Control International Corporation (the "Company") designs,
manufactures, markets and services an integrated line of noninvasive
emergency cardiac defibrillator and vital sign assessment devices, disposable
electrodes and data management software. The Company's products are used in
both out-of-hospital and hospital settings for the early detection and
treatment of life threatening events including trauma, heart attack and the
acute heart rhythm disturbances of ventricular fibrillation, tachycardia and
bradycardia. The Company established the market for noninvasive emergency
cardiac defibrillators with the introduction of the first commercially
available, direct current external defibrillation device for hospital use in
1961. Since that time, the Company has developed a full product line to meet
the needs of a broad spectrum of users including first responders, emergency
medical technicians ("EMTs"), paramedics, hospital code teams, critical care
nurses and physicians.

The Company was founded in 1955 by a renowned cardiac surgeon, Dr. William
Edmark, who sought to reduce deaths related to cardiac arrest. The Company
was a publicly traded corporation from 1971 through 1980 and, from 1980 to
mid-1994, operated as a wholly owned subsidiary of Eli Lilly and Company
("Lilly"). On July 29, 1994, the stock of the Company and certain other
related assets were purchased from Lilly in an acquisition led by affiliates
of Bain Capital, Inc. and certain other investors. In December 1995, the
Company again became a publicly traded corporation upon the completion of an
initial public offering of 13,421,650 shares of its Common Stock. As used
herein, the term "Company" refers to Physio-Control International Corporation
and its subsidiaries, and the term "Predecessor" refers to the Company during
the period in which it was a wholly owned subsidiary of Lilly.

Physio Control-Registered Trademark-, PHYSIO-CONTROL-Registered Trademark-,
LIFEPAK-Registered Trademark-, and FIRST MEDIC-Registered Trademark- are
registered trademarks of the Company. QUIK-COMBO-TM-, QUIK-VIEW-TM-,
QUIK-STAT-TM-, Shock Advisory System-TM-, LIFENET-TM-, and CODE-STAT-TM- are
trademarks.

Background

Cardiac defibrillator and vital sign assessment devices are used in a variety
of emergency situations for the early detection, assessment and treatment of
life threatening events arising from heart disease and trauma. The most
important factor in successfully treating a life threatening emergency is
time. In an emergency situation, the first action of a caregiver is usually
an assessment of the patient's vital signs. Therefore, it is critical to have
these assessment and treatment devices readily available. Trauma is one of
the leading causes of death in the U.S. Although various conditions are
associated with trauma, the most serious are shock and cardiac arrest.
Assessment of heart rhythms and blood pressure is crucial to determine
whether a patient is in shock or cardiac arrest.

The Marketplace

The Company estimates that the 1997 worldwide market for emergency cardiac
defibrillator and vital sign assessment devices, including service and
supplies, was approximately $425 million. The market can be described in
terms of the U.S. out-of-hospital market (1997 sales of approximately $115
million), the U.S. hospital market (1997 sales of approximately $105
million), and the international market (1997 sales of approximately $205
million).

U.S. Out-of-Hospital Market. This market can be characterized in several
distinct segments, typically defined by the skill level of the device user:

Advanced Life Support ("ALS"). The ALS market consists of a highly skilled
paramedic group. Paramedics generally receive over 1,500 hours of training in
emergency medicine including assessment and treatment of trauma. The ALS
market demands durable and reliable products that are suitable for a
high-use, harsh

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environment. Cardiac defibrillator and vital sign assessment devices sold to
this market include manual defibrillation, cardioversion, pacing, 12-lead and
other vital sign assessment capabilities.

Basic Life Support ("BLS"). The BLS market consists of both EMTs and other
medically trained caregivers who are likely to have the first contact with a
patient in an emergency. These individuals include firefighters and others
with limited training in defibrillation therapy. Cardiac defibrillator and
vital sign assessment devices sold to this user group generally do not
include pacing, cardioversion capability or 12-lead assessment. In this
segment, users rely on arrhythmia detection software for automated detection
and semi-automated delivery of defibrillation therapy.

First Responder. The first responder market consists of minimally trained
personnel such as security personnel, flight attendants and extended care
facility staff. While the potential size of this market is substantial, the
market is currently in the early development stages. Cardiac defibrillator
and vital sign assessment devices sold to this user group must be easy to
use, rely on voice-prompted protocols that assume little user training, must
be low maintenance and incorporate long battery life as well as automated
self-testing that alerts users to electromechanical problems or a low battery
condition. The Company introduced the LIFEPAK 500 automatic external
defibrillator in early 1997 to service this market group. To date, the
Company has received orders for over 7,500 units of the LIFEPAK 500 automated
external defibrillator (AED).

U.S. Hospital Market. Hospitals have traditionally been the largest users of
cardiac defibrillator and vital sign assessment devices both for patients
admitted for chest pain and for patients undergoing treatment for other
reasons. Many hospital procedures such as surgery, cardiac catheterization,
stress testing and general anesthesia place the patient at increased risk for
arrhythmias or cardiac arrest. Hospitals frequently use cardiac defibrillator
and vital sign assessment devices on a standby basis in connection with these
procedures. Since immediate treatment is a critical factor for successful
cardiac resuscitation, cardiac defibrillator and vital sign assessment
devices are placed throughout the hospital, including cardiac and critical
care units, emergency rooms, operating rooms, electrophysiology laboratories
and increasingly in general wards. Hospitals also use portable devices during
in-hospital transportation of patients.

International Market. The international market is segmented into developed
markets such as Europe, Australia and Japan, and emerging markets, such as
Eastern Europe, China, India and Latin America. The Company's non-U.S. sales
have principally occurred in developed markets where growth is driven by the
development of out-of-hospital emergency services similar to those which have
developed in the U.S. out-of-hospital market during the past 15 years. In
emerging markets, growth is driven by the development of basic medical
facilities that typically require emergency cardiac defibrillator and vital
sign assessment devices.

Products

The Company's current devices include the LIFEPAK 9, the LIFEPAK 10, the
LIFEPAK 11, the LIFEPAK 12, the LIFEPAK 300, the LIFEPAK 500, and the FIRST
MEDIC products. All are noninvasive external defibrillator and vital sign
assessment devices, some having optional noninvasive pacing and shock
advisory. The Company also offers tools for data management through its
CODE-STAT products. The Company has consistently supported all product
introductions and enhancements with extensive support documentation and
training.

The Company's products are designed to maintain functional compatibility with
its installed base of over 200,000 units through the use of common device
controls, electrodes, protocols, batteries and data management software. The
cost and time involved in training caregivers to use devices such as those
sold by the Company are significant. The Company's current focus on
functional compatibility between old and new products is important in
reducing the need to provide additional training and in reducing the risk of
associated user error. In addition, the Company's defibrillation and vital
sign assessment devices record the patient data monitored and action taken by
the caregiver for post-event review by an EMS medical director or other
responsible parties, thereby permitting post-event monitoring of caregiver
performance and product effectiveness.

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Defibrillator Products

The LIFEPAK 9 family of products combines cardiac vital sign assessment and
manual defibrillation. The products are also available with external
noninvasive pacing and an automated Shock Advisory System (to allow use by
minimally trained personnel). These products can be configured to provide
monitoring, defibrillation and pacing through a single pair of disposable
QUIK-COMBO electrodes. The LIFEPAK 9 products are targeted to the hospital
where they are used in the emergency room, special procedure rooms, critical
care units and general floors. These products are also used in surgical
centers, clinics and physician offices.

The LIFEPAK 10 family of portable products combines a cardiac vital sign
assessment device with manual defibrillation. The products are available with
external noninvasive pacing and QUIK-COMBO electrode capability. The LIFEPAK
10 unit is used primarily in the out-of-hospital ALS market and for transport
of patients within the hospital.

The LIFEPAK 11 unit is an advanced, portable product for the ALS market that,
in addition to manual defibrillation and noninvasive pacing capabilities,
also includes diagnostic 12-lead ECG capability. This product has made the
Company the leader in field collected diagnostic ECGs, which allow for
earlier diagnosis and faster treatment of myocardial infarctions.

The LIFEPAK 12 defibrillator/monitor provides therapeutic and diagnostic
functions in a single small device designed for both out-of-hospital and
hospital users. This new and innovative platform design provides ease of use
and the flexibility to add new features and enhancements at a future date.
Configurable options include automated and manual defibrillation, pacing,
pulse oximetry and interpretive 12-lead ECG analysis. Additional parameters
under development include non-invasive blood pressure, end-tidal CO2 and
invasive pressures. The Company obtained U.S. Food and Drug Administration
("FDA") approval under Section 510(k) in January 1998 for the LIFEPAK 12
defibrillator/monitor.

The LIFEPAK 300 defibrillator is a portable product that combines a cardiac
vital sign assessment device with a manual and automated defibrillator. This
product incorporates the Shock Advisory System, which supports its use as an
automated defibrillator by minimally trained personnel. While the LIFEPAK 300
unit is targeted for the BLS market, it can also be operated in manual mode
by ALS personnel. The product also includes event documentation capability
and a data management software package for use by a medical director for
efficient quality assurance.

The LIFEPAK 500 AED is a lightweight automated device that is designed to be
used by first responders to cardiac emergencies. This rugged device is
extremely portable at only seven pounds. Low maintenance requirements and
simple operation make it the ideal product for the first responder market.

The FIRST MEDIC 510 product is a portable automated defibrillator designed
primarily for EMT and fire department first responders. The product also
includes event documentation capability and a data management software
package for use by a medical director for efficient quality assurance.

The FIRST MEDIC 710 defibrillator is a portable product that combines a
cardiac vital sign assessment device with manual and automated defibrillation
for mixed BLS and ALS systems. The product is designed as a platform product
to incorporate additional assessment capabilities utilized by the ALS market
such as oximetry (for determining the amount of oxygen being carried in the
blood). This device can be used in either the manual or semi-automatic mode
at the option of the caregiver and is therefore attractive to mixed ALS/BLS
applications. The product also includes event documentation capability and
data management software for use by a medical director for efficient quality
assurance.

Other Products

The Company's QUIK-COMBO electrodes allow customers to upgrade from
traditional single function electrodes to multiple function electrodes
permitting the Company's pacing products to pace, defibrillate, and monitor
electrocardiograms through a single pair of electrodes. QUIK-COMBO electrodes
are compatible

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across the LIFEPAK product lines, enabling continuity of care from first
responders to BLS providers to ALS providers to hospital providers. With this
product, caregivers can provide one set of electrodes which remain with the
patient through different levels of care.

The Company's CODE-STAT data management system, a Windows(TM) based software
program, allows users to conduct post-event review and analyze system data.
This software stores data from the LIFEPAK 11 diagnostic cardiac monitor and
LIFEPAK 300 devices. The CODE-STAT system extends the Company's data
management product line, which began with the introduction of the QUIK-VIEW
data review system and the QUIK-STAT statistical report generator in 1988.

A significant upgrade to the CODE-STAT product line will be available
approximately mid-1998. CODE-STAT Suite data management platform provides
quality assessment and system performance analysis and offers post event
viewing, storage and report generation for both continuous and static
waveforms. Optional modules will include Utstein, chest pain and response
time reporting. The Suite is compatible with LIFEPAK 500, 11 and 12 products.
Future iterations will continue to enhance the utility of the LIFENET system
discussed below.

The Battery Support System 2 is an intelligent, highly automated system which
recognizes and optimizes maintenance of both NiCd (FASTPAK and FASTPAK 2) and
Sealed Lead-Acid (LIFEPAK SLA) chemistry batteries. All battery wells allow
charging, conditioning and shelf life testing. The FASTPAK 2 battery provides
an immediate battery capacity reading at the push of a button. It is designed
to be used with the LIFEPAK 12, 11, 10 and 5 products.

The LIFENET system is a data management solution which includes LIFEPAK
medical devices and the CODE-STAT Suite. By working with the Company, other
manufacturers' data management systems can become LIFENET compatible. The
system will be compatible with the MUSE CV(R) cardiovascular information
system from Marquette Medical Systems.

Service

The Company provides extensive, high quality, direct, on-site and depot
service in the U.S. and in Western Europe through a dedicated service team of
more than 150 individuals. The Company believes its service force is the
industry's only direct field service organization for the out-of-hospital
market segment. The Company also provides comprehensive service in other
markets through a network of third-party service partners. Service is
provided under the Company's standard product warranties which generally
range from 90 days to five years, through annual service contracts which the
Company sells to its customers for a fixed fee and upon request for repair
services. The services provided include repair service, scheduled preventive
maintenance, product technical support and technical training. In the
hospital market, in addition to on-site service, the Company provides support
to hospital maintenance staff in the form of parts sales, product training
programs and technical support.

Product Development

The Company's product development efforts include products for the hospital,
ALS, BLS and first responder market segments, as well as data management
software. The majority of the product development effort is focused on
product enhancements and new products which span the entire spectrum of
anticipated customer and clinical needs in all resuscitation and emergency
vital sign assessment market groups. The Company's product development
strategy is based on developing product platforms which have the flexibility
to be configured to respond to a variety of customer requirements. The
Company believes this strategy provides an opportunity to reduce the cost of
developing new products for use in multiple market segments.

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Sales and Marketing

The Company sells its broad product line across a diverse global customer
group, including individual hospitals, hospital buying groups, fire
departments, EMS departments, governments, militaries, as well as alternative
healthcare delivery sites including surgery centers and sub-acute care
centers. With the 1997 introduction of the LIFEPAK 500 AED, the Company's
customer base has now been expanded to include minimally trained first
responders such as police officers and security personnel.

The Company's marketing strategy is to target specific customer groups, as
well as align itself with strategic partners that will broaden the market
spectrum through joint sales and distribution agreements. During February
1997 the Company also announced a sales, marketing and technology transfer
alliance with Marquette Medical Systems, Inc. located in Milwaukee,
Wisconsin. Marquette is a market leader in the diagnostic cardiology, patient
monitoring and clinical information system markets. In late 1996 the Company
announced a sales and marketing alliance with Ambu International A/S, a
Danish company engaged in the development, manufacture and sale of airway
management products and CPR training devices for the emergency medical
market. Ambu's products are sold throughout the world. The Company has been
very successful during 1997 in marketing Ambu products in the U.K., and has
begun distribution of Ambu products in several other European markets.
Through these strategic alliances, the Company has positioned itself to
provide integrated products and clinical data management capabilities, from
the point of first intervention at the scene of a medical emergency, through
the point of final treatment.

The Company principally sells its products through a direct sales force in
the U.S. The Company's U.S. sales organization consists of approximately 105
individuals, principally comprised of a direct field sales force located
around the country, a dedicated national accounts team and a telemarketing
and customer support group. In early 1998, the Company realigned its direct
sales force into a hospital and an out-of-hospital focus. The Company
believes that this segregation will allow the sales organization to
specialize in each of the market segments, penetrate the market in a more
efficient manner, and provide the best customer service. In addition, the
Company has executed a limited number of distribution agreements with third
parties to service the alternate U.S. site market which includes doctors'
offices, surgery centers, sub-acute care centers and industrial accounts.
This alternative distribution channel is intended to penetrate the numerous
sites where the Company's sales force does not currently focus.

The Company's purchasing agreements with ten major hospital buying groups
cover approximately 75% of U.S. hospital beds. In addition, the Company has
agreements with the U.S. government and several major ambulance companies.
The Company believes these purchasing agreements contribute to growth
opportunities within the evolving managed care environment. For the year
ended December 31, 1997, domestic sales accounted for approximately 71% of
the total net revenues.

In the international market, the Company sells through both a direct sales
force and through distributors. The Company's international direct sales
force consists of a team of approximately 50 individuals located in Canada,
United Kingdom, Eastern Europe, France, Spain, Italy, Sweden, Finland,
Netherlands, Germany and Austria. The Company sells its products in other
geographical areas such as Japan, Asia Pacific, Australia, the Middle East
and Latin America using distribution partners, many of whom have been selling
the Company's products for more than ten years. The Company also invested in
the Chinese marketplace during 1996 by establishing a representative office
in Beijing and developed alliances with three distribution partners in major
regions of China. For the year ended December 31, 1997, international sales
accounted for approximately 29% of total net revenues.

Research and Development

As of December 31, 1997, the Company had an in-house research and development
staff of approximately 200 engineers and technicians. Product development
work is driven by small, dedicated teams which have overall responsibility
for the development of new products. These teams are supported by a strong
functional network of technical specialists who maintain expertise in
specific technologies such as software engineering,

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mechanical design engineering and electrical design engineering. The work of
this organization is complemented by a number of external, proprietary
development relationships, focused primarily on the development of
non-critical support or ancillary products. During the three years ended
December 31, 1997, 1996 and 1995, the Company's expenditures for research and
development totaled $21.0 million, $18.8 million and $19.5 million,
respectively.

To enhance its research and development capabilities, the Company has
developed close alliances with several leading research institutions and
universities. Currently, the Company supports basic research in the areas of
cardiac predictive and assessment algorithms, cardiac assessment models and
new waveform and energy transfer techniques.

Competition

The cardiac defibrillator and vital sign assessment device market is highly
competitive. The Company competes with many companies, some of which may have
access to greater financial and other resources than the Company. The
Company's primary domestic competitors include Hewlett-Packard Co., Zoll
Medical Corporation, Laerdal Medical Corporation, Heartstream, Inc., and
SurVivaLink. International competitors also include Nihon-Kohden, Corpuls,
Bruker-Odam, and Hellige.

The Company believes that the principal competitive factors for cardiac
defibrillator and vital sign assessment devices are ease of use,
compatibility with existing equipment, durability and technical support. In
the out-of-hospital market, additional factors include reliability of the
product and battery system, portability, automation, multi-parameter
capability, data management, as well as field service and training. The
Company believes that its products compete favorably in these areas.

Government Regulation

As a manufacturer of medical devices, the Company is subject to regulation
by, among other governmental entities, the FDA and the corresponding agencies
of foreign countries in which the Company sells its products. These
regulations govern the introduction of new medical devices, the maintenance
of certain records, the tracking of device location and other matters.
Noncompliance with applicable requirements can result in warning letters,
fines, injunction, civil penalties, recall or seizure of products, total or
partial suspension of production, failure of the government to grant
premarket clearance or premarket approval for a device, and criminal
prosecution. The Company believes that it is in substantial compliance with
all such governmental regulations.

FDA Regulation. The FDA requires that prior to introducing any medical device
in the U.S. market, the manufacturer of such device must secure either a
premarket notification clearance pursuant to Section 510(k) of the Federal
Food, Drug, and Cosmetic Act (a "510(k) clearance") or an approved premarket
approval application. A 510(k) clearance indicates that the FDA agrees with
an applicant's determination that the product for which clearance has been
sought is substantially equivalent to a legally marketed medical device. In
addition to requiring clearance or approval for new products, the FDA may
require clearance or approval prior to marketing products that are
modifications of existing products or that change the intended use of
existing products.

To date, the Company has obtained FDA marketing clearances only through the
510(k) clearance process. There can be no assurance that all necessary
approvals will be granted on a timely basis or at all. It is possible that
delays in receipt of or failure to receive any necessary clearance or
approval could have a material adverse effect on the Company. For any device
that is cleared through the 510(k) process, changes or modifications that
could significantly affect safety or effectiveness, or make a major change in
the intended use of the device, require a new 510(k) notification submission.

The Company is required to register with the FDA as a device manufacturer and
is required to comply with the FDA's good manufacturing practices ("GMP")
regulations. These regulations require that the Company

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manufacture its products and maintain its records in a prescribed manner with
respect to manufacturing, testing and control activities. Further, the
Company is required to comply with FDA requirements for labeling and
promotion of its products. The FDA's medical device reporting ("MDR")
regulations require that the Company provide information to the FDA whenever
there is an assertion which reasonably suggests that one of its devices may
have caused or contributed to a death or serious injury, or that a
malfunction has occurred that would be likely to cause or contribute to a
death or serious injury if the malfunction were to reoccur. Due to the large
number of the Company's products already in use and the fact that these
products are frequently used in an attempt to resuscitate patients who are
already clinically dead, the Company regularly submits MDRs to the FDA and
expects to continue to do so.

Medical device manufacturers are routinely subject to periodic inspections by
the FDA. If the FDA believes that a company may not be operating in
compliance with applicable laws and regulations, it can place the company
under observation and re-inspect the facilities; issue a warning letter
apprising of violative conduct; detain or seize products; mandate a recall;
enjoin future violations, and assess civil and criminal penalties against the
company, its officers or its employees. Failure to comply with regulatory
requirements or any adverse regulatory action could have a material adverse
effect on the Company.

Product Recalls. The Company manufactures critical medical devices and has a
strong commitment to providing highly reliable products. On occasion, the
Company has, on its own initiative or in response to customer or FDA
concerns, taken voluntary action to modify and upgrade customer products at
the Company's expense or provide instructional information to customers to
optimize the reliability of its products. Under the medical device
regulations, several of these actions have been classified as "recalls" or
"safety alerts" by the FDA. While the FDA has regulatory authority to mandate
medical device recalls of any manufacturer, all of the Company's product
upgrades have been voluntary. To date, no such recall or safety alert has had
a material adverse impact on the Company, although there can be no assurance
that future recalls or safety alerts would not have such an effect.

International Regulation. Medical device laws and regulations are also in
effect in many of the countries in which the Company does business outside
the U.S. These laws and regulations range from comprehensive device approval
requirements for some or all of the Company's medical device products to
simple requests for product data or certifications. The number and scope of
these requirements are increasing. International sales of certain medical
devices manufactured in the U.S. but not approved by the FDA for distribution
in the U.S. are subject to FDA export requirements. Thus, failure to comply
with applicable international or FDA regulations could have a material
adverse effect on the Company.

FDA Consent Decree. In July 1992, the FDA filed a civil complaint against the
Company for alleged violations of the GMP and MDR regulations. The complaint
alleged, among other things, violations of the FDA's GMP regulations relating
to the methods used in, and the facilities and controls used for, the
manufacture, packing and storage of Company devices and the FDA's MDR
regulations relating to the failure to submit reports to the FDA. The Company
did not agree with the allegations and voluntarily entered into a consent
decree for mutual resolution of the complaint. The terms of the consent
decree had a material adverse effect on the Company. The Company, however,
has met all obligations of the consent decree. It has no substantive ongoing
impact on the Company's operations so long as the Company maintains
compliance with applicable GMP and MDR regulations.

The laws and regulations applicable to the manufacture and sale of medical
devices and other aspects of the Company's business and the level of
enforcement thereof are subject to change. Any changes in the FDA's laws and
regulations or noncompliance with the Consent Decree could have a material
adverse effect on the Company.

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Intellectual Property

The Company believes that patents and other proprietary rights are important
to its business and relies upon them to develop and maintain its competitive
position. The Company currently holds numerous U.S. and foreign patents and
patent applications which relate to aspects of the technology used in the
Company's products. There can be no assurance that patent applications filed
by the Company will result in the issuance of patents or that any of the
Company's intellectual property will provide competitive advantages for the
Company's products or will not be challenged or circumvented by others.

The Company also relies upon trade secrets and proprietary technology for
protection of its confidential and proprietary information. There can be no
assurance that others will not independently develop substantially equivalent
proprietary information or techniques or that third parties will not
otherwise gain access to the Company's trade secrets or disclose such
technology. It is the Company's policy to require its employees, consultants,
outside collaborators, advisors and vendors to execute confidentiality
agreements. These agreements generally require that all information provided
by the Company be kept confidential and not be disclosed to third parties,
except in specific circumstances. In the case of employees and consultants,
the agreements generally provide that all technology and confidential
information relating to the Company's business that is developed while
rendering services for the Company will be the exclusive property of the
Company. There can be no assurance, however, that these agreements will
provide meaningful protection or adequate remedies for the Company's trade
secrets in the event of disclosure of such information.

Employees

As of December 31, 1997, the Company had approximately 840 full-time
employees. The Company considers its employee relations to be good.

Environmental Compliance

The Company is subject to various federal, state and local laws and
regulations relating to the protection of the environment. In the course of
its business, the Company is involved in the handling, storing and disposal
of materials which are classified as hazardous; however, it does not
anticipate that any related expenditures or expenses will have a material
adverse effect on its business, financial condition or results of operations.

Product Liability Exposure

The design, manufacture and marketing of medical devices produced by the
Company entail an inherent risk of product liability. The Company's principal
products are designed for use in the detection of abnormal heart rhythm
disturbances and for use in applying electrical therapy to restore or
maintain appropriate heart rhythms. As such, the Company's products are most
often used in emergency response settings, both in out-of-hospital and
hospital settings.

While the Company believes that, based on claims made against the Company in
the past, the amount of product liability insurance maintained by the Company
is adequate, there can be no assurance that the amount of such insurance will
be sufficient to satisfy claims made against the Company in the future or
that the Company will be able to maintain insurance in the future at
satisfactory rates or in adequate amounts. Product liability claims could
result in costs or litigation and could have a material adverse effect on the
business and the financial condition of the Company. In addition, the Company
is required, under certain of its contractual agreements, to indemnify third
parties against certain product liability claims.

Seasonality

The Company has not experienced significant seasonality over the past three
fiscal years.

                                       10

<PAGE>

Backlog

The Company's product backlog at December 31, 1997 and 1996 was $5.6 million
and $9.9 million, respectively.

Foreign and Domestic Operations

The information relating to the foreign and domestic operations of the
Company required by Item 1 is set forth in "Item 8, Financial Statements and
Supplementary Data."

Item 2. Properties.

The Company's manufacturing operations are carried out in an approximate
100,000 square foot owned facility located at the Company's headquarters in
Redmond, Washington. The Company believes that its current facility will be
sufficient to meet all of its manufacturing capacity requirements in the
foreseeable future.

The Company's European headquarters is an 8,000 square foot leased facility
located in the United Kingdom. The Company also leases certain facilities for
use as sales and service offices in the United States and throughout the
world.

Item 3. Legal Proceedings.

The Company is party to certain legal actions arising in the ordinary course
of its business. Based on information presently available to the Company, the
Company believes that it has adequate legal defenses or insurance coverage
for these actions, and the ultimate outcome of these actions will not have a
material adverse effect on the Company. In November 1995, the Company
initiated litigation in Washington State Court against Heartstream, Inc.
("Heartstream"), a company formed to develop, manufacture and market
defibrillators, as well as certain individuals who were formerly employed by
the Company and who are founders of and employees of Heartstream. The Company
claimed that Heartstream and such individuals had, among other things,
misappropriated certain of the Company's intellectual property and that such
individuals breached contractual obligations to the Company. In addition,
Heartstream initiated litigation against the Company in January 1997 alleging
that the Company had infringed a Heartstream patent related to product
self-test features. The Company filed an answer denying Heartstream's claims
and alleged certain counterclaims against Heartstream for infringement of a
Company self-test patent.

Effective as of October 10, 1997, the Company and Heartstream have entered
into a settlement agreement under which the referenced lawsuits have been
dismissed with prejudice and all outstanding claims between the parties have
been settled on mutually acceptable terms. The terms of the settlement are
confidential.

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

There were no matters submitted to the stockholders of the Company for action
in the fourth quarter of 1997.

                                       11

<PAGE>

                                     PART II

Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters.

The following table sets forth on a per share basis, the high and low closing
sale prices per share for the Common Stock as reported by the Nasdaq National
Market during 1997 and 1996.

<TABLE>
<CAPTION>

                                 High                 Low
                              --------            --------
<S>                             <C>                 <C>
    1997
--------------
First Quarter                   23 1/2              13 1/4
Second Quarter                  15 1/4              11 3/8
Third Quarter                   19 1/8              12 1/2
Fourth Quarter                  17 1/2              14 1/2


    1996
--------------
First Quarter                    22 1/2             17 1/2
Second Quarter                   23 3/4             17 1/8
Third Quarter                    25 1/4             15 3/8
Fourth Quarter                   24 1/8             18 1/4

</TABLE>

As of March 2, 1998, the Company's Common Stock was held by approximately 104
holders of record. The Company believes, however, it has a significantly
greater number of beneficial owners.

The Company does not presently intend to pay any cash dividends on the Common
Stock in the foreseeable future. Payment of future dividends, if any, will be
at the discretion of the Company's Board of Directors after taking into
account various factors, including the Company's financial condition,
operating results, current and anticipated cash needs and plans for
expansion. Furthermore, as a holding company, the ability of the Company to
pay dividends in the future is dependent upon the receipt of dividends or
other payments from its operating subsidiaries. Such operating subsidiaries
are currently prohibited under the Company's bank credit agreement from
declaring or paying any cash dividends or otherwise transferring any cash to
the Company for the purpose of paying dividends to the holders of Common
Stock.

                                       12

<PAGE>


Item 6. Selected Financial Data.

Income Statement Data (1)

(dollars in thousands, except share and per share data)


<TABLE>
<CAPTION>

                                                      Company                    Combined       Company          Predecessor
                                        ------------------------------------   ------------   ------------  ------------------------
                                         Year Ended  Year Ended   Year Ended   January 1 to    July 30 to    January 1   Year Ended
                                        December 31, December 31, December 31,  December 31,  December 31,  to July 31, December 31,
                                             1997        1996          1995      1994 (2)(3)     1994 (2)     1994 (2)    1993 (4)
                                        -----------  -----------  -----------  -----------    ------------  ----------- ------------
                                                                                (unaudited)
<S>                                       <C>          <C>          <C>          <C>          <C>           <C>          <C>
Net sales                                 $ 175,311    $ 173,165    $ 148,702    $ 150,028    $  60,208     $89,820    $ 107,129
Cost of sales                                88,320       84,360       69,537       82,205       37,390      44,815       67,229
                                          ---------    ---------    ---------    ---------    -----------   ---------    ---------

   Gross margin                              86,991       88,805       79,165       67,823       22,818      45,005       39,900

Research and development                     21,065       18,849       19,518       19,053        7,822      11,231       11,575
Selling, general and administrative          50,003       44,167       41,547       44,343       18,115      26,228       40,694
Corporate expense allocations and
   management consulting fees                                           2,950        2,708          258       2,450        4,571
Restructuring and special
   charges (credits)                                                                (5,767)                  (5,767)      16,701
                                          ---------    ---------    ---------    ---------    -----------   ---------    ---------

   Operating income (loss)                   15,923       25,789       15,150        7,486       (3,377)     10,863      (33,641)

Interest expense                             (1,640)      (1,844)      (2,836)      (1,313)      (1,313)
Other income (expense), net                      88         (347)        (482)          51          236        (185)        (456)
                                          ---------    ---------    ---------    ---------    -----------   ---------    ---------

Income (loss) before income
   tax, extraordinary item and
   cumulative effect of a change
   in accounting principles                  14,371       23,598       11,832        6,224       (4,454)     10,678      (34,097)
Income tax (expense) benefit                 (5,039)      (8,259)      (4,118)      (2,991)         959      (3,950)        (763)
                                          ---------    ---------    ---------    ---------    -----------   ---------    ---------

Income (loss) before extraordinary
   item and cumulative effect
   of a change in accounting principles       9,332       15,339        7,714        3,233       (3,495)      6,728      (34,860)

Extraordinary loss from early
   extinguishment of debt, net
   of income tax benefit of $780                                       (1,460)
Cumulative effect of a change in
   accounting principles                                                                                                  (1,087)
                                          ---------    ---------    ---------    ---------    -----------   ---------    ---------
Net income (loss)                         $   9,332    $  15,339    $   6,254    $   3,233    $  (3,495)    $ 6,728    $ (35,947)
                                          ---------    ---------    ---------    ---------    -----------   ---------    ---------


Basic earnings per common share               $0.54        $0.91
Weighted average common shares
   outstanding                           17,198,323   16,830,794

Diluted earnings per common and
   common equivalent share                    $0.53        $0.87

Weighted average number of
   common and common equivalent
   shares outstanding                    17,733,471   17,609,826

Pro forma basic earnings per common share                               $0.42
Pro forma weighted average
common shares outstanding                                          14,765,470
Pro forma diluted earnings per common and
   common equivalent share                                              $0.40
Pro forma weighted average number of common and
   common equivalent shares outstanding                            15,427,527

</TABLE>

                                       13

<PAGE>


Balance Sheet Data

(dollars in thousands)

<TABLE>
<CAPTION>
                                                        Company                                           Predecessor
                           --------------------------------------------------------------    -------------------------------------
                           December 31, 1997      December 31, 1996     December 31, 1995    December 31, 1994   December 31, 1993
                           -----------------      -----------------     -----------------    -----------------   -----------------
<S>                                  <C>                    <C>                   <C>                  <C>                 <C>
Working capital                      $52,039                $50,484               $35,172              $33,415             $14,863
Total assets                         106,659                 95,862                78,500               93,544              83,045
Total debt                            16,531                 21,031                16,211               36,496
Stockholders' equity                  56,204                 44,220                26,681                6,512              30,694

</TABLE>


Notes to Selected Financial Data

(1) The periods beginning July 30, 1994 reflect data of the Company and its
subsidiaries after the acquisition of stock by Bain Capital, Inc. The periods
prior to and including July 29, 1994 reflect data of the Predecessor, which
was acquired by the Company on July 29, 1994 from Lilly. See "Item 1,
Business."

(2) The Company's domestic sales during 1994 were positively impacted by
shipments of the Company's significant backlog from 1993 and 1992. Such large
backlog in the earlier periods was due to governmental restrictions. See
"Item 1, Business."

(3) For comparative purposes, the results of operations of the Predecessor
from January 1, 1994 to July 29, 1994 and of the Company from July 30, 1994
to December 31, 1994 have been combined.

(4) Operating results for 1993 were adversely affected by the temporary
suspension of the Predecessor's manufacturing operations in May 1992, after
the Predecessor received notification by the FDA of alleged deficiencies in
compliance with FDA regulations. See "Item 1, Business."

                                       14

<PAGE>

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

Overview

This Management's Discussion and Analysis of Financial Condition and Results
of Operation (and other portions of this report) may contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements due to many factors, including but not limited to those discussed
in "Item 1, Business," the effect of general economic conditions, including
without limitation those in Asia/Pacific, the impact of competitive products
and pricing, customer demand, product development, commercialization and
technological difficulties, U.S. and foreign regulatory requirements, the
effects of accounting policies and financing requirements, and other such
risks and factors.

Management's discussion and analysis provides information with respect to the
results of operations of the Company for the years ended December 31, 1997,
1996 and 1995.

Year Ended December 31, 1997 Compared to Year Ended December 31, 1996

For the year ended December 31, 1997 the Company reported worldwide sales of
$175.3 million. Revenues increased $2.1 million or 1% from the comparable
1996 year. Domestic sales of $123.9 million decreased $3.8 million or 3%
while international sales of $51.4 million increased $6.0 million or 13% from
the comparable prior year. The 13% increase in the international market was
driven by strong performance in Europe and Canada, partially offset by a 4%
decline from unfavorable currency movements in most foreign markets. The
sales increase in Europe reflected higher revenue in the United Kingdom and
former eastern block countries partly offset by weak sales in Germany. The
decrease in the domestic market is attributable to purchasing deferrals and
anticipation of the 1998 LIFEPAK 12 product release, offset by growth in
service and supply revenues.

Total equipment sales of $110.0 million decreased $6.0 million (5%) during
the current year primarily resulting from a 14% decline in the U.S. hospital
market, mainly due to purchasing deferrals and a 4% decline in the U.S.
out-of-hospital market as customer purchasing deferrals in anticipation of
the LIFEPAK 12 product release were only partly offset by strong sales of
LIFEPAK 500 AED's. International equipment revenue increased 2% from the
comparable 1996 period.

Supplies (disposable and accessories) revenue totaled $36.0 million, an
increase of $6 million or 20% from the comparable 1996 year. The increase was
driven by higher sales of accessories including distributed products
(training materials and portable monitors in Europe) and electrodes.
Worldwide service revenue of $29.4 million increased $2.1 million (8%) driven
by the Company's ever increasing installed base.

During the year ended December 31, 1997 worldwide product orders totaled
$154.1 million, an increase of $10.1 million or 7% over the prior year. The
increase in product orders resulted primarily from strong demand for the
LIFEPAK 500, and solid performance in the international markets. Domestic and
international orders increased 6% and 9%, respectively, from 1996.

Gross margin for the year ended December 31, 1997 was 50%, a decrease from
51% in the prior year, largely due to a less favorable product mix, mainly
higher service and supplies revenues, and the impact of a strong U.S. dollar
in international markets.

Research and development ("R&D") expenditures during the current year totaled
$21.1 million, an increase of $2.2 million over the comparable prior year.
The increase is attributable to the final developmental stages of the
Company's newest release, the LIFEPAK 12 product. The Company received FDA
approval for this product during January 1998. The Company has and will
continue to invest in the R&D activity as it is committed to new product
development and to conduct ongoing research for future products and
technology.

                                       15

<PAGE>

Selling, general and administrative ("SG&A") expenses totaled $50.0 million
during the year ended December 31, 1997. As a percentage of sales, these
expenses increased to 29% during 1997, from 26% in the prior year. Sales and
marketing expenses increased $5.2 million and is attributable to enhanced
sales and marketing efforts worldwide as well as additional selling expenses
associated with the Company's strategic alliances introduced and developed
during 1997. General and administrative expenditures of $10.7 million
increased $0.6 million from the prior year due primarily to an increase in
legal expenses.

Interest expense totaled $1.6 million during 1997, a decrease of $0.2 million
from 1996. The decrease is attributable to a reduction in the Company's
outstanding borrowings and lower interest rates obtained in the June 1997
refinancing of existing indebtedness as discussed below.

As a result of the above factors, net income totaled $9.3 million during 1997
with basic earnings per share reported at $0.54 and diluted earnings per
share reported at $0.53. Net income during 1997 represents a $6.0 million or
39% reduction in net income from the comparable 1996 year.

Year Ended December 31, 1996 Compared to Year Ended December 31, 1995

The Company reported worldwide sales of $173.2 million for the year ended
December 31, 1996, an increase of $24.5 million or 16% from 1995. Domestic
sales of $127.8 million increased $20.3 million or 19% while international
sales of $45.4 million increased $4.2 million (10%) from 1995. On a
consolidated basis, equipment sales of $116.0 million increased 11% during
1996 due primarily to increased demand for the Company's family of LIFEPAK
products, primarily the LIFEPAK 11 product. Worldwide service revenue of
$27.2 million increased 10% and supplies revenue of $30.0 million increased
54% from 1995, driven by disposable and accessory product sales.

The 19% increase in domestic revenue during 1996, when compared to 1995,
resulted from a 23% increase in out-of-hospital equipment sales, due mainly
to strong demand for LIFEPAK 11 products, and from a 30% increase in service
and supplies revenue (supplies revenue increased 56%). Domestic hospital
equipment sales increased 2% over 1995 in line with total hospital market
growth estimates. The 10% increase in international revenue for 1996
reflected a strong demand for LIFEPAK 9 products.

During the year ended December 31, 1996 worldwide product orders totaled
$144.0 million, an increase of $13.7 million or 11% over the comparable prior
year. The increase in product orders resulted primarily from strong demand
for the LIFEPAK 11 products and expanded growth in the international markets.
International and domestic orders increased 15% and 9%, respectively, from
1995.

Gross margin of $88.8 million increased $9.6 million or 12% during 1996 when
compared to 1995. As a percentage of sales, gross margin decreased from 53%
in 1995 to 51% in 1996, largely as a result of changes in product mix, mainly
higher service and supplies revenue, as well as certain trade-in programs
established earlier in the year which resulted in higher product discounts.

R&D expenditures during 1996 were $18.8 million, a decrease of $0.7 million
or 3% from the comparable prior year. As a percentage of sales, R&D expenses
decreased from 13% in the prior year to 11% during 1996.

SG&A expenses of $44.2 million during 1996 increased $2.6 million or 6% from
1995. The increase resulted from costs incurred to further develop the
Company's direct sales and service operations in Europe, as well as increased
selling expense related to a higher sales volume in 1996. As a percentage of
sales, SG&A expenses decreased during 1996 to 26% from 28% during 1995.

Management consulting fees due to Bain Capital, Inc. totaled $2.9 million
during 1995. During the fourth quarter of 1995, the management consulting
agreement was terminated. No management consulting fees were incurred during
1996.

                                       16

<PAGE>

Interest expense totaled $1.8 million during 1996, a decrease of $1.0 million
from the comparable prior year. The decrease resulted from lower interest
expense attributable to a reduction of the Company's outstanding debt and
lower interest rates obtained in the refinancing of the Company's then
existing credit facility during December 1995.

As a result of the above factors, net income totaled $15.3 million during
1996, with basic earnings per share reported at $0.91 and diluted earnings
per share reported at $0.87. Net income during 1996 represents a $9.1 million
or 145% increase in net income from the comparable 1995 year.

Quarterly Results

The Company's results of operations may fluctuate from quarter to quarter.
Various factors may affect results of operations, including variations in
timing of product orders, changes in product mix, timing of new product
introductions, changes in distribution channels, actions of competitors and
budgetary practices of the Company's customers.

Liquidity and Capital Resources

The Company has historically financed its operations with funds provided from
operations and bank borrowings, as well as the 1995 receipt of approximately
$23.7 million from Lilly in connection with certain 1994 purchase price
adjustments (see Part I, Item 1.). For the years ended December 31, 1997 and
1995, the Company generated approximately $9.8 million and $12.2 million,
respectively, in cash from operating activities. The cash provided from
operations during 1997 was driven by operating income and an increase in
trade accounts payable, offset by an increase in inventories. Cash provided
from operations during 1995 was due primarily to the receipt of the $23.7
million from Lilly described above. For the year ended December 31, 1996, the
Company used $0.1 million in cash from operations.

For the three years ended December 31, 1995, 1996 and 1997, the Company made
capital expenditures of approximately $5.9 million, $9.9 million and $7.0
million, respectively. During 1995 the majority of these capital expenditures
were for manufacturing molds, computer equipment and maintenance equipment.
During 1996 and 1997 the majority of the capital expenditures related to
software development and implementation of the Company's new computer
business system. The Company currently has no capital commitments outside the
ordinary course of business.

The Company's principal working capital requirements are for financing
accounts receivable and inventories. As of December 31, 1997, the Company had
working capital of $52.0 million, including approximately $39.1 million of
trade accounts receivable and $38.7 million of inventories.

In connection with the Company's initial public offering in December 1995,
the Company refinanced its then existing indebtedness and entered into the
Amended and Restated Credit Agreement (the "Revolver"). The Revolver provided
a credit facility in an amount not to exceed $30.0 million. The Revolver bore
interest, at the Company's option, at either (i) LIBOR plus 1.0%, or (ii) the
lender's base rate (the higher of such lender's prime rate or the federal
funds rate plus 0.5%).

During June 1997, the Company again refinanced its indebtedness under the
Revolver and entered into a new $30.0 million revolving bank credit facility
(the "Agreement") of which up to $5.0 million may be used for issuance of
standby letters of credit. The Agreement, which matures during May 2000,
replaced the $30.0 million Revolver scheduled to expire during December 1998.
Interest on advances under the Agreement bear interest at the borrower's
option, at either (i) LIBOR plus 0.5% or (ii) the reference rate (the higher
of the lender's prime rate or federal funds rate plus 1%) or (iii) quoted
rate (rate quoted by lender and accepted by borrower plus 0.5%). Such rates
are subject to increase in the event that the Company does not meet the fixed
charge coverage ratio as defined in the Agreement.

                                       17

<PAGE>

The Company's current indebtedness is secured by all of the accounts
receivable and inventories of the Company located in the United States. At
December 31, 1997, the interest rate on the amount outstanding under the
Agreement was 6.67%. At December 31, 1997, the Company had borrowing
availability under the Agreement of $15.9 million, after consideration of
outstanding letters of credit of $0.1 million, and was in compliance with all
related loan covenants.

The Company has subordinated promissory notes payable to Lilly related to the
1994 sale. Notes with a principal balance of $1.5 million bear interest at
LIBOR plus 3.25% (9.25% at December 31, 1997) and mature on January 31, 2001.
An additional note payable for $1.0 million bears interest at LIBOR plus 3.0%
(9.0% at December 31, 1997) and matures November 15, 1998. At December 31,
1997, the Company had an aggregate indebtedness of approximately $2.5 million
to Lilly under such notes.

The Company believes that, based upon current levels of operations and
anticipated growth, funds generated from operations together with other
available sources of liquidity, including borrowings under the current bank
Agreement, will be sufficient over the next twelve months for the Company to
make anticipated capital expenditures and fund working capital requirements.

One of the Company's strategies is to evaluate and make strategic
acquisitions of and/or alliances with companies with complementary product
lines. Future acquisitions may be financed by issuance of additional common
stock, borrowings, or excess cash flow.

Approximately 29% of the Company's net revenues during 1997 were from
international customers and the Company expects that sales to international
customers will continue to represent a material portion of its net sales.
Certain of the Company's international receivables are denominated in foreign
currency, and exchange rate fluctuations impact the carrying value of these
receivables. The Company has elected to hedge certain assets denominated in
foreign currency with the purchase of forward contracts. Historically,
fluctuations in foreign currency exchange rates have not had a material
effect on the Company's results of operations and together, with certain
hedging activities, the Company does not expect such fluctuations to be
material in the foreseeable future.

Year 2000

The Company has begun to review the impact of the Year 2000 upon its business
environment and business products. The Company has recently completed a
successful transition to a new, fully integrated, computer system with a
heavy emphasis in the manufacturing process. The transition also included
migration to a PC based, network environment. The new manufacturing and
financial modules within the system are designed to deal with the Year 2000.
Based on its initial assessment, the Company does not believe the software in
the Company's products currently in the marketplace will be materially
affected by the Year 2000. The Company has not yet determined the full effect
this event may have on its customers, suppliers, and other business partners.

Recent Accounting Pronouncements

The Financial Accounting Standards Board ("FASB") issued SFAS No. 130,
"Reporting Comprehensive Income," in June 1997. This statement establishes
new standards for reporting and displaying comprehensive income in the
financial statements. In addition to net income, comprehensive income
includes charges or credits to equity that are not the result of transactions
with shareholders. This statement is effective for fiscal years beginning
after December 15, 1997. Adoption of this standard will only require
additional financial statement disclosure detailing the Company's
comprehensive income.

In June 1997, FASB also issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes new
standards for reporting information about operating segments in interim and
annual financial statements. This statement is also effective for fiscal
years beginning after

                                       18

<PAGE>

December 15, 1997. The Company is currently evaluating the impact, if any,
this statement will have on disclosures in the consolidated financial
statements.

Effect of Inflation

Inflation generally affects the Company by increasing the interest expense of
floating rate indebtedness and by increasing the cost of labor, equipment and
raw materials. The Company does not believe that inflation has had any
material effect on the Company's business over the past three years.

Item 7A. Qualitative and Quantitative Disclosures Regarding Market Risk.

None.

                                       19

<PAGE>

Item 8. Financial Statements and Supplementary Data.


        Index to Consolidated Financial Statements and Supplementary Data

<TABLE>
<CAPTION>

                                                                                   Page No.
                                                                                   -------
<S>                                                                                <C>
Report of Independent Accountants ................................................    21

Consolidated Balance Sheets at December 31, 1997 and 1996 ........................    22

Consolidated Statements of Earnings for the years ended
  December 31, 1997, 1996 and 1995 ...............................................    23

Consolidated Statements of Changes in Stockholders' Equity for the years ended
  December 31, 1997, 1996 and 1995 ...............................................    24

Consolidated Statements of Cash Flows for the years ended
  December 31, 1997, 1996 and 1995 ...............................................    25

Notes to Consolidated Financial Statements .......................................    26

Financial Statement Schedules:

  Report of Independent Accountants ..............................................    47
  Schedule II Valuation and Qualifying Accounts and Reserves .....................    48

</TABLE>

All other financial statement schedules have been omitted because they are
not applicable or the required information is included elsewhere herein or
incorporated by reference.

                                       20

<PAGE>

Report of Independent Accountants
-----------------------------------------------------------------------------

To the Board of Directors and Stockholders of
Physio-Control International Corporation

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

Price Waterhouse LLP
Seattle, Washington
January 27, 1998



                                       21

<PAGE>



Physio-Control International Corporation


Consolidated Balance Sheets
-------------------------------------------------------------------------------

(dollars in thousands, except share data)
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>


                                                                 December 31, 1997              December 31, 1996
                                                                 -----------------              -----------------
Assets
<S>                                                                       <C>                             <C>
Current Assets
Cash and cash equivalents                                                   $4,340                         $3,336
Accounts receivable, net                                                    39,161                         38,869
Inventories, net                                                            38,711                         31,811
Prepaid expense                                                              1,237                          1,401
Deferred income tax                                                          2,463
Prepaid income tax                                                                                          3,967
                                                                  ----------------               ----------------

   Total current assets                                                     85,912                         79,384

Noncurrent Assets

Other assets                                                                 1,281                          1,180
Deferred income tax                                                          2,114                          2,175
Property, plant and equipment, net                                          17,352                         13,123
                                                                  ----------------               ----------------

Total assets                                                              $106,659                        $95,862
                                                                  ----------------               ----------------

Liabilities and Stockholders' Equity

Current Liabilities

Accounts payable                                                           $14,630                         $9,260
Accrued liabilities                                                         17,103                         19,146
Current portion of long-term debt                                            1,000
Income tax payable                                                           1,140
Deferred income tax                                                                                           494
                                                                  ----------------               ----------------

    Total current liabilities                                               33,873                         28,900
                                                                  ----------------               ----------------

Noncurrent Liabilities

Long-term debt                                                              15,531                         21,031
Unfunded pension obligation                                                  1,051                          1,711
                                                                  ----------------               ----------------

   Total noncurrent liabilities                                             16,582                         22,742
                                                                  ----------------               ----------------

Commitments and contingencies (Note 15)

Stockholders' Equity

Preferred stock, par value $0.01 per share, 5,000,000
   shares authorized, no shares issued or outstanding

Common stock, voting, par value $0.01 per share,
   40,000,000 shares authorized; 17,300,840 and

   17,020,245 shares issued and outstanding, respectively                      173                            170
Additional paid-in capital                                                  28,627                         25,707
Retained earnings                                                           27,430                         18,098
Equity adjustment from foreign currency translation                            (26)                           245
                                                                  -----------------              ----------------

   Total stockholders' equity                                               56,204                         44,220
                                                                  ----------------               ----------------

Total liabilities and stockholders' equity                                $106,659                        $95,862
                                                                  ----------------               ----------------

</TABLE>


   The accompanying notes are an integral part of these financial statements


                                      -22-


<PAGE>

Physio-Control International Corporation


Consolidated Statements of Earnings

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

(dollars in thousands, except share and per share data)
-------------------------------------------------------------------------------


<TABLE>
<CAPTION>

                                                  Year Ended                Year Ended                Year Ended
                                           December 31, 1997          December 31, 1996        December 31, 1995
                                           -----------------         ------------------        -----------------



<S>                                        <C>                        <C>                       <C>
Net sales                                           $175,311                   $173,165                  $148,702
Cost of sales                                         88,320                     84,360                    69,537
                                           -----------------          -----------------          ----------------

   Gross margin                                       86,991                     88,805                    79,165
                                           -----------------          -----------------          ----------------

Research and development                              21,065                     18,849                    19,518
Sales and marketing                                   39,289                     34,042                    30,073
General and administrative                            10,714                     10,125                    11,474
Management consulting fees                                                                                  2,950
                                           -----------------          -----------------          ----------------

   Operating expenses                                 71,068                     63,016                    64,015
                                           -----------------          -----------------          ----------------

Interest expense                                      (1,640)                    (1,844)                  (2,836)
Other income (expense), net                               88                       (347)                    (482)
                                           -----------------          -----------------          ----------------

   Other expense                                      (1,552)                    (2,191)                  (3,318)
                                           -----------------          -----------------          ----------------

Income before income tax and
   extraordinary item                                 14,371                     23,598                   11,832
Income tax expense                                    (5,039)                    (8,259)                  (4,118)
                                           -----------------          -----------------          ----------------

Income before extraordinary item                       9,332                     15,339                    7,714
Extraordinary loss from early extinguishment
   of debt, net of income tax benefit of $780                                                             (1,460)
                                           -----------------          -----------------          ----------------

Net income                                            $9,332                    $15,339                   $6,254
                                           -----------------          -----------------          ----------------




Basic earnings per common share                        $0.54                      $0.91
Weighted average common shares outstanding        17,198,323                 16,830,794
Diluted earnings per common and
   common equivalent share                             $0.53                      $0.87
Weighted average number of common
   and common equivalent shares outstanding       17,733,471                 17,609,826


Pro forma basic earnings per common share                                                                  $0.42
Pro forma weighted average common shares outstanding                                                  14,765,470
Pro forma diluted earnings per common and
   common equivalent share                                                                                 $0.40
Pro forma weighted average number of common and
   common equivalent shares outstanding                                                               15,427,527

</TABLE>

The accompanying notes are an integral part of these financial statements


                                      -23-

<PAGE>

Physio-Control International Corporation


Consolidated Statements of Changes in Stockholders' Equity
-------------------------------------------------------------------------------
(dollars in thousands, except share data)
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>


                                                                                                    Equity
                                            Common Stock          Common Stock                      Adjustment
                                           Class L (Voting)          (Voting)           Additional  Retained    from Foreign
                                           ----------------          --------           Paid-in     Earnings     Currency
                                            Shares  Dollars   Shares          Dollars   Capital    (Deficit)    Translation  Total
                                           -------  -------   ------          -------   -------    ----------   ----------- ------


<S>                                        <C>          <C>     <C>             <C>       <C>       <C>           <C>      <C>
Balance at December 31, 1994               1,410,636    $15     12,695,702      $127      $9,873      $(3,495)    $(8)     $6,512


Issuance of common shares in
   acquisition                                                     705,953         8          15                               23
Conversion of Class L shares
   immediately preceding
   initial public offering                (1,410,636)   (15)     2,219,754        22          (7)
Net proceeds from initial
   public offering                                               1,133,500        11      13,734                           13,745
Equity adjustment from foreign
   currency translation                                                                                           147         147
Net income                                                                                              6,254               6,254
                                          -----------   -----   ----------      ------    --------   ---------   ----     -------

Balance at December 31, 1995                                    16,754,909       168      23,615        2,759     139      26,681


Issuance of common shares                                           11,318                   212                              212
Stock issued upon exercise of options                              254,018         2         363                              365
Income tax benefit from exercise
   of stock options                                                                        1,517                            1,517
Equity adjustment from foreign
   currency translation                                                                                           106         106
Net income                                                                                             15,339              15,339
                                          -----------   -----   ----------      ------    --------   ---------   ----     -------
Balance at December 31, 1996                                    17,020,245       170      25,707       18,098     245      44,220


Issuance of common shares                                           60,993         1       1,060                            1,061
Stock issued upon exercise of options                              219,602         2         991                              993
Income tax benefit from exercise
   of stock options                                                                          869                              869
Equity adjustment from foreign
   currency translation                                                                                           (271)       (271)
Net income                                                                                              9,332                9,332
                                          -----------   -----   ----------      ------    --------   ---------   ----     -------

Balance at December 31, 1997               -            $  -    17,300,840      $173     $28,627      $27,430     $(26)    $56,204
                                          -----------   -----   ----------      ------    --------   ---------   ----     -------
</TABLE>










The accompanying notes are an integral part of these financial statements


                                  -24-


<PAGE>

Physio-Control International Corporation

Consolidated Statements of Cash Flows
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>

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

(dollars in thousands)
-----------------------------------------------------------------------------------------------------------------


                                                             Year Ended           Year Ended          Year Ended
                                                      December 31, 1997     December 31, 1996  December 31, 1995
                                                      -----------------     -----------------  -----------------

<S>                                                              <C>              <C>               <C>
Cash Flows From Operating Activities
Net income                                                       $9,332            $15,339           $6,254
   Adjustments to Reconcile Net Income to Net Cash
   Provided by (Used in) Operating Activities:
   Depreciation and amortization                                  2,755              1,006           1,677
   Extraordinary loss from early extinguishment of debt, net                                         1,460
   Increase in accounts receivable                               (1,108)            (9,414)         (5,151)
   Decrease (increase) in other receivables                         816             (1,921)         24,259
   Increase in inventories                                       (6,900)            (1,603)         (4,577)
   Decrease (increase) in prepaid income tax                      3,967             (1,330)         (2,637)
   Decrease (increase) in prepaid expense and other assets           63               (947)          1,906
   Decrease (increase) in deferred income tax                    (2,896)             4,233           3,619
   Increase (decrease) in accounts payable                        5,370               (849)          1,687
   Decrease in accrued liabilities                               (2,703)            (4,642)         (9,919)
   (Decrease) increase in income tax payable                      1,140                             (6,354)
                                                                --------           --------        --------
Net cash provided by (used in) operating activities               9,836               (128)         12,224
                                                                --------           --------        --------
Cash Flows From Investing Activities
Purchases of property, plant and equipment                       (6,984)             (9,919)        (5,853)
Acquisition of net assets, net of cash acquired                                                     (2,044)
Proceeds from sale/leaseback activity                                                 1,788          1,540
                                                                --------            --------       --------
Net cash used in investing activities                            (6,984)             (8,131)        (6,357)
                                                                --------            --------       --------
Cash Flows From Financing Activities
Net proceeds from issuance of common stock                        2,054                 577         13,768
Debt issue costs                                                                                      (151)
Repayment of term debt                                                                             (10,000)
Borrowings under revolving debt                                  45,984              59,395         17,031
Repayments on revolving debt                                    (50,484)            (54,575)       (27,316)
Income tax benefit from exercise of
   stock options                                                    869               1,517
                                                                --------           --------         --------
Net cash provided by (used in) financing activities              (1,577)              6,914          (6,668)
                                                                --------           --------         --------
Effect of exchange rate changes                                    (271)                106             147
                                                                --------           --------          --------
Net increase (decrease) in cash and cash equivalents              1,004              (1,239)           (654)
Cash and cash equivalents at beginning of year                    3,336               4,575           5,229
                                                               --------            --------         --------
Cash and cash equivalents at end of year                         $4,340              $3,336          $4,575
                                                               --------            --------         --------


Supplemental Information
Cash paid during the year for interest                           $1,804              $1,561          $3,145
Cash paid during the year for income tax                         $2,000              $4,498          $3,405

</TABLE>





The accompanying notes are an integral part of these financial statements

                                      -25-

<PAGE>



Notes to Consolidated Financial Statements

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

(dollars in thousands, except share and per share data)
-------------------------------------------------------------------------------
NOTE 1.  BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS

Physio-Control International Corporation as successor by merger to
Physio-Control Acquisition, Inc. (the "Company") was incorporated in Delaware
during 1994 to effect the acquisition on July 29, 1994 of Physio-Control
Corporation and certain assets of its affiliates ("Predecessor") from Eli Lilly
and Company ("Lilly"). During May 1997, the Company was re-incorporated in
the State of Washington.

The consolidated financial statements of the Company include its wholly owned
subsidiary, Physio-Control Corporation ("PCC") and its subsidiaries, (i)
Physio-Control Manufacturing Corporation ("PCMC"), (ii) European and (iii)
Canadian subsidiaries of PCC.

The Company's primary business activity is the design, manufacture, distribution
and servicing of an integrated line of noninvasive emergency cardiac
defibrillators and vital sign assessment devices, disposable electrodes and data
management software. The Company is headquartered in Redmond, Washington and
operations consist of manufacturing facilities in Redmond, Washington and
strategically located sales and service offices worldwide.

NOTE 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

This summary of significant accounting policies is presented to assist the
reader in understanding and evaluating the accompanying consolidated financial
statements. These policies are in conformity with generally accepted accounting
principles and have been consistently applied unless otherwise noted.

Principles of Consolidation

The consolidated financial statements include all majority owned subsidiaries.
All significant intercompany accounts and transactions have been eliminated.

Revenue Recognition

Revenue from product sales are recorded by the Company when products are shipped
to customers. Provision for sales returns is recorded for estimated products
returned by customers. Service revenue is recognized upon the completion of
service repair work. Additional service revenue earned on extended warranty
contracts is recognized on a straight-line basis over the life of the contract
period which is generally one year or less.

Earnings Per Share

Statement of Financial Accounting Standards No. 128 (SFAS 128) was issued in
February 1997. This pronouncement modifies the calculation and disclosure of
earnings per share and was adopted by the Company during 1997. Under the
provisions of SFAS 128, basic earnings per share is calculated as income
available to common stockholders divided by the weighted average number of
common shares outstanding during the periods. Diluted earnings per share is
based on the weighted average number of shares of common stock and common stock
equivalents outstanding during the periods, including options computed using the
treasury stock method. All earnings per common share amounts from prior periods
have been restated to reflect the adoption of SFAS 128.


                                      -26-

<PAGE>


Pro forma Earnings Per Share (Unaudited)

As a result of the changes in the Company's capital structure effective with the
initial public offering during December 1995 as described in Note 9, historical
earnings per common and common equivalent share amounts would not be meaningful
and therefore have not been presented for 1995. For purposes of calculating pro
forma net earnings per share, the weighted average number of shares outstanding
has been calculated giving retroactive effect to the Recapitalization described
in Note 9.

Cash Equivalents

The Company considers all highly liquid investments, with an original maturity
of three months or less, to be cash equivalents. These amounts are stated at
cost, which approximate fair value.

Inventories

Inventories are stated at the lower of cost, determined by the first-in,
first-out (FIFO) method, or market.

Property, Plant and Equipment

Property, plant and equipment is recorded at cost. Depreciation is determined
using the straight-line method over the estimated useful lives of the assets,
which are as follows: land and buildings improvements 18 to 40 years; machinery
and equipment 3 to 10 years; and furniture and fixtures 5 to 10 years. All
direct costs associated with the development and implementation of software for
internal use are capitalized and depreciated over 7 years. Expenditures for
renewals and betterments are capitalized, and maintenance and repairs are
charged to operations.

Income Taxes

Deferred income taxes are provided for all significant temporary differences in
reporting items of income and expense for financial statement purposes versus
income tax reporting. The Company files a consolidated income tax return with
its wholly owned subsidiaries.

Research and Development Expenditures

Expenditures related to the development of new products and processes, including
significant improvements and refinements are expensed as incurred.

Warranty and Service Update Allowances

Allowances are provided for the estimated cost of product coverage programs,
which include warranty and service updates. The reserves for warranty costs and
service updates are reviewed periodically and appropriately adjusted to ensure
adequate provisions.

Use of Estimates

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

Employee Stock Options

The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
stock-based compensation plans.


                                      -27-
<PAGE>

Foreign Currency

The functional currency of each of the Company's foreign subsidiaries is the
local currency in its respective country. Asset and liability accounts of each
entity are translated at the current exchange rate and income accounts are
translated at average exchange rates prevailing during the period. Gains and
losses resulting from the translation of these foreign currency financial
statements are classified as a separate component of stockholders' equity. For
other foreign operations of the Company, all monetary assets and liabilities
denominated in foreign currencies are remeasured into U.S. dollars at current
exchange rates. Income and expense items are remeasured at average exchange
rates during the period. The Company hedges its net position in all material
foreign currency exposures by entering into forward contracts. The contracts are
entered into in the regular course of business to manage its exposure against
foreign currency fluctuations. Discounts and premiums related to forward
contracts are amortized to income over the lives of the agreements and changes
in market value of the foreign currency are recognized into income currently. As
of December 31, 1997 the Company had foreign exchange contracts of $5.9 million
maturing in one to three months.

Concentration of Credit Risk/Financial Instruments

Financial instruments that potentially subject the Company to credit risk
consist principally of trade receivables. Trade receivables from international
customers account for a substantial portion of receivables, for which collateral
is generally not required. The risk associated with this concentration is
limited due to the large number of distributors and their geographic dispersion.
The carrying values of cash equivalents and other current assets and liabilities
(such as accounts receivable and payable) approximate fair value at December 31,
1997. The carrying value of the revolving credit facility approximates fair
value as the interest rate adjusts based upon market interest rate changes.

Reclassification

Certain amounts have been reclassified in the prior years in order to conform
with the current year presentation.

NOTE 3.  ACCOUNTS RECEIVABLE

Accounts receivable consist of the following:
<TABLE>
<CAPTION>

                                                                December 31, 1997       December 31, 1996
                                                                -----------------       -----------------
<S>                                                             <C>                     <C>
Trade receivables                                                     $38,215                 $37,118
Accounts receivable, other                                              1,701                   2,517
Less allowances                                                          (755)                   (766)
                                                                --------------          --------------

Total accounts receivable                                             $39,161                 $38,869
                                                                -------------           -------------
</TABLE>



NOTE 4.  INVENTORIES

Inventories consist of the following:

<TABLE>
<CAPTION>

                                                                December 31, 1997       December 31, 1996
                                                                -----------------       -----------------
<S>                                                             <C>                     <C>
Finished products                                                     $22,665                 $18,734
Purchased parts and assemblies in process                               7,544                   6,534
Service parts                                                          10,654                   9,037
                                                                -------------           -------------

                                                                       40,863                  34,305
Less inventory allowances                                              (2,152)                 (2,494)
                                                                --------------          --------------

Total inventories                                                     $38,711                 $31,811
                                                                -------------           -------------
</TABLE>


                                      -28-

<PAGE>


NOTE 5.  PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consists of the following:


<TABLE>
<CAPTION>

                                                             December 31, 1997      December 31, 1996
                                                             -----------------      -----------------
<S>                                                             <C>                      <C>
Land                                                                     $880                    $880
Buildings and land improvements                                           442                     388
Software development                                                    7,223                   4,955
Equipment, furniture and fixtures                                      13,087                   8,616
                                                                -------------           -------------

                                                                       21,632                  14,839
Less accumulated depreciation                                          (4,280)                 (1,716)
                                                                --------------          --------------

Total property, plant and equipment                                   $17,352                 $13,123
                                                                -------------           -------------
</TABLE>


The Company has entered into several agreements for the sale and leaseback of a
portion of its production and operating equipment. The leases are classified as
operating leases in accordance with FAS 13, "Accounting for Leases." The net
book value of the equipment sold during 1996 and 1995 totaled $1,539 and $1,393,
respectively, and the gain realized on these transactions was $0 and $147 in
1996 and 1995, respectively. No sale leaseback transactions occurred during
1997. Rental expense related to these operating leases during 1997, 1996 and
1995 was $811, $344 and $7, respectively. Future minimum lease payments are
disclosed in Note 15.

NOTE 6.  ACCRUED LIABILITIES

Accrued liabilities consist of the following:

<TABLE>
<CAPTION>


                                                            December 31, 1997       December 31, 1996
                                                            -----------------       -----------------
<S>                                                             <C>                     <C>
Employee compensation                                                  $6,034                  $7,421
Deferred service contract revenue                                       3,014                   3,045
Accrued product or technical service upgrade and update                 1,773                   2,287
Warranty allowance                                                      1,075                     997
Restructuring allowance                                                   210                     487
Other accruals                                                          4,997                   4,909
                                                                -------------           -------------

Total accrued liabilities                                             $17,103                 $19,146
                                                                -------------           -------------

</TABLE>


Product and Technical Service Upgrades and Updates

As of December 31, 1997, the Company has recorded its best estimate of the cost
to provide future update and upgrade services for its existing product lines.
The liabilities at December 31, 1997 and 1996 represent management's best
estimate of (i) the number of product upgrades and updates that will be made,
(ii) the related cost of each upgrade, and (iii) the cost of certain product
service updates. Management believes that any liability that may ultimately
result from the resolution of product upgrades and updates in excess of amounts
provided will not have a material adverse effect on the financial position or
results of operations of the Company.


                                      -29-

<PAGE>

NOTE 7.  LONG-TERM DEBT

As a result of the Company's initial public offering in December 1995, the
Company received net proceeds of $13.7 million, after discounts and other
charges of approximately $2.7 million. Of this amount, the Company used $12.0
million to reduce its term loan and its revolving credit facility in December
1995. This prepayment of debt resulted in an extraordinary loss of $1,460 ($0.09
per share), net of an income tax benefit of $780. Immediately thereafter, the
Company entered into an Amended and Restated Credit Agreement with a bank for a
$30.0 million revolving credit facility (the "Revolver") which matured December
15, 1998. Of this amount, up to $5.0 million could be used for issuance of
commercial and standby letters of credit on behalf of the Company. Interest on
drawings under the Revolver bore interest at the Company's option, at either (i)
LIBOR plus 1.0% or (ii) the lender's base rate (the higher of such lender's
prime rate or the federal funds rate plus 0.5%). Such rates were subject to
increase in the event that the Company did not meet certain leverage and
interest coverage ratios.

During June 1997, the Company refinanced its existing indebtedness and entered
into a new $30.0 million revolving bank credit facility (the "Agreement") of
which up to $5.0 million may be used for issuance of standby letters of credit.
The Agreement, which matures during May 2000, replaced the existing $30.0
million Revolver scheduled to expire during December 1998. Interest on advances
under the Agreement bear interest at the borrower's option, at either (i) LIBOR
plus 0.5% or (ii) the reference rate (the higher of the lender's prime rate or
federal funds rate plus 1%) or (iii) quoted rate (rate quoted by lender and
accepted by borrower plus 0.5%). Such rates are subject to increase in the event
that the Company does not meet the fixed charge coverage ratio as defined in the
Agreement. The Company is required to pay a commitment fee equal to 0.125% of
the amount by which the available credit exceeds the outstanding advances on a
quarterly basis. This rate is also subject to increase in the event that the
Company does not meet the fixed charge coverage ratio as defined.

At December 31, 1997, the interest rate on drawings under the Agreement was
6.67% and the outstanding balance on the Agreement was $14,000. At December 31,
1997 $15,900 was available for future borrowings, after consideration of
outstanding letters of credit of $0.1 million.

The Agreement is secured by a first priority security interest in and lien on
all of the accounts receivable and inventories of the Company (located in the
United States) and is guaranteed by all material subsidiaries. The Agreement
includes various affirmative and negative financial covenants which require,
among other things, that the Company maintain a certain fixed charge coverage
ratio, debt to net worth ratios, as well as a minimum tangible net worth, as
defined in the Agreement.

The Company has subordinated notes payable to Lilly in connection with the
acquisition of certain foreign assets. Notes with a principal balance of $1,531
mature on January 31, 2001 and bear interest at LIBOR plus 3.25% (9.25% at
December 31, 1997). An additional note payable with a principal balance of
$1,000 matures November 15, 1998 and bears interest at LIBOR plus 3.0% (9.0% at
December 31, 1997).

NOTE 8.  ACQUISITION OF FIRST MEDIC

On April 5, 1995, the Company completed the acquisition of substantially all of
the assets and the liabilities of the FIRST MEDIC Division of SpaceLabs Medical
Inc. ("FIRST MEDIC"), consisting primarily of inventory, fixed assets, certain
intangibles, and warranty liabilities. FIRST MEDIC is an out-of-hospital,
portable defibrillator product line. The acquisition was accounted for by the
purchase method of accounting in accordance with Accounting Principles Board No.
16, "Business Combinations" and, accordingly, the operating results from FIRST
MEDIC product sales have been included in the consolidated operating results
since the date of acquisition. The purchase price of the acquisition was $2.1
million in cash and 705,953 shares of voting common stock, which was assigned a
value of $23 ($0.033 per share) as agreed between the parties. The fair value of
the net assets acquired approximated the purchase price and accordingly no
goodwill was recorded.

                                    30

<PAGE>

NOTE 9.  STOCKHOLDERS' EQUITY

Immediately prior to the completion of the 1995 initial public offering, the
Company's outstanding shares of capital stock were reclassified into one class
of common stock and effected a 2.6246-for-one split of all of the then
outstanding shares of common stock (the "Recapitalization"). In connection with
the Recapitalization, each outstanding share of Class L common stock was
reclassified into one share of common stock plus an additional number of shares
of common stock determined by dividing a preferential payment amount for such
share of Class L common stock by the value of a share of common stock based on
the initial public offering price in the offering. The preferential payment
amount was equal to the original cost of such share plus an amount which
accumulated on a daily basis at 12.5% per annum on such cost and on the amount
so accumulated in prior quarters. Upon conversion, each share of Class L common
stock was entitled to the aforementioned preferential payment upon any
distribution by the Company to holders of its capital stock (whether by
dividend, liquidating distribution or otherwise). An aggregate of 2,219,754
shares of common stock was issued in exchange for the outstanding shares of
Class L common stock in connection with the Recapitalization. All references in
the accompanying consolidated financial statements to the number of common
shares, per share amounts, and options exercisable into common stock have been
restated to reflect the stock split.

NOTE 10.  EARNINGS PER SHARE

The difference between the weighted average number of common shares outstanding
used to calculate basic earnings per share and the weighted average number of
common and common equivalent shares outstanding used to calculate diluted
earnings per share is the incremental shares attributed to outstanding options
to purchase common stock computed using the treasury stock method.

<TABLE>
<CAPTION>


                                                           Year Ended           Year Ended         Year Ended
                                                        December 31, 1997   December 31, 1996   December 31, 1995
                                                        -----------------   -----------------   -----------------
                                                                                                 (Pro-Forma)
<S>                                                     <C>                 <C>                 <C>
     Weighted average number of common shares                17,198,323         16,830,794          14,765,470
       outstanding
     Effect of dilutive options                                 535,148            779,032             662,057
     Weighted average number of common and
       common equivalent shares outstanding              ---------------     --------------      --------------
                                                             17,733,471         17,609,826          15,427,527
                                                         ---------------     --------------      --------------

</TABLE>


Options to purchase 442,000 shares of common stock were outstanding at December
31, 1997, but were not included in the computation of diluted earnings per share
because the options' exercise prices were greater than the average market price
of the common shares.

                                      -31-


<PAGE>

NOTE 11.  STOCK OPTIONS

1994 Stock Purchase and Option Plan

During 1994, the Company adopted the 1994 Stock Purchase and Option Plan (the
"1994 Plan"), which authorizes grants of stock options to current or future
employees, directors, consultants, or advisors of the Company. The 1994 Plan
authorizes the granting of stock options for up to an aggregate of 262,460
shares of Class L common stock and 2,624,600 shares of common stock. The stock
option grants are of three types: time option grants, target option grants, and
fair market value option grants.

Time option grants are granted at the fair market value of the common stock on
the date of grant. Prior to the effectiveness of the Company's registration
statement under the Securities Act of 1933, the options vested in five equal
installments on each anniversary of the grant date. Effective with the offering,
all options vested immediately. At December 31, 1997 there were options
outstanding to purchase 241,009 shares of common stock at an exercise price of
$0.03 per share.

Target option grants are granted at the fair market value of the common stock on
the date of grant. Prior to the effectiveness of the Company's registration
statement, the options vested on the earlier of ten years or upon the occurrence
of one of several events, including a change in ownership. Effective with the
offering, all options vested immediately.

Fair market value options granted during 1994 (229,786) became fully vested with
the effectiveness of the Company's offering. Fair market value options granted
during 1995 (533,364) vest annually in five equal installments commencing on
December 31, 1995 of which 271,590 options vested upon the completion of the
offering. The exercise price of the stock option is determined on the date the
option vests and is equivalent to the fair market value of the common stock on
the vesting date. On October 16, 1995 the 1994 Plan was amended to fix the
exercise price of the fair market value options at $12.57 per share.

1996 Stock Incentive Plan

In December 1995, the Company adopted the Physio-Control International
Corporation 1996 Stock Incentive Plan (the "1996 Plan"). The 1996 Plan provided
for the granting to employees and other key individuals who perform services for
the Company and its subsidiaries the following types of incentive awards: stock
options, stock appreciation rights, restricted stock, performance grants and
other types of awards. An aggregate of 1,250,000 shares of Common Stock were
reserved for issuance under the 1996 Plan. Options granted under the 1996 Plan
were issued at the fair market value on the date of grant, and vest in equal
installments over a five year period.

1997 Stock Incentive Plan

In May 1997, the Company adopted the Amended and Restated Physio-Control
International Corporation 1997 Stock Incentive Plan (the "1997 Plan") which
amends and replaces the 1996 Plan described above. The 1997 Plan increases the
shares of common stock reserved for issuance under the Plan to an aggregate of
2,250,000 shares. There were no other significant changes from the 1996 Plan.
Options granted under the 1997 Plan are issued at the fair market value on the
date of grant, and vest under varied schedules.


                                      -32-
<PAGE>

The table below summarizes the Company's stock option activity:
<TABLE>
<CAPTION>
                                        Year Ended                    Year Ended              Year Ended
                                     December 31, 1997             December 31, 1996       December 31, 1995
                                ------------------------      -----------------------   --------------------
                                                Weighted                  Weighted               Weighted
                                                 average                   average                average
                                  Number of     exercise     Number of    exercise    Number of  exercise
                                     shares        price        shares       price       shares     price
                                  ---------    ---------     ---------   ---------    ---------   ---------
<S>                               <C>           <C>          <C>          <C>         <C>         <C>
Outstanding at
      beginning of year           2,292,180       $10.96     1,682,292      $ 5.72    1,148,901    $  2.54
   Granted                          873,300        13.37       898,500       18.20      533,391      12.57
   Exercised                       (219,602)        4.25      (254,018)       1.45
   Forfeited                        (93,631)       16.96       (34,594)      14.34
                                  ---------                   ---------               ---------
   Outstanding at
      end of year                 2,852,247       $12.01      2,292,180     $10.96    1,682,292     $ 5.72
                                  ---------                   ---------               ---------
   Options exercisable at
      year end                    1,723,768       $ 9.80      1,442,821     $ 7.23    1,472,861     $ 4.75

   Weighted average fair
      value of options granted
      during the year                             $ 8.08$                    18.03                  $12.32
</TABLE>


The following table summarizes information about stock options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
                      Options outstanding                                     Options exercisable

                                        Weighted
                                         average    Weighted                                Weighted
                                       remaining     average                                 average
    Range of            Number       contractual    exercise                 Number         exercise
exercise prices       outstanding           life       price               exercisable         price
---------------       -----------    -----------    --------               -----------      --------
<S>                     <C>                 <C>       <C>                     <C>             <C>
    $0.03                 547,901           6.58       $0.03                  547,901          $0.03
$12.57 - $15.38         1,862,346           8.60      $13.53                  999,067         $13.27
$19.75 - $20.50           442,000           8.10      $20.46                  176,800         $20.46

</TABLE>


Employee Share Purchase Plan

In December 1995, the Company adopted the Physio-Control International
Corporation Employee Share Purchase Plan (the "Share Purchase Plan"), which
permits employees of the Company to purchase Common Stock at 85% of the lower of
its beginning-of-the-year or end-of-year market price through payroll
deductions. All employees of the Company are eligible to participate in the
Share Purchase Plan. An aggregate of 600,000 shares of Common Stock have been
authorized for issuance under the Share Purchase Plan. During January 1998, a
total of 48,422 shares were purchased by employees from contributions made
during 1997.

Certain Pro Forma Disclosures

As discussed above, the Company has three-stock-based compensation plans: the
1994 Stock Purchase and Option Plan, the 1997 Stock Incentive Plan, and the
Employee Share Purchase Plan. The Company accounts for these plans in accordance
with the provisions of Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees." In October 1995 the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 123 ("FAS
123"), "Accounting for Stock-Based Compensation," which established a

                                      -33-

<PAGE>


fair value based method of accounting for employee stock option plans and
share purchase plans. FAS 123 provides for the disclosure of the value of
compensation associated with options held by participants, based on a fair
value methodology. If compensation cost for the Company's stock-based
compensation plans had been determined based on the fair value at the grant
and/or purchase dates, as prescribed by FAS 123, the Company's pro forma net
income and pro forma net earnings per common and common equivalent share
would have been as follows:

<TABLE>
<CAPTION>


                                                      Year Ended          Year Ended          Year Ended
                                               December 31, 1997   December 31, 1996   December 31, 1995
                                               -----------------   -----------------   -----------------

<S>                                                       <C>                <C>                  <C>
     Net income                                           $9,332             $15,339              $6,254
     Pro forma net income                                 $3,958             $10,109              $3,496

     Basic earnings per common share                       $0.54               $0.91               $0.42
     Pro forma basic earnings per common share             $0.23               $0.60               $0.24

     Diluted earnings per common
       and common equivalent share                         $0.53               $0.87               $0.40
     Pro forma diluted earnings per common
       and common equivalent share                         $0.22               $0.57               $0.23

</TABLE>


Stock option plans. For the purpose of the FAS 123 pro forma disclosures, the
fair value of each option grant has been estimated on the date of grant using
the Black-Scholes option pricing model with the following assumptions used for
grants during 1997, 1996, and 1995: dividend yield of 0.0% for all years;
volatility of 54% for 1997 and 190% for 1996 and 1995 and risk-free interest
rates of 5.7% to 6.5%, 5.2% to 6.7%, and 5.5% to 5.8% for options granted during
1997, 1996 and 1995, respectively. The Company has estimated an expected option
term of five years for options granted during each of the three years.

Employee Share Purchase Plan. For the purpose of the FAS 123 pro forma
disclosures, the fair value of the employees' purchase rights was estimated
using the Black-Scholes model using the same assumptions as stated above in
determining the fair value of options granted under the Company's stock option
plans. Based on the valuation model which considers such factors, the
weighted average valuation of these purchase rights granted during
1997 and 1996 was $8.55 and $17.20 respectively.

Because additional option grants and share purchases are expected to be made in
future years, the above pro forma disclosures are not representative of pro
forma effects on reported net income for future years.

                                      -34-

<PAGE>



NOTE 12.  FEDERAL INCOME TAXES

Income taxes have been provided as follows:
<TABLE>
<CAPTION>
                                                      Year Ended         Year Ended           Year Ended
                                               December 31, 1997   December 31, 1996   December 31, 1995
                                               -----------------   -----------------   -----------------
<S>                                                <C>                 <C>                <C>
Current Income Tax (Expense) Benefit
U.S. federal tax (expense) benefit                      $(7,475)             $(2,030)             $1,363
Foreign tax expense                                        (460)              (1,996)             (1,862)
                                                   ------------        --------------     ---------------
Total current tax expense                                (7,935)              (4,026)               (499)
Deferred Income Tax (Expense) Benefit                     2,896               (4,233)             (3,619)
                                                   -------------       --------------     --------------
Total income tax (expense)                              $(5,039)             $(8,259)            $(4,118)
                                                   -------------       --------------     --------------
</TABLE>

Significant components of the Company's deferred tax assets and liabilities
included in the provisions referred to above are as follows:

<TABLE>
<CAPTION>
                                                    December 31, 1997       December 31, 1996
                                                    -----------------       -----------------
<S>                                                    <C>                     <C>
Deferred Tax Assets:
Property, plant and equipment                                  $1,055                  $2,175
Accrued product upgrades and service updates                      686                     864
Restructuring and special charges                                 295                     541
Accrued pension liability                                         538                     791
Vacation liability                                                621                     439
Warranty accrual                                                  445                     397
Accounts receivable allowance                                     277                     196
Subpart F income                                                  450                     463
Other                                                             750                     210
                                                       --------------           -------------
Total deferred tax assets                                       5,117                   6,076
                                                       --------------           -------------


Deferred Tax Liabilities:
Inventories                                                      (540)                 (4,395)
                                                       ---------------          -------------

Net deferred taxes                                             $4,577                  $1,681
                                                       --------------           -------------
</TABLE>

At December 31, 1997 and 1996 the Company has not provided a valuation allowance
against its deferred tax assets because the Company believes it is more likely
than not that the assets will be realized.

A reconciliation of income taxes computed at federal statutory rates to the
reported income tax expense is as follows:
<TABLE>
<CAPTION>
                                                      Year Ended          Year Ended          Year Ended
                                               December 31, 1997   December 31, 1996   December 31, 1995
                                               -----------------   -----------------   -----------------
<S>                                                <C>                 <C>                 <C>
Income tax expense computed at
   federal statutory tax rates                          $(5,030)            $(8,259)            $(4,023)
Permanent differences                                       (99)               (181)               (286)
State taxes, net of federal tax expense                    (307)               (433)               (190)
Research tax credit                                          330                 181                 210
Effect of international operations                            87                 167                 171
Other                                                       (20)                 266
                                                   -------------       -------------       -------------

Income tax expense                                      $(5,039)            $(8,259)            $(4,118)
                                                   -------------       -------------      --------------
</TABLE>
                                      -35-

<PAGE>

Pretax income for the periods presented was taxed under the following
jurisdictions:
<TABLE>
<CAPTION>
                                                          Year Ended          Year Ended          Year Ended
                                                   December 31, 1997   December 31, 1996  December 31, 1995
                                                   -----------------   -----------------  -----------------

<S>                                                <C>                 <C>                  <C>
Domestic                                                     $13,056             $20,813              $9,151
Foreign                                                        1,315               2,785               2,681
                                                       -------------       -------------      --------------
Total pretax income                                          $14,371             $23,598             $11,832
                                                       -------------       -------------      --------------

</TABLE>



NOTE 13.  EMPLOYEE BENEFIT PLANS

Retirement Plan

The Company has a noncontributory defined benefit retirement plan that covers
substantially all United States employees. Benefits under this plan prior to its
amendment in September 1994 were calculated by using one of several formulas.
These formulas were based on a combination of years of service, final average
earnings, primary social security benefits and age. Effective September 1, 1994,
the defined benefit plan was amended to become a cash balance plan. Under the
amended plan, the Company makes contributions to the plan based on certain
percentages of the participants' salaries.

The Company's funding policy for all plans is consistent with governmental and
tax funding requirements. Plan assets consist of equity and fixed income
instruments.

Net pension expense for the U.S. retirement plan includes the following
components:

<TABLE>
<CAPTION>
                                                      Year Ended          Year Ended          Year Ended
                                               December 31, 1997   December 31, 1996  December 31, 1995
                                               -----------------   -----------------  -----------------

<S>                                                <C>                  <C>                 <C>
Service costs-benefits earned during the period             $214                 $23                 $32
Interest cost on projected benefit obligation                787                 750                 359
Actual return on plan assets                              (1,364)             (1,564)               (876)
Net amortization and deferral                               (297)                106                (409)
Settlement gain                                                                                   (1,233)
Cost of special termination benefits                                                               1,806
                                                   -------------       -------------      --------------
Net pension benefit                                        $(660)              $(685)              $(321)
                                                   --------------      --------------     ---------------
</TABLE>

On December 1, 1994, the Company offered for a short period of time (through
January 15, 1995) special benefits to its employees in connection with their
voluntary early retirement. The terms of the offer included the option of a
lump-sum payment (settlement) and the automatic addition of two years of service
and three years to the participants' age in the calculation of the termination
benefits due (special termination benefits). The lump-sum payments and the
resulting relief of the plan's obligation to the participants and special
termination benefits offered constitute a settlement and special termination
benefits respectively, under FAS No. 88, "Employers' Accounting for Settlement
and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,"
which resulted in a settlement gain of $1,233 and a special termination benefits
cost of $1,806 during the year ended December 31, 1995. The decrease in the
projected benefit obligation and the plan assets was primarily a result of the
early retirement program and the associated lump sum payments made.

                                      -36-

<PAGE>



The following table sets forth the funded status and amounts recognized in the
accompanying financial statements:
<TABLE>
<CAPTION>

                                                    December 31, 1997       December 31, 1996
                                                    -----------------       -----------------
<S>                                                    <C>                      <C>
Actuarial present value of benefit obligations:
Vested benefit obligation                                     $11,666                  $9,976
Nonvested benefit obligation                                      345                     313
                                                       --------------           -------------

Accumulated benefit obligation                                $12,011                 $10,289
                                                       --------------           -------------

Plan assets at fair value                                     $18,751                 $15,910
Projected benefit obligation                                  (12,011)                (10,289)
                                                       ---------------          --------------
Plan assets in excess of projected
   benefit obligation                                           6,740                   5,621
Unrecognized prior service cost                                (6,394)                 (6,796)
Unrecognized net asset arising at transition                    1,057                   1,162
Unrecognized net gain (loss)                                   (2,454)                (1,698)
                                                       ---------------          -------------

Unfunded pension obligation                                   $(1,051)                $(1,711)
                                                       ---------------          --------------

</TABLE>


The assumptions used in the actuarial computations are as follows:
<TABLE>
<CAPTION>

                                                    December 31, 1997       December 31, 1996
                                                    -----------------       -----------------
<S>                                                             <C>                      <C>
Discount rate                                                   7.25%                    7.5%
Expected long-term rate of return on plan assets                 8.5%                    8.0%

</TABLE>


Team Savings Plan

The Company also has defined contribution savings plans that cover eligible
employees worldwide. Participation in a given plan is dependent upon the country
in which the participant is employed. Certain employees are eligible to
participate in the plans. The purpose of the plans is generally to provide
additional financial security during retirement by providing employees with an
incentive to make regular savings. Contributions to the plans are determined by
the Company based on employee contributions and the level of the Company match.
Company contributions to the plans were as follows:

<TABLE>
<CAPTION>

<S>                                                              <C>
Year ended December 31, 1995                                     $703
Year ended December 31, 1996                                     $405
Year Ended December 31, 1997                                     $423

</TABLE>




                                      -37-

<PAGE>



NOTE 14.  GEOGRAPHICAL INFORMATION

<TABLE>
<CAPTION>

                                                            Year Ended              Year Ended            Year Ended
                                                     December 31, 1997       December 31, 1996     December 31, 1995
                                                     -----------------       -----------------     -----------------
<S>                                                  <C>                     <C>                   <C>
Net Sales
United States sales to domestic customers                     $123,914                $127,808              $107,460
United States sales to foreign customers                        10,742                  10,120                 9,734
Transfers to foreign subsidiaries                               11,273                   9,323                 8,491
                                                         -------------           -------------          ------------
Total United States sales                                      145,929                 147,251               125,685
International sales                                             40,655                  35,237                31,508

Eliminations                                                   (11,273)                 (9,323)               (8,491)
                                                         -------------           -------------          ------------
Net sales                                                     $175,311                $173,165              $148,702
                                                         -------------           -------------          ------------


Income Before Taxes

Domestic                                                       $13,056                 $20,813                $9,151
International                                                    4,082                   5,703                 5,319
Eliminations                                                    (2,767)                 (2,918)               (2,638)
                                                         -------------           -------------          ------------
Income before taxes                                            $14,371                 $23,598               $11,832
                                                         -------------           -------------          ------------


Total Assets

United States                                                  $81,457                 $70,591               $61,335
International                                                   25,969                  26,158                18,055
Eliminations                                                      (767)                   (887)                 (890)
                                                         -------------           --------------         ------------
Total assets                                                  $106,659                 $95,862               $78,500
                                                         -------------           -------------          ------------
</TABLE>


Export sales were $10,742, $10,120 and $9,734 for the years ended December 31,
1997, 1996 and 1995, respectively.

NOTE 15.  COMMITMENTS AND CONTINGENCIES

Leases

The Company leases office space, automobiles and equipment under various
operating lease agreements. Total rent expense is as follows:

<TABLE>
<CAPTION>
<S>                                                            <C>
Year ended December 31, 1995                                   $1,539
Year ended December 31, 1996                                   $1,735
Year ended December 31, 1997                                   $3,011
</TABLE>


Future minimum annual rental commitments on all operating leases at December 31,
1997 are as follows:

<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
<S>                                                            <C>
1998                                                           $3,180
1999                                                            1,629
2000                                                              360
2001                                                               11
2002                                                               --
Thereafter                                                         --
                                                             --------

Total future minimum annual rental commitments                 $5,180
                                                             --------
</TABLE>


                                      -38-

<PAGE>


FDA Compliance

The Company is subject to routine inspections by the Food and Drug
Administration ("FDA"). The FDA issued a report of its observations, Form FDA
483, to the Predecessor on May 14, 1992, which contained observations that the
Predecessor's manufacturing processes and methods of documentation were not in
compliance with FDA current Good Manufacturing Practices ("GMP") and Medical
Device Reporting ("MDR") regulations. On May 18, 1992, the Predecessor
voluntarily suspended its manufacturing operations for the U.S. in order to
evaluate its operations and to assure compliance with GMP. In July 1992, the
Predecessor entered into a consent decree with the government which, among other
things, required that the Predecessor be subject to FDA inspection and approval
in order to resume production and distribution of its current products in the
United States. The consent decree is in effect for a minimum of five years from
July 1992, after which time the Company may apply for its termination. The
Company has met all obligations of the consent decree and resumed shipping its
products in stages.

Litigation

The Company is a party to certain legal actions arising in the ordinary course
of its business. The Company's estimates of these exposures are based primarily
on historical claims experience. The Company expects settlements related to
these claims to be paid out over the next several years. The majority of the
costs associated with defending and disposing of these suits are covered by
insurance. In the opinion of management, the amount of ultimate liability with
respect to these actions will not materially affect the financial position of
the Company.

In November 1995, the Company initiated litigation in Washington State Court
against Heartstream, Inc. ("Heartstream"), a company formed to develop,
manufacture and market defibrillators, as well as certain individuals who were
formerly employed by the Company and who are founders of and employees of
Heartstream. The Company claimed that Heartstream and such individuals had,
among other things, misappropriated certain of the Company's intellectual
property and that such individuals breached contractual obligations to the
Company. In addition, Heartstream initiated litigation against the Company in
January 1997 alleging that the Company had infringed a Heartstream patent
related to product self-test features. The Company filed an answer denying
Heartstream's claims and alleged certain counterclaims against Heartstream for
infringement of a Company self-test patent.

Effective as of October 10, 1997, the Company and Heartstream have entered into
a settlement agreement under which the referenced lawsuits have been dismissed
with prejudice and all outstanding claims between the parties have been settled
on mutually acceptable terms. The terms of the settlement are confidential.


                                      -39-
<PAGE>

NOTE 16.  SUMMARY OF QUARTERLY FINANCIAL DATA (Unaudited)

<TABLE>
<CAPTION>

                                                                                1997
                                                     -----------------------------------------------------------
                                                       First           Second             Third           Fourth
                                                     -------          -------           -------          -------
<S>                                                  <C>              <C>               <C>              <C>
Net sales                                            $40,727          $45,011           $44,109          $45,464

Gross margin                                          20,881           23,052            20,967           22,091

Operating expenses                                    16,105           17,825            18,397           18,741

Net income                                             2,653            2,983             1,379            2,317

Basic earnings per weighted average
  common share outstanding                             $0.16            $0.17             $0.08            $0.13

Diluted earnings per weighted average
  common share and common equivalent

  shares outstanding                                   $0.15            $0.17             $0.08            $0.13


</TABLE>

<TABLE>
<CAPTION>

                                                                                1996
                                                     -----------------------------------------------------------
                                                       First           Second             Third           Fourth
                                                     -------          -------           -------          -------
<S>                                                     <C>              <C>               <C>              <C>

Net sales                                            $42,755          $42,923           $41,694          $45,793

Gross margin                                          21,323           22,208            21,553           23,721

Operating expenses                                    15,475           15,688            16,384           15,469

Net income                                             3,396            3,887             2,891            5,165

Basic earnings per weighted average
  common share outstanding                             $0.20            $0.23             $0.17            $0.30

Diluted earnings per weighted average
  common share and common equivalent

  shares outstanding                                   $0.19            $0.22             $0.16            $0.29

</TABLE>


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

None.

                                       40
<PAGE>

                                    PART III

Item 10. Directors and Executive Officers of the Registrant.

The information under this Item is furnished pursuant to Instruction 3 to
Item 401(b) of Regulation S-K. Executive officers of the Company are elected
by and serve at the discretion of the Board of Directors.

Richard O. Martin, has been Chairman of the Board and Chief Executive Officer
of the Company since February 1997 and a Director of the Company since July
1994. Prior to that appointment, Dr. Martin was the President and Chief
Executive Officer of the Company from July 1994 and prior thereto served as
President of the Company's predecessor since April 1991. Prior to being named
President of the Company's predecessor and since November 1989, Dr. Martin
was a Vice President of SULZERmedica Inc., a medical device company
specializing in implantable products. From January 1988 to November 1989, Dr.
Martin was the President and Chief Operations Officer of Positron
Corporation, a medical device company specializing in medical diagnostic
imaging equipment. Dr. Martin also serves as a director of Encore
Orthopedics, Inc., a designer and manufacturer of implantable orthopedic
devices; of Maxxim Medical Inc., a designer, manufacturer and marketer of a
diversified range of specialty medical products; of SeaMED Corporation, a
designer and manufacturer of electromechanical products; and of
CardioDynamics, Inc., a developer, manufacturer and marketer of non-invasive
cardiac output systems. Dr. Martin is 58 years old.

Robert M. Guezuraga has been President and Chief Operating Officer of the
Company since February 1997 and a Director of the Company since September
1994. Prior to this appointment, Mr. Guezuraga served as Executive Vice
President, Chief Operating Officer and a Director of the Company from
September 1994. From 1989 to September 1994, Mr. Guezuraga was the President,
Chief Executive Officer and a director of Positron Corporation, a medical
device company specializing in medical diagnostic imaging equipment. Mr.
Guezuraga was previously employed by General Electric Company in various
managerial positions in numerous operating divisions, including its medical
systems business division. Mr. Guezuraga serves as a director of CPR Prompt,
Inc. Mr. Guezuraga is 48 years old.

Joseph J. Caffarelli has been Executive Vice President and Chief Financial
Officer of the Company since November 1994. From 1989 to November 1994, Mr.
Caffarelli was the Executive Vice President and Chief Financial Officer of
OECO Corporation, a diversified electronics manufacturer. Mr. Caffarelli was
previously employed by General Electric Company in various financial
management positions including positions in its manufacturing operations. Mr.
Caffarelli is 52 years old.

V. Marc Droppert has been Executive Vice President-Law, Human Resources and
Corporate Affairs and Secretary of the Company since February 1997. Prior to
this appointment, Mr. Droppert served as Senior Vice President-Law, Human
Resources and Corporate Affairs and Secretary of the Company from December
1994. From April 1993 to December 1994, Mr. Droppert was President of
Virginia Mason Health Plan, a 40,000 member HMO, and Associate Administrator
of Virginia Mason Medical Center. Mr. Droppert was previously employed as a
consultant and by PACCAR Inc, a manufacturer of motor vehicles, in various
legal and human resources positions. Mr. Droppert serves as a director of
MEDMARC Mutual Insurance Company. Mr. Droppert is 46 years old.

Information with respect to Directors of the Company is set forth in the
Proxy Statement under the heading "Election of Directors," which information
is incorporated herein by reference. Information required by Item 405 of
Regulation S-K is set forth in the Proxy Statement under the heading
"Compliance with Section 16(a) of the Securities Exchange Act of 1934," which
information is incorporated herein by reference.

                                       41
<PAGE>

Item 11. Executive Compensation.

Information with respect to executive compensation is set forth in the Proxy
Statement under the heading "Compensation of Executive Officers," which
information is incorporated herein by reference (except for the Compensation
Committee Report on Executive Compensation and the Performance Graph).

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

Information with respect to security ownership of certain beneficial owners
and management is set forth in the Proxy Statement under the heading
"Beneficial Ownership of Common Stock," which information is incorporated
herein by reference.

Item 13. Certain Relationships and Related Transactions.

Information with respect to certain relationships and related transactions is
set forth in the Proxy Statement under the headings "Election of Directors
-Compensation Committee Interlocks and Insider Participation" and "Election
of Directors - Certain Relationships and Related Transactions," which
information is incorporated herein by reference.

                                       42
<PAGE>
                                     PART IV

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

    (a) Documents filed as a part of this report:

        1.   Financial Statements. Reference is made to the Index to
             Consolidated Financial Statements and Supplementary Data
             included in Item 8 herein.

        2.   Financial Statement Schedules. Reference is made to the Index to
             Consolidated Financial Statements and Supplementary Data
             included in Item 8 herein.

        3.   Exhibits. The Company will furnish to any eligible stockholder,
             upon written request of such stockholder, a copy of any exhibit
             listed below upon the payment of a reasonable fee equal to the
             Company's expenses in furnishing such exhibit.
<TABLE>
<CAPTION>
              Exhibit
              No.                                   Exhibit
              -------                               -------
              <S>       <C>

              2.1        Stock Purchase Agreement, dated July 29, 1994, between
                         Eli Lilly and Physio Control Acquisition Corp. (1)

              3.1(i)     Restated Certificate of Incorporation of the Company.
                         (2)

              3.1(ii)    Amended and Restated By-laws of the Company. (2)

              3.2        Agreement and Plan of Merger. (3)

              3.2 (i)    Articles of Incorporation. (3)

              3.2 (ii)   Certificate of Merger. (3)

              3.2 (iii)  Articles of Merger. (3)

              4.1        Form of certificate representing shares of Common
                         Stock, par value $0.01 per share.(1)

              4.2        Registration Rights Agreement, dated July 29, 1994,
                         among the Company and the stockholders named therein.
                         (1)

              4.3        Stockholders Agreement, dated July 29, 1994, among the
                         Company and the stockholders named therein. (1)

              10.1       Credit Agreement dated July 29, 1994, between the
                         Company, the banks named therein and Creditanstalt-
                         Bankverein, as administrative agent. (1)

              10.2       Pledge Agreement, dated July 29, 1994, between the
                         Company and Creditanstalt-Bankverein, as collateral
                         agent. (1)

              10.3       Security Agreement, dated July 29, 1994, between the
                         Company and Creditanstalt-Bankverein, as collateral
                         agent. (1)

              10.4       Subordinated Promissory Notes issued by the Company in
                         favor of Eli Lilly and Company on July 29, 1994. (1)

              10.5       1994 Stock Purchase and Option Plan. (1)*

              10.6       Amended and Restated Management Agreements for Messrs.
                         Martin and Guezuraga. (1)*

              10.7       Management Advisory Agreement, dated July 29, 1994,
                         between the Company and Bain Capital, Inc. (1)

              10.8       Physio-Control International Corporation 1996 Stock
                         Incentive Plan. (2)*
</TABLE>
                                       43
<PAGE>
<TABLE>
              <S>        <C>
              10.9       Indemnification Agreement between the Company and its directors and executive officers. (2)*

              10.10      Physio-Control International Corporation Employee Share Purchase Plan. (2)*

              10.11      Letter, dated October 18, 1994, to Joseph J. Caffarelli regarding severance arrangement.(1)*

              10.12      Amended and Restated Management Agreements for Messrs. Caffarelli and Droppert. (2)*

              10.13      Amended and Restated Credit Agreement, dated December 15, 1995, by and among Physio-Control
                         Corporation, certain banks and Creditanstalt-Bankverein, as administrative agent
                         and collateral agent. (2)

              10.14      Reaffirmation, dated December 15, 1995, between Physio-Control International Corporation
                         and Creditanstalt-Bankverein, as collateral agent. (2)

              10.15      Amended and Restated Pledge Agreement, dated December 15, 1995, between Physio-Control
                         Corporation and Creditanstalt-Bankverein, as collateral agent. (2)

              10.16      Release Agreement, dated June 3, 1997, between Physio-Control International Corporation,
                         Physio-Control Corporation and Creditanstalt-Bankverein. (3)

              10.17      Credit Agreement, dated June 3, 1997, by and among Physio-Control Corporation, certain
                         banks and Bank of America, National Trust and Savings Association, as
                         administrative agent. (3)

              10.18      Commercial security agreement, dated June 3, 1997, between Physio-Control Corporation
                         and Bank of America, National Trust and Savings Association, as administrative agent. (3)

              10.19      Commercial Security Agreement, dated June 3, 1997, between Physio-Control Manufacturing
                         Corporation and Bank of America National Trust and Savings Association,
                         as administrative agent. (3)

              10.20      Amended and Restated 1997 Stock and Incentive Plan. (Incorporated by Reference to the
                         Company's Annual Proxy Statement filed with the Securities and Exchange
                         Commission in April, 1997.)

              10.21      Termination Agreement for Messrs. Martin, Guezuraga, Caffarelli and Droppert
                         (all substantially in the form attached as Exhibit 10.21 except that the "blank" in
                         paragraph 6(a) is completed by "two and one-half," "two and one-half," "one and one-half", and
                         "one," respectively.

              21.1       Subsidiaries of the Company.

              23.1       Consent of Price Waterhouse LLP.

              24.1       Power of Attorney for 1995 Annual Report on Form 10-K. (2)

              27.1       Financial Data Schedule for Fiscal Year ended December 31, 1997.

              27.2       Financial Data Schedule for Quarters 1, 2, 3 and Year ended December 31, 1996.

              27.3       Financial Data Schedule for Quarters 1, 2, 3 of Fiscal Year 1997.
</TABLE>

              ---------------
              (1) Incorporated herein by reference to the same numbered exhibit
                  filed with the Securities and Exchange Commission as part of
                  the Company's Registration Statement on Form S-1, as amended
                  (Registration No. 33-98856), as declared effective by the
                  Commission on December 12, 1995.

              (2) Incorporated herein by reference to the same numbered exhibit
                  filed with the Securities and Exchange Commission as part of
                  the Company's Annual Report on Form 10-K for the year ended
                  December 31, 1995.

                                       44

<PAGE>

              (3) Incorporated herein by reference to the same numbered exhibit
                  filed with the Securities and Exchange Commission as part of
                  the Company's Report on Form 10Q for the quarter ended June
                  30, 1997.

               *  Denotes a management contract or compensatory plan or
                  arrangement required to be filed with this Form 10-K pursuant
                  to Item 14(c) of Form 10-K.

     (b) Reports on Form 8-K.

         None.

                                       45

<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 on this 30th day
of March, 1998.

                                       PHYSIO-CONTROL INTERNATIONAL CORPORATION

                                            By        /s/ Joseph J. Caffarelli
                                              --------------------------------
                                                       Joseph J. Caffarelli
                                                   Executive Vice President and
                                                     Chief Financial Officer

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 in the capacities indicated on this 30th day of March, 1998.

<TABLE>
<CAPTION>

                         Signature                                                 Capacity
              <S>                                             <C>

                   /s/ Richard O. Martin
              -----------------------------                   Chairman of the Board, Chief Executive Officer
                     Richard O. Martin                        and Director (Principal Executive Officer)

                  /s/ Robert M. Guezuraga
              -----------------------------                   President, Chief Operating Officer and Director
                    Robert M. Guezuraga

                 /s/ Joseph J. Caffarelli
              -----------------------------                   Executive Vice President and Chief Financial Officer
                   Joseph J. Caffarelli                       (Principal Financial Officer and Principal
                                                              Accounting Officer)


                   /s/ V. Marc Droppert
              -----------------------------                   Executive Vice President-Law, Human Resources
                     V. Marc Droppert                         and Corporate Affairs and Secretary


                  /s/ Stephen G. Pagliuca
              -----------------------------                   Director
                    Stephen G. Pagliuca


                   /s/ Ronald W. Dollens
              -----------------------------                   Director
                     Ronald W. Dollens


                   /s/ Robert A. Sandler
              -----------------------------                   Director
                     Robert A. Sandler


                    /s/ Robert C. Gay
              -----------------------------                   Director
                       Robert C. Gay


                   /s/ John J. O'Malley
              -----------------------------                   Director
                     John J. O'Malley

</TABLE>

                                       46

<PAGE>

                                       Report of Independent Accountants on
                                            Financial Statement Schedule



To the Board of Directors and Stockholders of Physio-Control
International Corporation


Our audit of the Physio-Control International Corporation consolidated
financial statements referred to in our report dated January 27, 1998,
appearing on page 21 of this Annual Report on Form 10-K, also included an
audit of the Financial Statement Schedule listed in Item 14(a) of this Form
10-K. In our opinion, this Financial Statement Schedule presents fairly, in
all material respects, the information set forth therein when read in
conjunction with the related financial statements.

Price Waterhouse LLP
Seattle, Washington
January 27, 1998


                                       47

<PAGE>


PHYSIO-CONTROL INTERNATIONAL CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNT AND RESERVES

(dollars in thousands)
-----------------------------------------------------------------------------

<TABLE>
<CAPTION>

                                                Balance at    Charge to Costs                       Balance at
                                       Beginning of Period       and Expenses      Deductions    End of Period
                                       -------------------    ---------------      ---------     -------------
<S>                                    <C>                    <C>                  <C>           <C>

Year ended December 31, 1997
Allowance for doubtful accounts               $  766              $  282           $  (293)          $  755
Inventory Allowances                           2,494                 838            (1,180)           2,152

Year ended December 31, 1996
Allowance for doubtful accounts                  649                 280              (163)             766
Inventory Allowances                           3,687               4,513            (5,706)           2,494

Year ended December 31, 1995
Allowance for doubtful accounts                  918                 673              (942)             649
Inventory Allowances                           1,778               6,981            (5,072)           3,687

</TABLE>

                                                       48

<PAGE>

                        Consent of Independent Accounts


We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 333-00248 and 333-00640) of Physio-Control
International Corporation of our reports dated January 27, 1998, appearing on
page 21 of this Form 10-K. We also consent to the incorporation by reference
of our report on the Financial Statement Schedule, which appears on page 47
of this Form 10-K.


Price Waterhouse LLP
Seattle, Washington
March 27, 1998