<PAGE>   1
                                                                    EXHIBIT 13.1

NELLCOR PURITAN BENNETT INCORPORATED

Selected Financial Data

<TABLE>
<CAPTION>
Years ended (in thousands, except per share amounts)       1996           1995          1994           1993          1992
<S>                                                    <C>            <C>           <C>            <C>           <C>
Revenue                                                $706,131       $623,066      $564,132       $536,935      $467,323
R&D expenses                                             54,322         49,182        50,730         50,357        47,284
Income (loss) from operations                              (47)         73,404         8,441         60,018        32,982
Income from operations (as adjusted)                   108,852 (1)      76,058(2)     52,110 (3)     60,018        32,982
Net income (loss)                                       (9,360)         48,112        (8,695)        41,006        23,680
Net income (as adjusted)                                74,953 (1)      53,808(2)     50,864 (3)     41,006        23,680
Net income (loss) per share                               (.16)           0.82         (0.15)          0.72          0.43
Net income per share (as adjusted)                       1.271           0.922         0.893           0.72          0.43
Working capital                                        243,597         266,959       228,363        242,523       197,146
Total assets                                           587,838         602,390       527,569        497,610       420,253
Long-term obligations                                   26,054          84,690        66,062         64,351        49,085
Stockholders' equity                                   405,780         392,265       343,518        352,258       297,214
</TABLE>

   This summary unaudited combined condensed financial information reflects the
   August 1995 merger of Nellcor Incorporated (Nellcor) and Puritan-Bennett
   Corporation (Puritan-Bennett), and the Company's June 1996 acquisition of
   Infrasonics, Inc. (Infrasonics), both accounted for as a
   pooling-of-interests; accordingly, the separate historical financial results
   of Nellcor, Puritan-Bennett and Infrasonics have been combined in this table
   and throughout the Annual Report.

(1) Excludes pretax merger and related charges of $108.9 million, $84.3 million
after-tax, or ($1.43) per share.

(2) Excludes pretax restructuring charge and unsolicited offer costs of $2.7
million and $5.0 million (nonoperating expense), respectively, $5.7 million
after-tax, or ($0.10) per share.

(3) Excludes pretax restructuring charges and litigation settlements of $43.7
million and $13.0 million (nonoperating expense), respectively, and a $2.9
million after-tax charge related to the adoption of a new accounting standard.
The net after-tax effect of these charges was $59.6 million, or ($1.04) per
share.
<PAGE>   2
NELLCOR PURITAN BENNETT INCORPORATED

Consolidated Balance Sheet
<TABLE>
<CAPTION>
                                                                                                    July 7,        July 2,
   (in thousands, except share amounts)                                                              1996           1995
<S>                                                                                                <C>           <C>
   ASSETS

   Current assets:
   Cash and cash equivalents                                                                       $ 68,549      $ 83,193
   Marketable securities                                                                              5,825        66,028
   Accounts receivable                                                                              151,461       124,005
   Inventories                                                                                      128,078        95,300
   Deferred income taxes                                                                             31,658        17,122
   Other current assets, net                                                                         14,030         6,746
---------------------------------------------------------------------------------------------------------------------------
   Total current assets                                                                             399,601       392,394
   Property, plant and equipment                                                                    130,891       130,712
   Intangible and other assets                                                                       44,245        73,653
   Deferred income taxes                                                                             13,101         5,631
---------------------------------------------------------------------------------------------------------------------------
                                                                                                   $587,838      $602,390
   LIABILITIES & STOCKHOLDERS' EQUITY

   Current liabilities:
   Accounts payable                                                                                $ 39,198      $ 37,590
   Notes payable                                                                                         --        18,004
   Employee compensation and related costs                                                           29,918        25,708
   Merger and related costs                                                                          32,452            --
   Other accrued expenses                                                                            33,771        28,879
   Current maturities of long-term debt                                                                 143         9,527
   Income taxes payable                                                                              20,522         5,727
---------------------------------------------------------------------------------------------------------------------------
   Total current liabilities                                                                        156,004       125,435
   Long-term debt, less current maturities                                                            6,493        54,492
   Deferred compensation and pensions                                                                 9,522        19,303
   Deferred revenue                                                                                  10,039        10,895
---------------------------------------------------------------------------------------------------------------------------
   Total liabilities                                                                                182,058       210,125
---------------------------------------------------------------------------------------------------------------------------
   Stockholders' equity:
   Preferred stock, $.001 par value; 5,000,000 shares authorized; none outstanding                       --            --
   Common stock, $.001 par value; 150,000,000 shares authorized;
   62,975,926 shares issued and outstanding (60,333,242 in 1995)                                         63            60
   Additional paid-in-capital                                                                       230,428       187,264
   Retained earnings                                                                                232,433       241,103
   Accumulated translation adjustment                                                                   304          (259)
   Deferred stock awards and other                                                                    1,369        (1,364)
   Treasury stock, at cost (3,224,020 shares in 1996; 2,296,000 shares in 1995)                     (58,817)      (34,539)
---------------------------------------------------------------------------------------------------------------------------
   Total stockholders' equity                                                                       405,780       392,265
---------------------------------------------------------------------------------------------------------------------------
                                                                                                   $587,838      $602,390
</TABLE>
   See accompanying notes to consolidated financial statements.
<PAGE>   3
NELLCOR PURITAN BENNETT INCORPORATED

Consolidated Statement of Operations
<TABLE>
<CAPTION>
                                                                                                  Years Ended

                                                                                     July 7,        July 2,        July 3,
   (in thousands, except per share amounts)                                           1996           1995           1994
<S>                                                                                 <C>            <C>           <C>
   Net revenue                                                                      $706,131       $623,066      $564,132
   Cost of goods sold                                                                346,020        312,970       284,159

---------------------------------------------------------------------------------------------------------------------------
   Gross profit                                                                      360,111        310,096       279,973

---------------------------------------------------------------------------------------------------------------------------
   Operating expenses:
   Research and development                                                           54,322         49,182        50,730
   Selling, general and administrative                                               196,937        184,856       177,133
   Restructuring charges                                                                  --          2,654        43,669
   Merger and related costs                                                          108,899             --            --

---------------------------------------------------------------------------------------------------------------------------
                                                                                     360,158        236,692       271,532

---------------------------------------------------------------------------------------------------------------------------
   Income (loss) from operations                                                         (47)        73,404         8,441
   Interest income and other income (expense), net                                     4,406          7,182         3,865
   Interest expense                                                                   (3,033)        (5,830)       (4,565)
   Litigation settlements, net                                                            --             --       (13,000)
   Costs associated with unsolicited takeover offer                                       --         (5,049)           --

---------------------------------------------------------------------------------------------------------------------------
   Income (loss) before income taxes and cumulative
   effect of accounting change                                                         1,326         69,707        (5,259)
   Provision for income taxes                                                         10,686         21,595           546

---------------------------------------------------------------------------------------------------------------------------
   Income (loss) before cumulative effect of accounting change                        (9,360)        48,112        (5,805)
   Cumulative effect of accounting change,
   net of income taxes (Note 1)                                                           --             --        (2,890)

---------------------------------------------------------------------------------------------------------------------------
   Net income (loss)                                                                $ (9,360)      $ 48,112      $ (8,695)

   Income (loss) per common share before cumulative
   effect of accounting change                                                      $   (.16)      $    .82      $   (.10)
   Per common share effect of accounting change                                           --             --          (.05)

---------------------------------------------------------------------------------------------------------------------------
   Net income (loss) per common share                                               $   (.16)      $    .82      $   (.15)

   Weighted average common and common equivalent shares                               59,077         58,343        57,210
</TABLE>

   See accompanying notes to consolidated financial statements.
<PAGE>   4
NELLCOR PURITAN BENNETT INCORPORATED

Consolidated Statement of Stockholders' Equity
<TABLE>
<CAPTION>
                                                           Additional             Accumulated  Deferred
   (in thousands,                        Common Stock        Paid-in    Retained  Translation Stock Awards     Treasury Stock
   except share amounts)              Shares    Par Value    Capital    Earnings  Adjustment   and Other    Shares     Par Value
<S>                                <C>             <C>      <C>         <C>         <C>         <C>       <C>           <C>
   Balance at July 4, 1993         56,840,064      $56      $148,096    $204,636    $ (15)      $ (515)          --          --
   Issuance of common stock and
   related tax benefits of $2,394
   under employee stock plans       1,281,622        1        12,177                                                    $ 1,984
   Stock awards granted,
   net of cancellations                16,418                    374                              (374)
   Amortization of deferred
   stock awards                                                                                    282
   Acquisition of treasury stock                                                                          1,109,784     (16,258)
   Acquisition and retirement
   of common stock                   (420,000)                (5,853)
   Shares issued in a business
   combination                        751,396        1         8,644
   Accumulated translation
   adjustment                                                                         115
   Net loss                                                               (8,695)
   Dividends declared                                                     (1,432)
   Unrealized gain on
   available-for-sale securities                                                                   294

--------------------------------------------------------------------------------------------------------------------------------
   Balance at July 3, 1994         58,469,500       58       163,438     194,509      100         (313)   1,109,784     (14,274)
   Issuance of common stock and
   related tax benefits of $3,487
   under employee stock plans       1,816,665        2        22,642                                                        644
   Stock awards granted,
   net of cancellations                47,077                  1,184                            (1,184)
   Amortization of deferred
   stock awards                                                                                    427
   Acquisition of treasury stock                                                                          1,186,216     (20,909)
   Accumulated translation
   adjustment                                                                        (359)
   Net income                                                             48,112
   Dividends declared                                                     (1,518)
   Realized gain on
   available-for-sale securities                                                                  (294)

   Balance at July 2, 1995         60,333,242       60       187,264     241,103     (259)      (1,364)   2,296,000     (34,539)
   Puritan-Bennett net income
   for the period from
   2/1/95 - 6/30/95                                                          690
   Issuance of common stock and
   related tax benefits of $7,199
   under employee stock plans       2,642,684        3        43,164
   Amortization of deferred
   stock awards                                                                                  1,359
   Acquisition of treasury stock                                                                            928,020     (24,278)
   Accumulated translation
   adjustment                                                                         563
   Net loss                                                               (9,360)
   Unrealized gain on
   available-for-sale securities                                                                 1,374

--------------------------------------------------------------------------------------------------------------------------------
   Balance at July 7, 1996         62,975,926      $63      $230,428    $232,433     $304       $1,369    3,224,020    $(58,817)
</TABLE>
   See accompanying notes to consolidated financial statements.
<PAGE>   5
NELLCOR PURITAN BENNETT INCORPORATED

Consolidated Statement of Cash Flows
<TABLE>
<CAPTION>
                                                                                                  Years Ended

                                                                                     July 7,        July 2,        July 3,
   (in thousands)                                                                     1996           1995           1994
<S>                                                                                 <C>             <C>          <C>
   Cash flows from operating activities:
   Net income (loss)                                                                $ (9,360)       $48,112      $ (8,695)
   Adjustments to reconcile net income (loss) to
   cash provided by operating activities:
   Depreciation and amortization                                                      30,952         32,849        33,037
   Deferred income taxes                                                             (18,919)        (4,131)      (18,054)
   Cumulative effect of accounting change                                                 --             --         2,890
   Restructuring charges                                                                  --          2,205        38,404
   Merger and related charges                                                        108,899             --            --
   Deferred compensation and pensions                                                (11,635)         1,859         2,536
   Shares issued to employee benefit plans                                                --          2,376         3,317
   Other                                                                                 128            113         1,194
   Increases (decreases) in cash flows, net of effect of purchased companies, as
   a result of changes in:
   Accounts receivable                                                               (31,369)        (7,179)       (2,744)
   Inventories                                                                       (23,544)        (9,083)       (5,643)
   Other current assets                                                              (10,607)        (2,540)         (799)
   Intangible and other assets                                                         1,788         (3,703)        1,619
   Accounts payable                                                                    5,834           (543)       (2,714)
   Merger and related costs                                                          (45,366)            --            --
   Employee compensation and other accrued expenses                                    5,336          8,271           625
   Income taxes payable                                                               14,686            612         2,158
   Deferred revenue                                                                     (920)           933         3,991

---------------------------------------------------------------------------------------------------------------------------
   Cash provided by operating activities                                              15,903         70,151        51,122

---------------------------------------------------------------------------------------------------------------------------
   Cash flows from investing activities:
   Puritan-Bennett net cash used during the period from 2/1/95 - 6/30/95              (3,628)            --            --
   Capital expenditures                                                              (29,740)       (30,959)      (31,555)
   Purchase of securities held-to-maturity                                                --        (48,235)      (89,190)
   Purchase of available-for-sale securities                                          (2,800)        (2,100)           --
   Proceeds from maturities of securities held-to-maturity                                --         37,654       106,634
   Proceeds from the sale of available-for-sale securities                            66,400             --            --
   Proceeds from the sale of capital assets                                               --          5,893         1,362
   Acquisitions, net of cash acquired                                                 (4,923)       (23,415)      (17,617)
   Other investing activities                                                            220           (599)       (1,311)

---------------------------------------------------------------------------------------------------------------------------
   Cash provided by (used for) investing activities                                   25,529        (61,761)      (31,677)

---------------------------------------------------------------------------------------------------------------------------
   Cash flows from financing activities:
   Issuance of common stock under the
   Company's stock plans and related tax benefits, net                                43,164         20,901        10,846
   Purchase of treasury stock, including shares retired                              (24,278)       (20,909)      (22,111)
   Issuance (repayment) of notes payable, net                                        (18,004)        (9,787)       19,890
   Additions to loans payable                                                         40,000             --            --
   Repayment of loans payable                                                        (40,000)            --            --
   Additions to long-term debt                                                            --         20,000           515
   Repayment of long-term debt                                                       (57,374)        (6,045)       (6,680)
   Payment of dividends                                                                   --         (1,500)       (1,430)

---------------------------------------------------------------------------------------------------------------------------
   Cash provided by (used for) financing activities                                  (56,492)         2,660         1,030

---------------------------------------------------------------------------------------------------------------------------
   Effect of exchange rate changes on cash                                               416            570           218

---------------------------------------------------------------------------------------------------------------------------
   (Decrease) increase in cash and cash equivalents                                  (14,644)        11,620        20,693

---------------------------------------------------------------------------------------------------------------------------
   Cash and cash equivalents at the end of the year                                  $68,549        $83,193       $71,573
</TABLE>
   See accompanying notes to consolidated financial statements.
<PAGE>   6
NELLCOR PURITAN BENNETT INCORPORATED

Notes to Consolidated Financial Statements

   1.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

   Organization | Nellcor Puritan Bennett Incorporated (together with its
   wholly-owned subsidiaries, the Company) is a corporation organized under the
   laws of the State of Delaware in 1986 and, until the acquisition of
   Puritan-Bennett Corporation (Puritan-Bennett) in August 1995, operated under
   the name Nellcor Incorporated (Nellcor). The Company develops, manufactures
   and markets monitoring systems and diagnostic and therapeutic products for
   management of the respiratory-impaired patient across the continuum of care.
   The Company's products are primarily sold to hospitals, private and
   governmental institutions and health care agencies, medical equipment
   distributors and rental companies, and doctors' offices. Nellcor Puritan
   Bennett markets its products worldwide with international sales accounting
   for approximately one-third of the Company's consolidated revenue.

   Combined financial results | The mergers with Puritan-Bennett and
   Infrasonics, Inc. (Infrasonics) were intended to qualify as tax-free
   reorganizations and were both accounted for as a pooling-of-interests.
   Accordingly, the consolidated historical financial statements for all periods
   presented combine the financial results of Nellcor, Puritan-Bennett, and
   Infrasonics. The Company's consolidated balance sheet at July 2, 1995
   combines the historical balance sheet of Nellcor at July 2, 1995,
   Puritan-Bennett at January 31, 1995 and Infrasonics at June 30, 1995. The
   Company's consolidated statement of operations combines the historical
   statement of operations of Nellcor for each of the two fiscal years in the
   period ended July 2, 1995, Puritan-Bennett for each of the two fiscal years
   in the period ended January 31, 1995, and Infrasonics for each of the two
   fiscal years in the period ended June 30, 1995, respectively. The results of
   operations of Puritan-Bennett for the period February 1, 1995 through June
   30, 1995 of $690,000 have been recorded as an increase to stockholders'
   equity for the fiscal year ended July 7, 1996. The Company's consolidated
   statement of operations for the fiscal year ended July 2, 1995, also reflects
   an adjustment to reduce Puritan-Bennett's valuation allowance provided for
   its deferred tax assets based upon the combined income from operations of
   Nellcor and Puritan-Bennett as required by Statement of Financial Accounting
   Standard No. 109. The effect of this adjustment was to reduce the provision
   for income taxes, as presented herein, by $3.9 million and $4.8 million in
   fiscal 1995 and 1994, respectively. Adjustments made to conform the
   accounting policies of Nellcor, Puritan-Bennett, and Infrasonics were
   immaterial.

   Principles of consolidation | The Company's significant intercompany
   transactions and balances have been eliminated. The Company uses the equity
   method of accounting for its investments that represent greater than 20%, but
   less than 50%, of the investee. Investments which represent less than 20% of
   the investee are recorded at cost. All such investments were immaterial for
   all periods presented.

   Fiscal year | The Company's fiscal year ends on the first Sunday in July,
   which results in a 52- or 53-week fiscal year. Fiscal 1996 was a 53-week year
   whereas fiscal 1995 and 1994 were 52-week years.

   Foreign currency translation | Certain of the Company's foreign subsidiaries
   use the local currency, while others use the U.S. dollar as their functional
   currency. Subsidiaries using the local currency translate assets and
<PAGE>   7
   liabilities denominated in foreign currencies at the rates of exchange at the
   balance sheet date. Income and expense items are translated at average
   monthly rates of exchange. Any resulting translation adjustments are recorded
   as a separate component of stockholders' equity. Subsidiaries using the
   dollar as the functional currency measure assets and liabilities at the
   balance sheet date or historical rates depending on their nature; income and
   expenses are remeasured at the weighted-average exchange rates for the year.
   Foreign currency gains and losses resulting from transactions are included in
   operations in the year of occurrence and have not been material.

   Revenue recognition and product warranty | The Company recognizes revenue at
   the time of shipment of product and provides currently for the estimated cost
   to repair or replace products under the warranty provisions in effect at the
   time of sale.

   Deferred revenue | Deferred revenue relates to extended warranty agreements
   offered by the Company which are amortized over the life of the agreement,
   with the related extended warranty costs charged to expense as incurred.

   Cash equivalents | The Company considers all highly liquid investments with
   original maturities of three months or less to be cash equivalents. These
   investments are stated at cost which approximates fair value due to their
   short maturity.

   Inventories | Inventories are stated at the lower of cost (first-in,
   first-out) or market. Allowances are made for slow-moving, obsolete,
   unsalable, or unusable inventories.

   Property, plant and equipment | Depreciation is provided using the
   straight-line method over the estimated useful lives of the assets which
   range from three to twenty-five years. Leasehold improvements are amortized
   over the life of the lease, or the estimated useful life of the asset,
   whichever is shorter.

   Intangible and other assets | Intangible and other assets, including excess
   of cost over the fair value of identifiable net assets acquired, are
   amortized on a straight-line basis over the estimated useful lives of the
   assets which range from two to fifteen years. An impairment of intangible
   assets is recognized when it is considered probable that the carrying amount
   of an asset cannot be fully recovered, based on estimated future cash flows
   of the related business.

   Fair value of financial instruments | The estimated fair value of long-term
   debt is determined based upon rates currently available to the Company for
   debt with similar terms and remaining maturities.

   Income taxes | Deferred income taxes are computed using the liability method.
   Under the liability method, taxes are recorded based on the future tax effect
   of the difference between the income tax and financial reporting bases of the
   Company's assets and liabilities. In estimating future tax consequences, all
   expected future events are considered, except for potential income tax law or
   rate changes.

      The Company plans to continue to finance foreign expansion and operating
   requirements by reinvestment of undistributed earnings of its foreign
   subsidiaries and, accordingly, has not provided for United States federal
   income tax on these earnings.

   Stock split | On June 27, 1996, stockholders approved a two-for-one split of
   the Company's common stock. All share and per share data for all periods
   presented have been restated to give effect to the split.

   Net income (loss) per share | Net income (loss) per share is based upon
   weighted average common shares and includes the dilutive effect of stock
   options outstanding, if any (using the treasury stock method).

   Accounting changes | In March 1995, The Financial Accounting Standards Board
   (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 121,
   "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
   To Be Disposed Of," which requires the Company to review for
<PAGE>   8
   impairment of long-lived assets, certain identifiable intangibles, and
   goodwill related to those assets whenever events or changes in circumstances
   indicate that the carrying amount of an asset may not be recoverable. In
   certain situations, an impairment loss would be recognized. SFAS 121 is
   effective for the Company's 1997 fiscal year. The Company is evaluating the
   impact of the new standard on its financial position, results of operations,
   and cash flows and expects the effect to be immaterial.

   In October 1995, the FASB issued SFAS 123 "Accounting for Stock-Based
   Compensation" which also will be effective for the Company's 1997 fiscal
   year. The Company does not expect SFAS 123 to have a material impact on its
   financial position, results of operations, and cash flows. SFAS 123 allows
   companies which have stock-based compensation arrangements with employees to
   adopt a new fair-value basis of accounting for stock options and other equity
   instruments, or it allows companies to continue to apply the existing
   accounting rules under APB Opinion 25 "Accounting for Stock Issued to
   Employees," but requires additional financial statement footnote disclosure.
   The company expects to continue to account for stock-based compensation
   arrangements under APB Opinion 25 and will include additional footnote
   disclosure in its fiscal 1997 annual report.

   In fiscal 1994, the Company changed its method of accounting for income taxes
   to conform with SFAS No. 109 "Accounting for Income Taxes." The cumulative
   effect of this change resulted in a charge to operations of $2.9 million.

   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, the disclosure of contingent assets and liabilities, and the
   reported amounts of revenues and expenses for each fiscal period. Actual
   results could differ from those estimated.

   2.      MARKETABLE SECURITIES

   At July 7, 1996, the Company held available-for-sale marketable securities
   with a fair market value of $5.8 million. Available-for-sale marketable
   securities are securities which the Company does not intend to hold to
   maturity. The Company's marketable securities are, generally, high quality
   government, municipal, and corporate obligations with original maturities of
   up to two years. The Company has established guidelines relative to
   investment quality, diversification and maturities to maintain appropriate
   levels of safety and liquidity.

   During the first quarter of fiscal 1996, the Company transferred its
   remaining marketable securities which had been classified as held-to-maturity
   as of July 2, 1995, to available-for-sale. The marketable securities which
   were transferred to available-for-sale were government and corporate issued
   debt securities with an amortized cost of $41.4 million, which approximated
   their fair value. The decision to classify all of the Company's marketable
   securities as available-for-sale was due to the Company's merger with
   Puritan-Bennett during the first quarter of fiscal 1996, and the significant
   cash outlays which were expected to be made as part of integrating the two
   companies.

   Realized gains and losses resulting from the sale of available-for-sale
   marketable securities during the period were not material. The difference
   between the cost and market value of the Company's marketable securities at
   July 7, 1996, an unrealized gain of approximately $1.4 million associated
   with equity securities held by the Company, is recorded as a component of
   deferred stock awards and other in stockholders' equity.
<PAGE>   9
   3.      INVENTORIES

   Inventories are as follows:

<TABLE>
<CAPTION>
                                       July 7,     July 2,
   (dollars in thousands)               1996        1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                   <C>          <C>
   Raw materials                      $ 64,205     $52,270
   Work-in-process                      15,579      11,064
   Finished goods                       48,294      31,966
---------------------------------------------------------------------------------------------------------------------------
   Total inventories                  $128,078     $95,300
---------------------------------------------------------------------------------------------------------------------------
   4.      PROPERTY, PLANT AND EQUIPMENT     

   Property, plant and equipment consists of:

<CAPTION>
                                       July 7,     July 2,
   (dollars in thousands)               1996        1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                   <C>         <C>
   Land and land improvements         $ 10,838    $ 10,713
   Buildings                            38,575      38,221
   Machinery and equipment             178,220     162,775
   Leasehold improvements               11,103       9,971
   Demonstration equipment              12,259      12,497
   Furniture and fixtures               22,142      23,857
---------------------------------------------------------------------------------------------------------------------------
                                       273,137     258,034
   Less accumulated depreciation
   and amortization                   (142,246)   (127,322)
---------------------------------------------------------------------------------------------------------------------------
   Property, plant and equipment, net $130,891    $130,712
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

      The Company leases a facility which is classified as a capital lease and
   the related asset is being amortized over its estimated useful life of 15
   years. As of July 7, 1996, the cost of the asset and accumulated amortization
   was $4.4 million and $0.69 million, respectively, and is included in
   Buildings.

      Depreciation and amortization expense was approximately $23.7 million in
   fiscal 1996, $22.5 million in fiscal 1995, and $21.2 million in fiscal 1994.


   5.      FINANCIAL INSTRUMENTS AND OFF BALANCE SHEET RISK


   Foreign currency instruments | The Company enters into foreign currency
   exchange contracts, primarily foreign currency forward contracts, to reduce
   exposure to currency exchange risk. The effect of this practice is to
   minimize the impact of foreign exchange rate movements on the Company's
   operating results as gains and losses on these contracts offset losses and
   gains on the assets, liabilities and transactions being hedged. The Company
   does not engage in foreign currency speculation. The counterparties to
   foreign currency exchange contracts are major domestic and international
   financial institutions. To decrease the risk of non-performance which may
   result in currency losses, the Company diversifies its selection of
   counterparties. At July 7, 1996, the Company had foreign currency forward
   exchange contracts with a notional amount of $65.1 million ($35.4 million at
   July 2, 1995), and a fair market value of approximately $65.2 million ($35.9
   million at July 2, 1995), all of which were denominated in European
   currencies.

   The fair market value was determined using foreign currency exchange rates in
   effect at the end of each fiscal period. The Company records both the
   amortized premium and any unrealized gain or loss on outstanding foreign
   currency forward exchange contracts as non-operating income or expense. For
   both fiscal 1996 and fiscal 1995, all outstanding foreign currency exchange
   contracts were due to mature within six months of fiscal year end.

   Concentration of credit risk | The Company provides credit in the form of
   trade accounts receivable to hospitals, private and governmental institutions
   and health care agencies, medical equipment distributors and rental
   companies, and doctors' offices. The Company does not generally require
   collateral to support customer receivables. The Company performs ongoing
<PAGE>   10
   credit evaluations of its customers and maintains allowances which management
   believes are adequate for potential credit losses. At July 7, 1996, the
   Company was carrying allowances for doubtful accounts totaling $2.4 million
   ($2.8 million at July 2, 1995).

   The credit risk associated with the Company's trade receivables is further
   limited due to dispersion of the receivables over a large number of customers
   in many geographic areas. Payment of certain accounts receivable is made by
   the national health care systems of several member countries of the European
   Economic Community. Although the Company does not currently anticipate credit
   problems associated with these receivables, payment may be impacted by the
   economic stability of these countries.

   The Company limits credit risk exposure to foreign exchange contracts by
   periodically reviewing the credit-worthiness of the counterparties to the
   transactions.


   6.      ACQUISITIONS


   Melville | On August 23, 1995, the Company acquired Melville Software Ltd.
   (Melville), a privately held Canadian company that manufactures and markets
   sleep diagnostic products used primarily in sleep labs for $4.9 million in
   cash. In the event that certain profitability levels are achieved in the
   three fiscal years following the acquisition, additional compensation
   totaling $1.0 million would be payable to the former principal stockholders
   of Melville who continue to manage the company. Such amounts will be expensed
   when, and if, earned. At July 7, 1996, no additional compensation amounts had
   been earned or accrued.

   The acquisition of Melville has been accounted for as a purchase and,
   accordingly, Melville's results are included in the Company's financial
   statements subsequent to the acquisition date. The excess of cost over the
   fair value of identifiable net assets acquired, primarily working capital, of
   $3.7 million is being amortized over 7 years.

   Pierre Medical | On May 3, 1995, the Company acquired Pierre Medical, a
   privately held French manufacturer of respiratory products used in the home,
   for $21.5 million in cash. In the event that certain performance milestones
   were achieved subsequent to the acquisition, additional compensation totaling
   30 million French Francs ($5.8 million as of July 7, 1996) would be payable
   to the former principal stockholders of Pierre Medical who continue to manage
   the company. During fiscal 1996, $3.8 million of this additional compensation
   was accrued as a merger and related cost to reflect the effect that
   integration decisions associated with the Company's merger with
   Puritan-Bennett were expected to have upon the achievement of certain of the
   performance milestones. Any additional amounts will continue to be expensed
   when, and if, earned. Pierre Medical manufactures and markets noninvasive
   ventilators, sleep apnea therapy systems, oxygen concentrators and related
   respiratory products in Western Europe, primarily in France.

   The acquisition of Pierre Medical has been accounted for as a purchase and,
   accordingly, Pierre Medical's results are included in the Company's financial
   statements subsequent to the acquisition date. The fair value of identifiable
   net assets acquired consisted of approximately $4.0 million of working
   capital. The excess of cost over the fair value of identifiable net assets
   acquired of $18.1 million, including acquisition-related costs, was
   subsequently written down by $2.4 million during fiscal 1996 to reflect the
   effect that certain integration decisions associated with the Company's
   merger with Puritan-Bennett were expected to have upon Pierre Medical's
   estimated future cash flows. The remainder of the excess purchase price,
   $15.7 million, is being amortized over 15 years.

   In connection with the acquisition, supplemental cash flow information is as
   follows:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
   (DOLLARS IN THOUSANDS)
<S>                                                 <C>
   Fair value of identifiable net assets acquired,
   except for cash and cash equivalents             $26,999
   Liabilities assumed                               (5,584)
---------------------------------------------------------------------------------------------------------------------------
   Cash paid to acquire Pierre Medical, net
   of cash and cash equivalents acquired            $21,415
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

   Hoyer Medizintechnik | During fiscal 1994, the Company acquired a German
   distributor, Hoyer Medizintechnik (Hoyer), for $10.6 million in cash, of
   which $8.6 million was paid in fiscal 1994 and $2.0 million was paid during
   fiscal 1995.
<PAGE>   11
   SEFAM S.A. | The Company also acquired SEFAM S.A., a French supplier of
   diagnostic and therapeutic sleep products during fiscal 1994 for a total of
   $21.6 million, of which $12.9 million was paid in cash with the remainder
   paid through the issuance of 751,396 restricted shares of the Company's
   common stock.

   The acquisitions of SEFAM S.A. and Hoyer have been accounted for as purchases
   and, accordingly, their results are included in the Company's financial
   statements subsequent to their respective acquisition dates. The excess of
   cost over the fair value of identifiable net assets acquired, primarily
   working capital, of $22.5 million, including acquisition related costs, was
   subsequently written down by $15.9 million during fiscal 1996 to reflect the
   effect that certain integration decisions associated with the Company's
   merger with Puritan-Bennett were expected to have upon both entities' future
   estimated cash flows. The remainder of the excess purchase price, $4.9
   million, is being amortized over 15 years.

   In connection with these acquisitions, supplemental cash flow information is
   as follows:

<TABLE>
<CAPTION>
   (dollars in thousands)
---------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>
   Fair value of identifiable net assets acquired,
   except for cash and cash equivalents             $34,481
   Liabilities assumed                               (6,464)
   Stock issued                                      (8,645)
   Other                                             (1,755)
---------------------------------------------------------------------------------------------------------------------------
   Cash paid to acquire SEFAM S.A. and Hoyer,
   net of cash and cash equivalents acquired        $17,617
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

      If these acquisitions had occurred as of the beginning of the respective
   fiscal years they were acquired, the revenues or results of operations of
   these acquired businesses would have been immaterial to the results of
   operations of the Company for fiscal 1996, 1995 and 1994.

   Costs associated with an unsolicited offer | During fiscal 1995, $5.0 million
   of costs were incurred in connection with an unsolicited offer to acquire
   Puritan-Bennett. These costs included investment banking fees, public
   relations expenses and legal fees, of which $0.9 million was paid during
   fiscal 1995 and the remaining $4.1 million was paid during fiscal 1996.

   7.      MERGERS WITH PURITAN-BENNETT AND INFRASONICS

   Puritan-Bennett | On August 24, 1995, the merger of Nellcor and
   Puritan-Bennett was approved by stockholders of both companies. On August 25,
   the merger was consummated, and Nellcor was renamed Nellcor Puritan Bennett
   Incorporated. Under the terms of the merger agreement, Puritan-Bennett
   shareholders received .88 of a share of the Company's common stock for each
   Puritan-Bennett share, resulting in the Company issuing approximately 23.2
   million shares, valued at approximately $600 million based upon the closing
   price of the Company's common stock on August 25, 1995. Additionally,
   outstanding options to acquire Puritan-Bennett common stock were replaced
   with options to acquire approximately 1,047,000 shares of the Company's
   common stock.

   Puritan-Bennett develops, manufactures, and markets ventilators, oxygen
   delivery systems, home sleep diagnostic and therapeutic equipment, and
   certain complementary products such as medical gases, gas-related equipment,
   and spirometers. Puritan-Bennett reported revenue of $336.0 million and net
   income of $8.4 million for its fiscal 1995 ended January 31, 1995.

   Infrasonics | On June 27, 1996, the Company acquired Infrasonics in a
   stock-for-stock merger. The issuance of the Company's common stock in
   accordance with the Agreement and Plan of Merger was approved by stockholders
   at special stockholders meetings held by both companies on June 27, 1996.
   Under the terms of the Agreement and Plan of Merger, shareholders of
   Infrasonics received .12 of a share of the Company's common stock for each
   Infrasonics share, resulting in the Company issuing approximately 2.6 million
   shares, valued at $62 million based upon the closing price of the Company's
   common stock on June 27, 1996. Additionally, outstanding options to acquire
<PAGE>   12
   Infrasonics common stock were assumed by the Company and converted into
   options to acquire approximately 130,000 shares of the Company's common
   stock. Infrasonics is a respiratory equipment manufacturer of neonatal,
   pediatric and adult ventilators and accessories.

   Separate results for each of Nellcor's, Puritan-Bennett's, and Infrasonics'
   fiscal 1995, and combined results for the twelve months ended July 2, 1995,
   including the adjustment described in Note 1, were as follows:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                           NELLCOR PURITAN-BENNETT INFRASONICS                                   COMBINED
   Twelve months ended (in thousands):  July 2, 1995    January 31, 1995   June 30, 1995      Adjustment       July 2, 1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>               <C>               <C>               <C>              <C>
   Revenue                                $264,040          $336,026          $23,000           $   --           $623,066
---------------------------------------------------------------------------------------------------------------------------
   Net income (loss)                      $ 37,165          $  8,398          $(1,351)          $3,900           $ 48,112
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

   Merger and related costs | Associated with the Company's mergers with
   Puritan-Bennett and Infrasonics, one-time merger and related costs totaling
   $108.9 million were recorded during fiscal 1996.

   In connection with the merger with Puritan-Bennett, the Company recorded
   merger and related costs during the first quarter of fiscal 1996 of $92.6
   million. Included in this charge were provisions for merger transaction costs
   ($13.7 million), certain intangible asset write-downs ($19.6 million), costs
   to combine and integrate operations ($53.8 million), and other merger-related
   costs ($5.5 million). In connection with the acquisition of Infrasonics, the
   Company recorded merger and related costs during the fourth quarter of fiscal
   1996 of $16.3 million. Included in this charge were provisions for merger
   transaction costs ($2.5 million), costs to combine and integrate operations
   ($11.8 million), and certain intangible asset write-downs ($2.0 million). The
   merger transaction costs include expenses for investment banker and
   professional fees, and other costs associated with completing the
   transactions. The write-down of certain intangible assets, primarily goodwill
   associated with prior acquisitions made by both companies, results from the
   effect that certain integration decisions are expected to have upon the
   future realization of these assets.

   The costs to combine and integrate operations included provisions for the
   following types of costs:

<TABLE>
<CAPTION>
                            Puritan-
   (dollars in millions)     Bennett    Infrasonics    Total
---------------------------------------------------------------------------------------------------------------------------
<S>                            <C>         <C>         <C>
   Employee severance and
   benefits termination        $26.7       $ 4.1       $30.8
   Product line integration
   and facilities closing       18.0         2.9        20.9
   Other                         9.1         4.8        13.9
---------------------------------------------------------------------------------------------------------------------------
   Total                       $53.8       $11.8       $65.6
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

   Employee severance and benefits termination costs include amounts associated
   with the elimination of approximately 300 positions from the Company's total
   workforce. The positions to be eliminated are primarily associated with
   corporate administrative groups, field sales and customer service
   organizations, and the consolidation of manufacturing sites. As of July 7,
   1996, approximately 165 positions contemplated by this workforce
   consolidation, primarily in the Company's field sales and corporate
   administrative groups, had been eliminated. The Company expects the remainder
   of these positions to be eliminated during fiscal 1997.

   Of the $108.9 million in merger and related costs which were accrued,
   approximately $76.4 million had been utilized as of July 7, 1996, primarily
   associated with the write-down (non-cash charge) of certain intangible assets
   to their net realizable value ($21.8 million), the payment of merger
   transaction costs ($14.3 million), initial costs incurred to combine and
   integrate operations ($37.2 million, of which $8.5 million was associated
   with employee severance) and other merger-related costs ($3.1 million). The
   remaining merger and related costs accrued at July 7, 1996 of $32.5 million,
   approximately $31 million of which is expected to result in a cash outlay,
   should be substantially utilized by the end of fiscal year 1997.
<PAGE>   13
   8.      INTANGIBLE AND OTHER ASSETS

   Intangible and other assets consist of:

<TABLE>
<CAPTION>
                                       July 7,     July 2,
   (dollars in thousands)               1996        1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>         <C>
   Other intangibles from
   acquisitions, and purchased
   technologies and rights              10,144      13,502
   Other assets                         16,073      27,423
---------------------------------------------------------------------------------------------------------------------------
   Total cost                           69,968      97,117
   Less accumulated amortization       (25,723)    (23,464)
---------------------------------------------------------------------------------------------------------------------------
   Intangible and other assets, net    $44,245     $73,653
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

   9.      NOTES PAYABLE AND CREDIT FACILITY

   The Company has a $50 million credit facility with a group of four banks
   which provides an option to convert outstanding borrowings under the facility
   to a term loan repayable over four years. The rate of interest payable under
   this facility is a floating rate, which is a function of the London Interbank
   Offered Rate. A facility fee equal to 0.25% of the total commitment is paid
   quarterly. The credit facility contains various covenants which require the
   Company to maintain specified financial ratios, limit liens, regulate asset
   dispositions, and subsidiary indebtedness, and restrict certain acquisitions
   and investments. During fiscal 1996, the Company borrowed $40 million against
   the credit facility. These funds were in turn used to pay down a portion of
   the long-term debt the Company had assumed in its merger with
   Puritan-Bennett. At July 7, 1996, the Company was in compliance with the
   credit facility covenants and all borrowings had been repaid.

   10.     LONG-TERM DEBT

   Long-term debt is summarized as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                               July 7,    July 2,
   (dollars in thousands)                       1996       1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                          <C>         <C>
   Unsecured promissory notes payable:
   Various notes with interest rates, both
   fixed and variable, ranging from 5.13%
   to 9.85%, interest payable
   semi-annually and principal payable in
   annual installments with maturities
   from December 1997 through July 2000          --      $56,843
   Secured bank note payable:
   Interest rate 7.95%, principal payable
   in monthly installments through
   August 2003, collateralized by a
   building                                  $1,530        1,707
   Capital lease:
   Interest rate 7.0%, principal payable
   in monthly installments through
   February 2009                              4,645        4,782
   Other                                        461          687
---------------------------------------------------------------------------------------------------------------------------
                                              6,636       64,019
   Less current maturities                     (143)      (9,527)
---------------------------------------------------------------------------------------------------------------------------
   Total long-term debt                      $6,493      $54,492
</TABLE>
<PAGE>   14
           The estimated fair value of total long-term debt at July 7, 1996 was
   approximately $6.6 million.

           The future minimum lease payments required under the capital lease
   are included in the aggregate maturities of long-term debt listed below.

           As of July 7, 1996, the Company was in compliance with the provisions
   of its debt agreements. The aggregate maturities of long-term debt during
   each of the next five fiscal years are as follows: 1997 - $143,000; 1998 -
   $452,000; 1999 - $487,000; 2000 - $587,000; and 2001 - $631,000.

           Interest paid related to all Company debt in 1996, 1995 and 1994
   totaled $2.7 million, $6.1 million and $4.7 million, respectively.

   11.     RESTRUCTURING CHARGES

   During fiscal 1995, Puritan-Bennett recorded a $2.7 million restructuring
   charge associated with a workforce reduction.

   During fiscal 1994, Puritan-Bennett restructured the hospital ventilator and
   portable ventilator portions of its business, consolidated its aviation
   facilities and substantially reduced a division's operations to improve
   profitability. In connection with the restructuring, during fiscal 1994
   Puritan-Bennett recorded restructuring charges of $43.2 million. Included in
   these charges were provisions for personnel-related charges ($7.7 million),
   non-cash asset write-downs ($29.7 million), consolidation of manufacturing
   and marketing facilities ($1.3 million), and other restructuring-related
   costs ($4.5 million). During the third quarter of fiscal 1995,
   Puritan-Bennett completed the shut down of the division. During fiscal 1994,
   Nellcor recorded a restructuring charge of $.5 million associated with the
   consolidation of two of Nellcor's divisions. As of July 7, 1996,
   substantially all of these restructuring charges had been utilized.

   12.     EMPLOYEE BENEFITS

   Defined benefit plans | The Company's wholly-owned subsidiary,
   Puritan-Bennett, has non-contributory, defined benefit pension plans covering
   certain employees in the U.S., and substantially all employees in Canada,
   Ireland, and Germany. The Company contributes to each plan on an annual basis
   the amounts necessary to satisfy the funding requirements of the various
   jurisdictions in which the plans are established.

   The U.S. defined benefit pension plan was terminated as of October 24, 1995.
   The costs associated with terminating the plan were not material. As of June
   11, 1996, all participants in the plan had either received a lump sum
   distribution or had an annuity purchased on their behalf.

   The Canadian defined benefit pension plan provides retirement benefits based
   upon the employee's average earnings and years of service. The Irish plan
   provides benefits equal to a certain percentage of the participant's final
   salary. Puritan-Bennett has an unfunded supplemental retirement plan covering
   certain key employees which provides supplemental retirement benefits based
   upon average earnings. Puritan-Bennett also has an unfunded retirement plan
   for its former outside directors.

   A summary of the components of net costs for the defined benefit plans
   follows:

<TABLE>
<CAPTION>
                                                                     Pension                          Supplemental

   (dollars in thousands)                                  1996       1995       1994         1996        1995        1994
---------------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>       <C>         <C>          <C>         <C>         <C>
   Service cost - benefits earned during the year          $169      $2,189      $1,832       $105        $ 85        $ 25
   Interest cost                                            148       3,811       3,615        374         287         268
   Return on plan assets                                   (341)        466        (615)        --          --          --
   Net amortization and deferral                             98      (3,932)     (3,494)        72         105         104
---------------------------------------------------------------------------------------------------------------------------
   Net cost                                                $ 74      $2,534      $1,338       $551        $477        $397
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

   Assumptions used in determining the net cost for the defined benefit plans
   were:

<TABLE>
<CAPTION>
                                                                     Pension                         Supplemental

                                                          1996        1995       1994        1996        1995       1994
---------------------------------------------------------------------------------------------------------------------------
<S>                                                       <C>         <C>        <C>         <C>         <C>         <C>
   Weighted average discount rates                        8.00%       7.50%       8.75%      8.00%       8.50%       8.50%
   Rate of increase in compensation levels                4.50%       4.50%       6.00%      4.50%       4.50%       6.00%
   Expected long-term rate of return                      9.75%       9.00%      10.00%       N/A         N/A         N/A
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>   15
   The following table sets forth the funded status and amounts recognized in
   the Company's consolidated balance sheets at July 7, 1996 and July 2, 1995,
   for the defined benefit plans:

<TABLE>
<CAPTION>
                                                                              Pension                    Supplemental

   (dollars in thousands)                                                1996          1995           1996           1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>          <C>             <C>            <C>
   Vested benefit obligation                                            $1,540       $39,858         $5,117         $3,233
---------------------------------------------------------------------------------------------------------------------------
   Accumulated benefit obligation                                        1,540        40,897          5,117          3,233
---------------------------------------------------------------------------------------------------------------------------
   Projected benefit obligation                                          2,233        49,302             --          3,677
   Plan assets at fair value                                             3,048        35,280             --             --
---------------------------------------------------------------------------------------------------------------------------
   Projected plan assets in (excess of) or less than projected
   benefit obligation                                                     (815)       14,022          5,117          3,677
   Unrecognized net gain (loss)                                           (238)       (5,788)          (770)          (592)
   Unrecognized net (asset) liability                                      314         2,309             --           (144)

   Net (asset) liability recognized in the consolidated balance sheet   $ (739)      $10,543         $4,347         $2,941
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

   Assumptions used in determining the actuarial present value of the projected
   benefit obligation for the pension plans were:

<TABLE>
<CAPTION>
                                                                U.S.                  Canada                 Ireland

                                                          1996(1)    1995        1996        1995       1996        1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>       <C>         <C>          <C>      <C>        <C>
   Weighted average discount rate                          8.00%     8.50%       8.00%        8.50%     8.75%      8.75%
   Rate of increase in compensation levels                 4.50%     4.50%       4.50%        4.50%     6.00%      6.00%
   Expected long-term rate of return on assets              N/A      9.00%       9.50%        9.50%    10.00%     10.00%
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
   (1) Supplemental plan only

      Both the Canadian and Irish plan assets are invested in pooled mutual
   funds. For the unfunded supplemental retirement benefits plan, the Company
   has purchased company-owned life insurance policies intended to ultimately
   fund the cost of the plan.

      As part of the merger of Nellcor and Puritan-Bennett, future benefit
   accruals under the supplemental portion of the U.S. defined benefit pension
   plan were eliminated. As this decision reduced expected years of future
   service, the event resulted in a curtailment charge of $560,000 which was
   recorded as a component of merger and related costs.

   Postretirement benefits other than pensions | The Company provides
   postretirement health care benefits to certain eligible retirees of its
   subsidiary, Puritan-Bennett. The cost of the postretirement medical plan is
   shared by the Company and eligible retirees through such features as annually
   adjusted contributions, deductibles and coinsurance. The retiree's
   contribution is a factor of age and service at the time of retirement. The
   postretirement health care benefits are funded by the Company as claims are
   paid. The Company accounts for these benefits in accordance with SFAS No.
   106, "Employers Accounting for Postretirement Benefits other than Pensions."
   In the valuation of the liability, an 8.5% discount assumption was used.
   Medical costs were trended at 7%, trailing down to 6%. The components of the
   Company's postretirement benefits obligation are as follows:

<TABLE>
<CAPTION>
   (dollars in thousands)                1996        1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                     <C>         <C>
   Accumulated benefit obligation       $1,003      $1,754
   Less unrecognized amounts:
   Unrecognized net liability                        1,659
   Net (gain)                             (509)       (411)
---------------------------------------------------------------------------------------------------------------------------
   Net liability                        $1,512      $  506
</TABLE>

   The following summarizes the components of the annual net cost of the
   postretirement benefits:

<PAGE>   16
<TABLE>
<CAPTION>
   (dollars in thousands)                1996        1995
-------------------------------------------------------------------------------
<S>                                     <C>         <C> 
   Service cost                           $ 31        $ 39
   Interest cost                           125         131
   Net amortization and deferral            64          85
-------------------------------------------------------------------------------
   Total                                  $220        $255
-------------------------------------------------------------------------------
</TABLE>


      As a result of the merger of Nellcor and Puritan-Bennett, it was
   determined that employees retiring from Puritan-Bennett on or after January
   1, 1997 would no longer be eligible for postretirement medical coverage. This
   decision resulted in a curtailment charge of $971,000, which was recorded as
   a component of merger and related costs.

   Voluntary Investment Plus (VIP) plan | The Company has a Voluntary Investment
   Plus (VIP) 401(k) Plan under which substantially all U.S. employees may elect
   to contribute up to 15% of their earnings. The Company matches each
   employee's contributions, up to a maximum of $1,000 each calendar year.

      Prior to the merger with Nellcor, Puritan-Bennett had a 401(k) plan under
   which substantially all U.S. employees were eligible to participate. The
   Puritan-Bennett Board of Directors amended Puritan-Bennett's 401(k) plan at
   the merger date to provide a matching consistent with the Company's plan. The
   plan assets were subsequently merged into the Company's VIP plan.

      Infrasonics has a 401(k) plan under which substantially all U.S. employees
   may elect to contribute up to 15% of their earnings. Infrasonics contributes
   an additional 25% for up to 6% of each individual's contribution. This plan
   will continue to exist until January 1997, when it will be merged into the
   Company's VIP plan. The amount charged to expense under all plans was $2.3
   million, $1.8 million, and $1.8 million in fiscal 1996, 1995 and 1994,
   respectively.

   13.     INCOME TAXES


   The provision for income taxes consists of the following:




<TABLE>
<CAPTION>
                                     Years Ended
-------------------------------------------------------------------------------

                           July 7,     July 2,     July 3,
  ( in thousands)           1996        1995        1994
-------------------------------------------------------------------------------
<S>                      <C>         <C>         <C>    
   Federal:
   Current                 $22,474     $18,978     $12,723
   Deferred                (17,156)     (2,860)    (12,336)

-------------------------------------------------------------------------------
                             5,318      16,118         387

-------------------------------------------------------------------------------
   State:
   Current                   2,338       3,355       3,246
   Deferred                 (1,562)       (456)     (3,138)

-------------------------------------------------------------------------------
                               776       2,899         108

   Foreign:
   Current                   4,793       3,393       2,631
   Deferred                   (201)       (815)     (2,580)

-------------------------------------------------------------------------------
                             4,592       2,578          51

-------------------------------------------------------------------------------
                           $10,686     $21,595       $ 546

-------------------------------------------------------------------------------
</TABLE>


      Pretax income from foreign operations used to determine related tax
   liabilities amounted to $4,151,000; $14,541,000; and $1,372,000 for fiscal
   1996, 1995, and 1994, respectively. The Company has manufacturing operations
   in Ireland which qualify for a reduced tax rate of 10 percent. The reduced
   rate available on manufacturing profits earned in Ireland will expire in
   fiscal year 2011.
<PAGE>   17
   The most significant components of the Company's deferred tax assets and
   liabilities at July 7, 1996 and July 2, 1995 are as follows:

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------
                                                        July 7, 1996                July 2, 1995
                                                        Deferred Tax                Deferred Tax

   (in thousands)                                   Assets       Liabilities     Assets       Liabilities
-------------------------------------------------------------------------------------------------------
<S>                                                <C>           <C>            <C>           <C>        
   Inventory and product allowances                $20,442       $ 1,714        $11,773             --
   Property, plant and equipment                     2,934         8,070             --        $ 5,657
   Intangible assets                                 3,469            --            832            759
   Employee benefits                                 7,292            --         10,144             --
   Deferred revenue                                  3,112            --          3,785             --
   State income tax accrual                          1,188            --          1,392             --
   Provision for accounts receivable                   983            --            642             --
   Tax/book year end difference                         --         2,716             --          1,504
   Losses carried forward                            5,254            --          7,447             --
   Merger and related costs                         12,394            --             --             --
   Credits carried forward                           2,842            --          2,666             --
   Other                                             1,218           381          8,065          2,376

-------------------------------------------------------------------------------------------------------
   Total                                            61,128        12,881         46,746         10,296
   Less: valuation allowance                        (3,488)           --        (13,697)            --

-------------------------------------------------------------------------------------------------------
   Deferred income taxes                           $57,640       $12,881       $ 33,049        $10,296 
-------------------------------------------------------------------------------------------------------
</TABLE>


      As of July 7, 1996, the Company had net operating loss carryforwards
   resulting from the acquisition of Puritan-Bennett, which expire beginning in
   fiscal year 2006 and ending in fiscal year 2010.

      The valuation allowance decreased by $10.2 million during fiscal 1996,
   reflecting the portion of Puritan-Bennett's operating loss carryforwards
   which were realized ($2.1 million), or are expected to be realized ($7.2
   million) in the future based upon the current and projected profitability of
   Puritan-Bennett, and the realization of remaining EdenTec net operating loss
   carryforwards ($0.9 million). The decrease in the EdenTec valuation allowance
   was recorded as a reduction of the remaining net book value of the EdenTec
   goodwill.

      The Company paid income taxes of approximately $11.1 million, $21.6
   million, and $13.9 million in fiscal 1996, 1995, and 1994, respectively.

      The difference between the Company's actual effective income tax rate and
   the United States federal statutory income tax rate is reconciled as follows:



<TABLE>
<CAPTION>
                                                                                           Years Ended

                                                                            July 7, 1996         July 2, 1995  July 3, 1994

   (dollars in thousands)                                                 $              %              %             %
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                   <C>            <C>            <C>           <C>    
   Federal statutory rate                                                $ 463          35.0%          35.0%         (35.0)%
   State income taxes, net of federal benefit                              504          38.1            2.2           (6.9)
   Research and experimental credits                                      (166)        (12.5)          (1.7)         (43.7)
   Tax legislation changes                                                              --             --            (13.7)
   Foreign statutory tax rate differences                               (3,818)       (287.9)          (6.8)         (26.5)
   Merger and related costs                                             23,363       1,761.8           --             --
   Increase (decrease) in valuation allowance                           (9,300)       (701.4)           1.7          120.7
   Net operating loss utilized                                          (1,351)       (101.9)          --             --
   Foreign earnings taxed in U.S.                                          399          30.1           --             --
   Other                                                                   592          44.6             .6           15.5

---------------------------------------------------------------------------------------------------------------------------
   Income tax provision                                                $10,686         805.9%            31%          10.4%

---------------------------------------------------------------------------------------------------------------------------
</TABLE>


   14.     STOCKHOLDERS' EQUITY

   Common stock | On June 27, 1996, stockholders approved a two-for-one stock
   split of the Company's common stock. As of July 7, 1996, taking into account
   the two-for-one stock split, an aggregate of 12,167,110 shares of authorized
   but unissued Company common stock remained reserved for issuance under the
   Infrasonics 1995 Stock Option Plan (the "Infrasonics 1995 Plan"), the 1995
   Merger Stock Incentive Plan (the "1995 Plan"), the 1994 Equity Incentive
   Plan, as amended (the "1994 Plan"), the Infrasonics 1991 Stock Option Plan
   (the "Infrasonics 1991 Plan"), the 1991 Equity Incentive Plan, as amended
   (the "1991 Plan"), the 1988 Stock Option Plan for Non-Employee Directors, as
   amended (the "1988 Plan"), the 1985 Equity Incentive Plan (the "1985 
<PAGE>   18
   Plan"), the Infrasonics 1983 Employee Stock Option Plan (the "Infrasonics
   1983 Plan"), the 1986 Employee Stock Participation Plan as amended (the "1986
   ESPP"), which terminated August 1996, and the 1995 Employee Stock
   Participation Plan (the "1995 ESPP").

   Stock option plans | The Company maintains six employee stock option plans:
   the Infrasonics 1995 Plan, the 1995 Plan, the 1994 Plan, the Infrasonics 1991
   Plan, the 1991 Plan and the Infrasonics 1983 Plan. In August 1995, the
   Company obtained stockholder approval of the 1995 Plan, which authorized the
   issuance of up to 1,558,000 shares of Company common stock in the form of
   replacement stock options to holders of unexercised options to purchase
   Puritan-Bennett stock as of the effective date of the merger between Nellcor
   and Puritan-Bennett. Replacement options representing 1,046,996 shares of
   Company common stock were issued. No additional options will be granted from
   the 1995 Plan. As of the effective date of the merger between the Company and
   Infrasonics, the Company assumed the Infrasonics 1995 Plan, the Infrasonics
   1991 Plan and the Infrasonics 1983 Plan (the "Infrasonics Plans") and
   authorized the issuance of Company common stock upon exercise of options
   outstanding under the Infrasonics Plans. As of the effective date of the
   merger, options to purchase approximately 130,000 shares of Company common
   stock were outstanding under the Infrasonics Plans. No additional options
   will be granted from the Infrasonics Plans.

      In October 1994, the Company obtained stockholder approval of the 1994
   Plan, which authorized the issuance of up to 3,000,000 shares of common stock
   to executive officers, other key employees and consultants in the form of
   incentive and nonqualified stock options, stock bonuses and restricted stock.
   the 1994 Plan satisfies the performance-based compensation requirements of
   the Omnibus budget reconciliation act of 1993. In August 1995, the
   stockholders approved an amendment to the 1994 Plan to increase the number of
   shares authorized for issuance from 3,000,000 to 5,000,000.

      The Company obtained stockholder approval of the 1991 Plan in October
   1991. Upon stockholder approval of the 1991 Plan, the Company's 1982
   Incentive Stock Option Plan (The "1982 Plan") and the 1985 Plan were
   terminated; however, shares available for issuance under these plans at the
   time of termination, including shares underlying outstanding options that
   later expire or are canceled, totaling approximately 938,500 shares were
   pooled with the 1,500,000 additional shares reserved for issuance under the
   1991 Plan. In October 1992, the Company obtained stockholder approval for an
   amendment to the 1991 Plan increasing the number of shares authorized for
   issuance under the 1991 Plan by an additional 3,000,000 shares.

      Restricted stock grants totaling 19,400 shares have been made under the
   1991 Plan, of which 5,000 shares were subsequently canceled. These grants
   vest on an annual basis over a three-year period. stock bonus awards totaling
   37,600 shares have been made under the 1991 and 1994 Plans.

      Options granted under the Infrasonics plans vest on an annual basis over a
   four-year period. non-employee directors of Infrasonics were granted options
   that vest 100% at the date of grant. Options granted under the 1995 Plan
   generally vest on an annual basis over a period of two years. Options granted
   under the 1994 and 1991 Plans generally vest on a quarterly basis over a
   period of four years from the date of grant. A one-year waiting period is
   required before vesting in the case of initial grants under the 1994 and 1991
   Plans. The 1995, 1994, 1991, and Infrasonics Plans authorize the grant of
   incentive stock options at exercise prices equal to the fair market value of
   the company's common stock on the date of grant and permit the grant of
   nonqualified stock options at exercise prices not less than 85 percent of
   fair market value on the date of grant. To date, only Incentive Stock Options
   and Nonqualified Stock Options with exercise prices equal to the fair market
   value of the underlying common stock on the date of grant have been granted
   under these plans.

      As of July 7, 1996, options representing 2,652,711 shares, including
   options issued under the Infrasonics plans, the 1995, 1994 and 1991 Plans and
   the terminated 1982 and 1985 plans, were outstanding and exercisable, and the
   company, as of such date, had 5,084,973 shares available for issuance under
   the 1994 and 1991 Plans.

      Certain options issued under the 1994 and 1991 Plans permit exercise prior
   to vesting.As to these options, if the optionee's relationship with the
   company is terminated prior to the complete vesting of the options, the
   company has the right to repurchase unvested shares at the exercise price
   plus interest. as of July 7, 1996, no shares were subject to repurchase by
   the company under these options.
<PAGE>   19
      The following is a summary of option activity under the 1995, 1994, 1991
and Infrasonics Plans:


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                            OPTIONS                            AGGREGATE          RANGE OF EXERCISE PRICES
                                           Available          Options       Exercise Price               (per share)
                                           For Grant        Outstanding     (in thousands)         High              Low
---------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>               <C>                 <C>                   <C>              <C> 
   Balance at July 4, 1993                3,613,714         4,556,382           $49,066               34.42            3.94
   Granted                               (1,404,250)        1,404,250            16,561               14.25           10.00
   Exercised                                     --          (943,376)           (6,517)              18.25            4.63
   Canceled                                 602,100          (642,276)           (7,822)              16.00            5.00

---------------------------------------------------------------------------------------------------------------------------
   Balance at July 3, 1994                2,811,564         4,374,980            51,288               34.42            4.63
   Increase in options available 
     for grant                            3,000,000               --
   Granted                               (1,788,840)        1,788,840            27,159               23.13           13.50
   Exercised                                     --        (1,323,328)          (14,022)              17.07            5.00
   Canceled                                 407,198          (470,558)           (5,943)              17.07            5.32

---------------------------------------------------------------------------------------------------------------------------
   Balance at July 2, 1995                4,429,922         4,369,934            58,482               34.42            5.00
   Increase in options available 
     for grant                            3,558,000
   Granted                               (2,636,402)        2,636,402            55,184               32.50            5.61
   Exercised                                     --        (1,255,745)          (16,021)              27.88            5.00
   Canceled                                 248,241          (277,089)           (4,802)              32.50            9.38
   Unissuable                              (514,788)

---------------------------------------------------------------------------------------------------------------------------
   Balance at July 7, 1996                5,084,973         5,473,502            92,843               34.42            5.00

---------------------------------------------------------------------------------------------------------------------------
</TABLE>


      1988 Plan. In October 1988, the Company obtained stockholder approval of
   the 1988 Plan which authorized the non-discretionary grant of options to
   non-employee Directors. Under the 1988 Plan, non-employee Directors
   automatically receive stock option grants upon joining the Board of Directors
   and annually thereafter. Until amended in May 1994, the 1988 Plan provided
   for an initial grant of an option to purchase 40,000 shares of common stock
   upon a Director joining the Board and an annual grant of an option to
   purchase 20,000 shares of stock. On May 14, 1994, the Board of Directors
   amended the 1988 Plan to reduce the number of shares issuable to non-employee
   Directors in the form of options to an initial grant of 20,000 shares and
   annual grant of 10,000 shares. Options issued to non-employee Directors under
   the 1988 Plan are nonqualified stock options having a five-year term and an
   exercise price equal to the fair market value of the Company's common stock
   on the date of grant and vesting over a four year period in the case of
   initial options grants and over the succeeding fiscal year in the case of
   annual grants.

      In October 1994, the Company obtained stockholder approval to amend the
1988 Plan to increase the number of shares authorized for issuance by 150,000
shares and the term of options to be issued under the plan from five to ten
years.    

      As of July 7, 1996, options representing 250,000 shares were outstanding
   and exercisable under the 1988 Plan, and the Company, as of such date, had
   170,000 shares available for issuance under the 1988 Plan.

      The following is a summary of option activity under the 1988 Plan:


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                                                     Aggregate    Range of Exercise Prices
                                                       Available       Options    Exercise Price         (per share)
                                                       For Grant     Outstanding    (thousands)       High            Low
---------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>            <C>            <C>                <C>             <C> 
   Balance at July 4, 1993                              260,000        295,000        $2,991             12.81           4.69
   Granted                                             (100,000)       100,000         1,175             11.75          11.75
   Exercised                                                 --        (10,000)          (47)            13.75           4.69

---------------------------------------------------------------------------------------------------------------------------
   Balance at July 3, 1994                              160,000        385,000         4,119             12.81           6.81
   Increase in options available for grant              150,000
   Granted                                              (50,000)        50,000           662             13.25          13.25
   Exercised                                                 --       (110,000)       (1,055)            10.38           7.12

---------------------------------------------------------------------------------------------------------------------------
   Balance at July 2, 1995                              260,000        325,000         3,726             13.25           6.81
   Granted                                              (90,000)        90,000         2,175             26.81          22.34
   Exercised                                                 --       (125,000)       (1,451)            28.50          24.38

---------------------------------------------------------------------------------------------------------------------------
   Balance at July 7, 1996                              170,000        290,000        $4,450             26.81           6.81

---------------------------------------------------------------------------------------------------------------------------
</TABLE>


   Stock purchase plans | Under the 1986 ESPP and the 1995 ESPP, qualified
   employees, not including members of the Board of Directors and executive
   officers, may purchase semi-annually, up to a specified maximum amount,
   shares of the Company's common stock through payroll deductions at a price
<PAGE>   20
   equal to 85% of the fair market value of the stock at the beginning or end of
   the six month plan period, whichever is less. In August 1996, the 1986 ESPP
   expired with 148,635 shares remaining authorized and unissued. In October
   1995, the Company obtained stockholder approval of the 1995 ESPP, which
   authorized the issuance of up to 1,000,000 shares of common stock. As of July
   7, 1996, 1,651,365 shares of common stock had been purchased under the 1986
   ESPP since inception and 1,000,000 shares remained available for purchase by
   employees under the 1995 ESPP.


   Stock repurchase programs | During the fourth quarter of fiscal 1993, the
   Board of Directors approved a Limited Stock Repurchase Program (the "Limited
   Program") which commenced early in fiscal 1994. The objective of the Limited
   Program is to utilize a portion of available cash balances to repurchase on
   the open market shares of the Company's common stock to mitigate the dilutive
   effects of the issuance of shares under the Company's stock option and
   participant plans. Repurchases made under the Limited Program totaled $24.3
   million (928,020 shares) and $20.9 million (1,251,000 shares) during the
   fiscal years ended July 7, 1996, and July 2, 1995, respectively.

   Stock rights -- Series A Junior Participating Preferred Stock | During fiscal
   1991, the Board of Directors of the Company declared a dividend of one
   preferred share purchase right for each outstanding share of common stock.
   Each right entitles the holder to purchase from the Company one two-hundredth
   of a share of Series A Junior Participating Preferred Stock, par value $.001
   per share, initially at a price of $160 per one two-hundredth of a preferred
   share. Each one two-hundredth of a preferred share is substantially the
   economic equivalent of one share of common stock.

      In the event that a third party acquires 15 percent or more of the
   Company's Common Stock or announces an offer which would result in such
   party's owning 15 percent or more of the Company's Common Stock, the rights
   will become exercisable. on March 8, 1996, the Board of Directors of the
   Company approved amendments which extend the expiration date of the rights to
   March 8, 2006, and allow for their redemption, subject to certain conditions,
   at a price of $.01 per right.

   Supplemental cash flow information | Puritan-Bennett had a restricted stock
   award program which was terminated following the merger with Nellcor.
   Non-cash amounts, net of cancellations, included in additional paid in
   capital for this program were $1.2 million and $.4 million for fiscal 1995
   and 1994, respectively. No shares of stock were granted to employees under
   this program in fiscal 1996.

   15.     COMMITMENTS

   The Company leases its facilities under agreements that expire at various
   dates through June 2011. Rental expense was approximately $11.8 million,
   $11.7 million and $11.7 million in fiscal years 1996, 1995 and 1994,
   respectively.

      Aggregate minimum annual rental commitments under long-term operating 
   leases are as follows: 

   (in thousands)

<TABLE>
<CAPTION>
   Fiscal Years
-------------------------------------------------------------------------------
<S>                                             <C>
   1997                                            $ 7,798
   1998                                              7,653
   1999                                              6,130
   2000                                              5,134
   2001                                              4,506
   After 2001                                       16,943

-------------------------------------------------------------------------------
   Total rental commitments                        $48,164

-------------------------------------------------------------------------------
</TABLE>
<PAGE>   21
   16.     GEOGRAPHIC INFORMATION AND EXPORT SALES


   The Company operates within a single industry segment in which it develops,
   manufactures, and markets monitoring systems and diagnostic and therapeutic
   products for management of the respiratory-impaired patient across the
   continuum of care. The Company's products are sold worldwide through a direct
   sales force, assisted by clinical education consultants and supplemented by
   distributors in selected countries.

      Geographic information with respect to the Company's operations is as
follows:

<TABLE>
<CAPTION>
                                                              Transfers
                                            Sales to           Between                          Operating
                                          Unaffiliated       Geographic                          Income        Identifiable
  (in thousands)                            Customers           Areas           Total            (Loss)           Assets
---------------------------------------------------------------------------------------------------------------------------
<S>                                     <C>                <C>              <C>               <C>              <C>     
   1996:
   United States domestic                  $481,154               $--          $481,154          $11,778          $407,271
   United States export                      92,734            28,071           120,805               --                --
   Europe                                   132,243           131,178           263,421           13,854           151,594
   Corporate and other                           --                --                --               --            55,893
   Eliminations                                  --          (159,249)         (159,249)         (25,679)          (26,920)

---------------------------------------------------------------------------------------------------------------------------
Consolidated                                706,131                --           706,131              (47)          587,838

---------------------------------------------------------------------------------------------------------------------------
   1995:
   United States domestic                   439,177                --           439,177           56,338           335,135
   United States export                      79,142            23,966           103,108               --                --
   Europe                                   104,747            43,063           147,810           17,391           146,860
   Corporate and other                           --                --                --               --           160,210
   Eliminations                                  --           (67,029)          (67,029)            (325)          (39,815)

---------------------------------------------------------------------------------------------------------------------------
   Consolidated                             623,066                --           623,066           73,404           602,390

---------------------------------------------------------------------------------------------------------------------------
   1994:
   United States domestic                   425,782                --           425,782            6,524           338,769
   United States export                      69,031            17,628            86,659               --                --
   Europe                                    69,319            25,472            94,791            1,104           103,738
   Corporate and other                           --                --                --               --           123,315
   Eliminations                                  --           (43,100)          (43,100)             813           (38,253)

---------------------------------------------------------------------------------------------------------------------------
   Consolidated                            $564,132               $--          $564,132          $ 8,441          $527,569

---------------------------------------------------------------------------------------------------------------------------
</TABLE>


      Transfers between geographic areas are generally recorded at amounts above
   cost and in accordance with the rules and regulations of the governing tax
   authorities. Operating income (loss) is total revenue less cost of sales and
   operating expenses and does not include interest expense, interest income and
   other income (expense), net, litigation settlements, costs associated with
   unsolicited takeover offer and income taxes. Identifiable assets of
   geographic areas are those assets used in the Company's operations in each
   area. Identifiable corporate assets consist primarily of cash and cash
   equivalents, marketable securities and other assets.


   17.     LITIGATION


   From time to time the Company has received, and in the future may receive,
   notice of claims against it, which in some instances have developed, or may
   develop, into lawsuits. The claims may involve such matters, among others, as
   product liability, patent infringement, and employment-related claims. In
   management's opinion, the ultimate resolution of claims currently pending
   will not have a material adverse effect on the Company's financial position
   or results of operations.

      On May 15, 1996, the Company brought an action in Kansas Federal District
   Court, requesting a temporary restraining order, preliminary injunction and
   damages against Healthdyne Technologies and two former Company employees
   based on misappropriation of trade secrets, utilization of trade secrets and
   various other causes of action. The Company was granted a permanent
   injunction against Healthdyne enjoining it from utilizing the Company's trade
   secrets and limiting the scope of work of one of the former employees. The
   second employee was terminated by Healthdyne, and the Company was granted a
   permanent injunction against that employee relating to use of trade secrets
   and limiting the scope of the former employee's future work. The Court has
   ongoing jurisdiction to enforce the injunctions and related matters.

      On May 3, 1996, the Company and several of its officers and members of its
   Board of Directors received notice that they had been named as defendants in
   a class action lawsuit seeking unspecified damages based upon alleged
   violations of California state securities and other laws. The complaint
   alleges misrepresentations during the period from September 29, 1995 through
   April 16, 1996 with respect to the Company's business, particularly about 
<PAGE>   22
   the merger with Puritan-Bennett and the integration of Nellcor and
   Puritan-Bennett. The Company believes that the action, filed in the Superior
   Court of the State of California, County of Alameda, is without merit and
   intends to vigorously defend against the action.

      On July 11, 1995, the U.S. Federal District Court in Delaware issued a
   decision in favor of the Company, ruling that four key oximeter and sensor
   technology patents are valid and would be infringed by Ohmeda, Inc., a
   subsidiary of BOC Health Care, Inc., if Ohmeda sold either its adult or
   neonatal OxyTip sensors for use with non-Ohmeda monitors. BOC Health Care
   filed an appeal with the Court of Appeals Federal Circuit relating to one of
   these key patents and the Company is awaiting the outcome of that appeal. BOC
   Health Care had filed a suit against the Company in December 1992, seeking a
   declaratory judgment that the Company's patents were invalid and would not be
   infringed.

      In a related matter, in the third quarter of fiscal 1994, the Company
   agreed to settle trade secrets and patent litigation with BOC Health Care,
   Inc., and its Ohmeda, Inc. subsidiary, and Square One Technology. Under the
   terms of the agreement, the patent in issue was assigned to the Company. The
   Company also received a $2.0 million pretax payment and receives ongoing
   royalties. The $2.0 million payment was recorded as non-operating income.

      In the fourth quarter of fiscal 1994, the Company agreed to settle its
   patent litigation with Camino Laboratories, Inc., ("Camino") of San Diego,
   CA. Under the terms of the settlement, Camino agreed not to sue the Company
   or its current or future customers relating to the use or sale of the
   Company's sensors and monitors intended for use with such sensors. A cash
   payment of $15.0 million was made by the Company to Camino and was recorded
   as a non-operating expense. This settlement neither recognizes the validity
   nor acknowledges infringement of the Camino patent at issue.




NELLCOR PURITAN BENNETT INCORPORATED

Management's Discussion and Analysis of
Financial Condition and Results of Operations



   RESULTS OF OPERATIONS

   The following sets forth, for the indicated periods, the relationship that
certain items bear to net revenue:


<TABLE>
<CAPTION>
                                                 Years Ended

                                        July 7,  July 2,  July 3,
                                          1996    1995     1994
-------------------------------------------------------------------------------
<S>                                    <C>      <C>      <C> 
   Net revenue                            100%     100%     100%
   Gross margin                            51%      50%      50%
   Operating expenses:
   Research and development                 8%       8%       9%
   Selling, general and administrative     28%      30%      31%
   Restructuring charges                   --       --        8%
   Merger and related costs                15%      --       --
   Total operating expenses                51%      38%      48%
   Income (loss) from operations           --       12%       1%
   Litigation settlements, net             --       --       (2%)
   Costs associated with unsolicited
   takeover offer                          --       (1%)     --
   Income (loss) before income taxes       --       11%      (1%)
   Net income (loss)                       (1%)      8%      (2%)

-------------------------------------------------------------------------------
</TABLE>


   Revenue

   1996 vs 1995.

   The Company's net revenue for fiscal 1996 increased 13 percent to $706.1
   million from $623.1 million in fiscal 1995. Both the hospital and home care
   product lines experienced revenue growth over fiscal 1995 of 12 percent and
   16 percent, respectively. Revenue from sales in the United States increased
   10 percent in fiscal 1996 while international revenue grew by 22 percent.
<PAGE>   23
      Hospital product line revenue, which includes the oximetry, ventilator and
   clinical information systems product lines, increased to $440.5 million in
   fiscal 1996 from $394.9 million in fiscal 1995. The increase in hospital
   product sales is due primarily to higher sales of oximetry and ventilator
   products.

      Oximetry product revenue increased due to higher oximetry sensor and
   instrument sales. Oximetry sensor revenue increased due to continued growth
   in the installed base of the Company's monitors and the products of the
   Company's licensees and OEM customers that use the Company's sensors.
   Oximetry instrument revenue increased due primarily to higher sales of the
   N-3000 pulse oximeter. Average selling prices for oximetry sensors decreased
   slightly whereas average selling prices for oximetry instruments were
   moderately lower in comparison to the prior year.

      Sales of ventilator products increased due primarily to higher sales of
   critical care ventilators and Infrasonics' neonatal, pediatric and adult
   ventilators and accessories. Higher sales volume for the Company's adult
   ventilators was partially offset by moderately lower average selling prices.

      Sales from the home care product lines, which include the Oxygen Therapy,
   Gas Products and Spirometry Group, the Global Sleep Solutions Group and the
   Aero Systems Group, increased to $265.6 million in fiscal 1996 from $228.2
   million in fiscal 1995, due to higher sales volume across all product lines.
   The revenue growth was also due to the first full year of sales from the
   Company's Pierre Medical subsidiary and the inclusion of revenue from
   Melville after its acquisition in the first quarter of fiscal 1996. Revenue
   from these two acquisitions accounted for approximately one-half of the
   fiscal 1996 home care product line revenue growth. Overall home care product
   line revenue growth rates during fiscal 1996 were impacted by changes to the
   Company's home care product distribution structure. These changes included
   the termination of the Company's independent home care sales network at the
   end of the second quarter, and the transition to a newly integrated direct
   home care sales force during the third quarter of fiscal 1996. Because of
   these changes to the Company's home care distribution channels, this period
   of transition may continue to affect home care product line revenue growth
   rates in the near term.

      International revenue increased 22 percent to $225.0 million from $183.9
   million in fiscal 1995. Much of the international revenue growth occurred in
   Europe, principally due to higher oximetry and ventilator product unit sales
   and to the first full year of revenue from the Company's Pierre Medical
   subsidiary, which was acquired in the fourth quarter of fiscal 1995. The
   favorable effect of foreign currency exchange rates accounted for 2
   percentage points of the international revenue growth.

   1995 vs 1994.

   The Company's net revenue for fiscal 1995 increased 10 percent to $623.1
   million from $564.1 million in fiscal 1994. The increase in net revenue
   principally resulted from higher unit sales across the Company's hospital and
   home care product lines. Sales of the Company's products into international
   markets were also particularly strong.

      Hospital product sales increased 9 percent to $394.9 million in fiscal
   1995 from $363.5 million in fiscal 1994.

      Oximetry instrument revenue for fiscal 1995 increased slightly as higher
   unit sales of the N-3000 pulse oximeter and the N-20 portable pulse oximeter
   were partially offset by lower average selling prices.

      Revenue from oximetry sensors increased moderately during fiscal 1995
   primarily due to continued growth in the installed base of the Company's
   monitors and the products of the Company's licensees and OEM customers that
   use the Company's sensors. Higher unit sales were partially offset by
   slightly lower average selling prices for adhesive and recycled sensors.

      OEM oximetry module revenue increased significantly in fiscal 1995 as
   higher unit shipments were partially offset by moderately lower average
   selling prices. At the end of fiscal 1995, the Company had OEM or licensing
   agreements in place with 40 medical systems and monitor manufacturers
   worldwide.

      Revenue related to the critical care ventilator product line, and the 
   small Holter monitoring and international portable ventilator product lines
   decreased 1 percent from fiscal 1994. The decrease is primarily the result 
   of the Company's decision to withdraw from the United States portable 
   ventilator market.

      Home care product sales increased 14 percent to $228.2 million in fiscal
   1995 from $200.6 million in fiscal 1994. Home care product line revenue
   increased due primarily to higher unit sales of sleep and respiratory support
   systems products.

      Sleep and respiratory support systems products include the Assurance 2000
   and 3000 heart and respiration monitors, the EdenTrace II and II Plus
   multichannel recording systems and related products, the GoodKnight 314 and
   318 nasal CPAP (continuous positive airway pressure) systems used to treat
   sleep apnea, and the KnightStar 320 bilevel device and 335 respiratory
   support system for patients with apnea or respiratory insufficiency. The
   therapeutic products also include a variety of masks and accessories such as
   the innovative ADAM nasal pillow interface. During the fourth quarter of
   fiscal 1995, the Company acquired Pierre Medical, a privately held French
   manufacturer of respiratory products used in the home. Pierre Medical markets
   the O'Nyx noninvasive ventilation system, the Omega(TM) oxygen concentrator
   and the Morphee(TM) and Morphee Plus(TM) sleep apnea therapy systems in
   Western Europe, primarily in France. Revenue from the above mentioned home
   health care products increased significantly during fiscal 1995 primarily due
   to higher sales of the EdenTrace II Plus and the Assurance 3000, as well as
   sales from Pierre Medical included in the Company's results subsequent to its
   May 3, 1995 acquisition. In addition, the Company had a full year of revenue
   from SEFAM S.A., a European supplier of diagnostic and therapeutic sleep
   disorder products, which was acquired in January 1994.
<PAGE>   24
      International revenue increased 33 percent to $183.9 million in fiscal
   1995 from $138.3 million in fiscal 1994. International revenue increased
   significantly across all markets principally due to higher unit sales of
   oximetry sensors, the N-3000 pulse oximeter, OEM oximetry modules, the
   acquisition of SEFAM S.A., and the favorable effect of foreign currency
   exchange rates.


   Gross margin | Gross margin improved to 51 percent of net revenue in fiscal
   1996 from 50 percent in fiscal 1995 due primarily to improved manufacturing
   efficiencies, the favorable effect which foreign currency exchange rates had
   upon revenue, and savings associated with producing certain ventilator
   components internally.

      Gross margin at 50 percent of net revenue in fiscal 1995 was comparable to
   the prior year, as pricing pressures across a number of hospital and home
   care product lines were offset by improved sleep product margins and the
   favorable effect which foreign currency exchange rates had upon revenue.

   Research and development expenses | In fiscal 1996, research and
   development expenses as a percentage of net revenue remained constant from
   fiscal 1995 at 8 percent but increased in absolute dollars by $5.1 million
   due primarily to higher spending on ventilator product development and costs
   associated with perinatal product clinical studies.

      Research and development expenses decreased to 8 percent of net revenue
   during fiscal 1995 from 9 percent for fiscal 1994 and decreased in absolute
   dollars from fiscal 1994. The decrease was due to the elimination of the
   intra-arterial blood gas monitoring product line during fiscal 1994,
   partially offset by higher spending on the development of additional modules
   of the Nellcor Symphony monitoring system, and increased sleep product
   development costs.

   Selling, general and administrative expenses | Selling, general and
   administrative expenses in fiscal 1996 decreased to 28 percent of net revenue
   from 30 percent of net revenue in fiscal 1995. Selling, general and
   administrative expenses increased in absolute dollars due primarily to
   operating expenses associated with the Company's recently acquired Pierre
   Medical and Melville subsidiaries, and the unfavorable effect foreign
   currency exchange rates had upon international operating expenses.

      Selling, general and administrative expenses in fiscal 1995 decreased to
   30 percent of net revenue from 31 percent of net revenue in fiscal 1994.
   Selling, general and administrative expenses increased in absolute dollars
   due primarily to the unfavorable effect foreign currency exchange rates had
   upon international operating expenses, the inclusion of operating expenses
   from Pierre Medical and SEFAM S.A. subsequent to their acquisition, and
   increased costs related to the Company's profit sharing and bonus plans,
   partially offset by lower patent litigation expenses.

   Net income | The Company reported a net loss for fiscal 1996 of $9.4 million
   or ($0.16) per share compared to net income of $48.1 million, $0.82 per
   share, for fiscal 1995. Excluding the effect of merger and related costs of
   $108.9 million, fiscal 1996 net income of $75.0 million, $1.27 per share,
   increased 39 percent over net income of $53.8 million, $0.92 per share for
   fiscal 1995, exclusive of the restructuring and unsolicited takeover charges
   discussed below.

      The Company's net income for fiscal 1995 was $48.1 million, $0.82 per
   share, compared to a net loss of $8.7 million, ($0.15) per share, for fiscal
   1994. Excluding the effect of the restructuring and unsolicited takeover
   attempt charges, fiscal 1995 net income of $53.8 million, $0.92 per share,
   increased 6 percent over net income of $50.9 million, $0.89 per share for
   fiscal 1994, exclusive of the restructuring charges and litigation
   settlements discussed below.


   UNUSUAL AND/OR NONRECURRING ITEMS

   Restructuring charges | During fiscal 1995, Puritan-Bennett recorded a $2.7
   million restructuring charge associated with a workforce reduction.

      During fiscal 1994, Puritan-Bennett restructured the hospital ventilator
and portable ventilator portions of its business, consolidated its aviation
facilities and substantially reduced a division's operations to improve
profitability. In connection with the restructuring, during fiscal 1994
Puritan-Bennett recorded restructuring charges of $43.2 million. Included in
these changes were provisions for personnel-related charges ($7.7 million),
non-cash asset write-downs ($29.7 million), consolidations of manufacturing and
marketing facilities ($1.3 million), and other restructuring related costs
($4.5 million). During the third quarter of fiscal 1995, Puritan-Bennett
completed the shutdown of the division. During fiscal 1994, Nellcor recorded a
restructuring charge of $0.5 million associated with the consolidation of two
of Nellcor's divisions.   
<PAGE>   25
   Merger and related costs | The Company's results for fiscal 1996 reflect
   merger and related costs of $108.9 million associated with the Company's
   first quarter and fourth quarter acquisitions of Puritan-Bennett ($92.6
   million in merger and related costs) and Infrasonics ($16.3 million in merger
   and related costs), respectively. For additional information on the costs
   included in this charge, see the separate discussion on mergers and
   acquisitions below.

   Litigation settlements, net | In the third quarter of fiscal 1994, the
   Company agreed to settle trade secrets and patent litigation with BOC Health
   Care, Inc., and its Ohmeda, Inc. subsidiary, and Square One Technology. Under
   the terms of the agreement, the patent in issue was assigned to the Company.
   The Company also received a $2.0 million pretax payment and receives ongoing
   royalties. The $2.0 million payment was recorded as non-operating income.

      In the fourth quarter of fiscal 1994, the Company agreed to settle its
   patent litigation with Camino Laboratories, Inc., ("Camino") of San Diego,
   CA. Under the terms of the settlement, Camino agreed not to sue the Company
   or its current or future customers relating to the use or sale of the
   Company's sensors and monitors intended for use with such sensors. A cash
   payment of $15.0 million was made by the Company to Camino and was recorded
   as a non-operating expense. This settlement neither recognizes the validity
   nor acknowledges infringement of the Camino patent at issue.

   Costs associated with an unsolicited offer | During fiscal 1995, $5.0 million
   of costs were incurred associated with an unsolicited offer to acquire
   Puritan-Bennett. These costs included investment banking fees, public
   relations expenses and legal fees, of which $0.9 million was paid during
   fiscal 1995 and the remaining $4.1 million was paid during fiscal 1996.

   BUSINESS CONSIDERATIONS

   Mergers and acquisitions | The Company has either merged with or acquired
   four companies during fiscal 1995 and 1996. Each acquisition was intended to
   broaden the Company's product offerings and expand sales into hospital and
   emerging markets, such as home health care. The Company intends to continue
   pursuing acquisition opportunities in the future.

      Puritan-Bennett. On August 25, 1995 the merger of Nellcor and
   Puritan-Bennett was consummated. The issuance of Company common stock in
   connection with the Agreement and Plan of Merger was approved by shareholders
   at special shareholder meetings held by both companies on August 24, 1995.
   Under the terms of the agreement, shareholders of Puritan-Bennett received
   0.88 of a share of the Company's common stock for each Puritan-Bennett share.
   These financial statements and Management's Discussion and Analysis reflect
   the consummation of this transaction as a pooling-of-interests, resulting in
   the combining of the two company's balance sheets and income statements for
   all periods presented.

      Upon consummation of the merger, the Company recorded one-time merger and
   related costs of $92.6 million during the first quarter of fiscal 1996.
   Included in this charge were provisions for merger transaction costs ($13.7
   million), costs to combine and integrate operations ($53.8 million), certain
   intangible asset write-downs ($19.6 million), and other merger-related costs
   ($5.5 million). The merger transaction costs included expenses for investment
   banker and professional fees, and other costs associated with completing the
   transaction. The costs to combine and integrate operations included
   provisions for severance and severance-related costs, facilities
   consolidations and other integration costs. The write-down of certain
   intangible assets, primarily goodwill associated with prior acquisitions made
   by both companies, results from the effect that certain integration decisions
   have had upon the future realization of these assets.

      Nellcor Puritan Bennett is headquartered in Pleasanton, California, site
   of Nellcor's headquarters. 

      Infrasonics. On June 27, 1996 the Company acquired Infrasonics in a
   stock-for-stock merger. The issuance of Company common stock in connection
   with the Agreement and Plan of Merger was approved by shareholders at special
   shareholder meetings held by both companies on June 27, 1996. Under the terms
   of the agreement, shareholders of Infrasonics received .12 of a share of
   Company common stock for each Infrasonics share. These financial statements
   and management's discussion and analysis reflect the consummation of this
   transaction as a pooling-of-interests, resulting in the combining of the two
   companies' balance sheets and income statements for all periods presented.
   Infrasonics is a respiratory equipment manufacturer of neonatal, pediatric
   and adult ventilators and accessories.

      Upon consummation of the merger, the Company recorded one-time merger and
   related costs of $16.3 million during the fourth quarter of fiscal 1996.
   Included in this charge were provisions for merger transaction costs ($2.5
   million), costs to combine and integrate operations ($11.8 million), and
   certain 
<PAGE>   26
   intangible asset write-downs ($2.0 million). The merger transaction costs
   include expenses for investment banker and professional fees, and other costs
   associated with completing the transaction. The costs to combine and
   integrate operations include provisions for severance and severance-related
   costs, facilities consolidations, and other integration costs. The write-down
   of certain intangible assets, primarily intangibles associated with prior
   acquisitions by Infrasonics, results from the effect that certain integration
   decisions have had upon the future realization of these assets.

      Melville. During the first quarter of fiscal 1996, the Company acquired
   Melville Software Ltd. (Melville), a privately held Canadian company that
   manufactures and markets sleep diagnostic products used primarily in sleep
   labs for $4.9 million in cash. In the event that certain profitability levels
   are achieved over the next three fiscal years, additional compensation
   totaling $1.0 million would be payable to the former principal stockholders
   of Melville who continue to manage the company. Such amounts will be expensed
   when, and if, earned. The acquisition of Melville was accounted for under the
   purchase method and its results are included since the date of acquisition.

      Pierre Medical. During the fourth quarter of fiscal 1995, the Company
   acquired Pierre Medical, a privately held French manufacturer of respiratory
   products used in the home, for $21.5 million in cash. In the event that
   certain profitability targets are achieved or certain of Pierre Medical's
   products receive FDA approval for marketing in the United States subsequent
   to the acquisition, additional compensation totaling 30 million French Francs
   ($5.8 million as of July 7, 1996), would be payable to the former principal
   stockholders of Pierre Medical who will continue to manage the company.
   During fiscal 1996, $3.8 million of this additional compensation was accrued
   as a merger and related cost to reflect the effect that integration decisions
   associated with the Company's merger with Puritan-Bennett would have upon the
   achievement of certain of the performance milestones. Pierre Medical
   manufactures and markets noninvasive ventilators, sleep apnea therapy
   systems, oxygen concentrators, and related respiratory products in Western
   Europe, primarily France. The acquisition of Pierre Medical was accounted for
   under the purchase method and its results are included since the date of
   acquisition.

   International markets | During fiscal 1996 and 1995, sales of the Company's
   products into international markets accounted for 32 and 30 percent,
   respectively, of the Company's consolidated revenue. International revenue
   grew 22 percent to $225.0 million in fiscal 1996 from $183.9 million in
   fiscal 1995.

      Although the Company experienced sales growth in all its international
   markets during fiscal 1996, the strongest growth occurred in Europe. The
   Company continues to expand sales, service and distribution operations in
   this market, and has broadened its product offerings through recent
   acquisitions.

      The Company continues to devote significant resources to the development
   of its other international markets, particularly Asia Pacific, and believes
   that growth in international revenue and market shares will be key factors in
   the Company's overall long-term performance.

   Timing of orders and shipments | Historically, orders in the first quarter
   have been lower than in the second, third and fourth quarters. Of the orders
   received by the Company in any quarter, a disproportionately large percentage
   have typically been received and shipped toward the end of the quarter.
   Accordingly, backlog has historically been modest and not an accurate
   predictor of future revenues, and results for a given quarter can be
   adversely affected if there is a substantial order shortfall in that quarter.

   Accounting changes | In March 1995, The Financial Accounting Standards Board
   (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 121,
   "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
   to Be Disposed Of," which requires the Company to review for impairment of
   long-lived assets, certain identifiable intangibles, and goodwill related to
   those assets whenever events or changes in circumstances indicate that the
   carrying amount of an asset may not be recoverable. In certain situations, an
   impairment loss would be recognized. SFAS 121 is effective for the Company's
   1997 fiscal year. The Company is evaluating the impact of the new standard on
   its financial position, results of operations, and cash flows and expects the
   effect to be immaterial.

      In October 1995, the FASB issued SFAS 123 "Accounting for Stock-Based
   Compensation" which also will be effective for the Company's 1997 fiscal
   year. The Company does not expect SFAS 123 to have a material impact on its
   financial position, results of operations, and cash flows. SFAS 123 allows
   companies which have stock-based compensation arrangements with employees to
   adopt a new fair-value basis of accounting for stock options and other equity
   instruments, or to continue to apply the existing accounting rules under APB
   Opinion 25 "Accounting for Stock Issued to Employees" but with 
<PAGE>   27
   additional financial statement disclosure. The company expects to continue to
   account for stock-based compensation arrangements under APB Opinion 25 and
   will include additional footnote disclosure in its fiscal 1997 annual report.

   Other business considerations | The Company is a United States Food and Drug
   Administration (FDA) regulated business operating in the rapidly changing
   health care industry. From time to time the Company may report, through its
   press releases and/or Securities and Exchange Commission filings, certain
   matters that would be characterized as forward-looking statements that are
   subject to risks and uncertainties that could cause actual results to differ
   materially from those projected. Certain of these risks and uncertainties are
   beyond management's control. Such risks and uncertainties may include, among
   other things, the following items.

      Integration of Acquired Businesses. Since the acquisition of
   Puritan-Bennett, the Company has dedicated, and will continue to dedicate,
   substantial management resources in order to achieve the anticipated
   operating efficiencies from integrating the two companies. While the Company
   has achieved certain operating cost savings to date, difficulties encountered
   in integrating the two companies' operations could adversely impact the
   business, results of operations or financial condition of the Company. Also,
   the Company intends to pursue additional acquisition opportunities in the
   future. The integration of any business that the Company might acquire could
   require substantial management resources. There can be no assurance that any
   such integration will be accomplished without having a short or potentially
   long-term adverse impact on the business, results of operations or financial
   condition of the Company or that the benefits expected from any such
   integration will be fully realized.

      Managed Care and Other Health Care Provider Organizations. Managed care
   and other health care provider organizations have grown substantially in
   terms of the percentage of the population in the United States that receives
   medical benefits through such organizations and in terms of the influence and
   control that they are able to exert over an increasingly large portion of the
   health care industry. These organizations are continuing to consolidate and
   grow, which may increase the ability of these organizations to influence the
   practices and pricing involved in the purchase of medical devices, including
   the products sold by the Company.

      Health Care Reform/Pricing Pressure. The health care industry in the
   United States is experiencing a period of extensive change. Health care
   reform proposals have been formulated by the current administration and by
   members of Congress. In addition, state legislatures periodically consider
   various health care reform proposals. Federal, state and local government
   representatives will, in all likelihood, continue to review and assess
   alternative health care delivery systems and payment methodologies, and
   ongoing public debate of these issues can be expected. Cost containment
   initiatives, market pressures and proposed changes in applicable laws and
   regulations may have a dramatic effect on pricing or potential demand for
   medical devices, the relative costs associated with doing business and the
   amount of reimbursement by both government and third-party payors. In
   particular, the industry is experiencing market-driven reforms from forces
   within the industry that are exerting pressure on health care companies to
   reduce health care costs. These market-driven reforms are resulting in
   industry-wide consolidation that is expected to increase the downward
   pressure on health care product margins, as larger buyer and supplier groups
   exert pricing pressure on providers of medical devices and other health care
   products. Both short-term and long-term cost containment pressures, as well
   as the possibility of regulatory reform, may have an adverse impact on the
   Company's results of operations.

      Government Regulation; Consent Decree. There has been a trend in recent
   years, both in the United States and abroad, toward more stringent regulation
   of, and enforcement of requirements applicable to, medical device
   manufacturers. The continuing trend of more stringent regulatory oversight in
   product clearance and enforcement activities has caused medical device
   manufacturers to experience longer approval cycles, more uncertainty, greater
   risk and higher expenses. At the present time, there are no meaningful
   indications that this trend will be discontinued in the near-term or the
   long-term either in the United States or abroad.

      Puritan-Bennett has been subject to significant FDA enforcement activity
   with respect to its operations in recent years. In January 1994,
   Puritan-Bennett entered into a consent decree with the FDA pursuant to which
   Puritan-Bennett agreed to maintain systems and procedures complying with the
   FDA's good manufacturing practices regulation and medical device reporting
   regulation in all of its device manufacturing facilities.

      Puritan-Bennett has experienced and will continue to experience
   incremental operating costs due to ongoing compliance requirements and
   quality assurance programs initiated in part as a result of the FDA consent
   decree. Puritan-Bennett expects to continue to incur additional operating
   expenses associated with its ongoing regulatory compliance program, but the
   amount of these incremental costs cannot be completely predicted and will
   depend upon a variety of factors, including future changes in statutes and
   regulations governing medical device manufacturers and the manner in which
   the FDA continues to enforce and interpret the requirements of the consent
   decree. There can be no assurance that such compliance requirements and
   quality assurance programs will not have an adverse impact on the business,
   results of operations or financial condition of the Company or that the
   Company will not experience problems associated with FDA regulatory
   compliance, including increased general costs of ongoing regulatory
   compliance and specific costs associated with the Puritan-Bennett consent
   decree.
<PAGE>   28
      Intellectual Property Rights. From time to time, the Company has received,
   and in the future may receive, notices of claims with respect to possible
   infringement of the intellectual property rights of others or notices of
   challenges to its intellectual property rights. In some instances such
   notices have given rise to, or may give rise to, litigation. Any litigation
   involving the intellectual property rights of the Company may be resolved by
   means of a negotiated settlement or by contesting the claim through the
   judicial process. There can be no assurance that the business, results of
   operations or the financial condition of the Company will not suffer an
   adverse impact as a result of intellectual property claims that may be
   commenced against the Company in the future.

      Competition. The medical device industry is characterized by rapidly
   evolving technology and increased competition. There are a number of
   companies that currently offer, or are in the process of developing, products
   that compete with products offered by the Company. Some of these competitors
   may have substantially greater capital resources, research and development
   staffs and experience in the medical device industry, including with respect
   to regulatory compliance in the development, manufacturing and sale of
   medical products similar to those offered by the Company. These competitors
   may succeed in developing technologies and products that are more effective
   than those currently used or produced by the Company or that would render
   some products offered by the Company obsolete or noncompetitive. Competition
   based on price is expected to become an increasingly important factor in
   customer purchasing patterns as a result of cost containment pressures on,
   and consolidation in, the health care industry. Such competition has exerted,
   and is likely to continue to exert, downward pressure on the prices the
   Company is able to charge for its products. The Company may not be able to
   offset such downward price pressure through corresponding cost reductions.
   Any failure to offset such pressure could have an adverse impact on the
   business, results of operations or financial condition of the Company.

      New Product Introductions. As the Company's existing products become more
   mature and its existing markets more saturated, the importance of developing
   or acquiring new products will increase. The development of any such products
   will entail considerable time and expense, including research and development
   costs and the time and expense required to obtain necessary regulatory
   approvals, which could adversely affect the business, results of operations
   or financial condition of the Company. There can be no assurance that such
   development activities will yield products that can be commercialized
   profitably, or that any product acquisitions can be consummated on
   commercially reasonable terms or at all. Any failure to acquire or develop
   new products to supplement more mature products could have an adverse impact
   on the business, results of operations or financial condition of the Company.

      Product Liability Exposure. Because its products are intended to be used
   in health care settings on patients who are physiologically unstable and may
   also be seriously or critically ill, the Company is exposed to potential
   product liability claims. From time to time, patients using the Company's
   products have suffered serious injury or death, which has led to product
   liability claims against the Company. The Company does not believe that any
   of these claims, individually or in the aggregate, will have a material
   adverse impact on its business, results of operations or financial condition.
   However, the Company may, in the future, be subject to product liability
   claims that could have such an adverse impact.

      The Company maintains product liability insurance coverage in amounts that
   it deems sufficient for its business. However, there can be no assurance that
   such coverage will ultimately prove to be adequate, or that such coverage
   will continue to remain available on acceptable terms or at all.

      Impact of Currency Fluctuations; Importance of Foreign Sales. Because
   sales of products by the Company outside the United States typically are
   denominated in local currencies and such sales are growing at a rate that is
   generally faster than domestic sales, the results of operations of the
   Company are expected to continue to be affected by changes in exchange rates
   between certain foreign currencies and the United States Dollar. Although the
   Company currently engages in some hedging activities, there can be no
   assurance that the Company will not experience currency fluctuation effects
   in future periods, which could have an adverse impact on its business,
   results of operation or financial condition. The operations and financial
   results of the Company also may be significantly affected by other
   international factors, including changes in governmental regulations or
   import and export restrictions, and foreign economic and political conditions
   generally.

      Possible Volatility of Stock Price. The market price of the Company's
   stock is, and is expected to continue to be, subject to significant
   fluctuations in response to variations in quarterly operating results, trends
   in the health care industry in general and the medical device industry in
   particular, and certain other factors beyond the control of the Company. In
   addition, broad market fluctuations, as well as general economic or political
   conditions and initiatives such as health care reform, may adversely impact
   the market price of the Company's stock, regardless of the Company's
   operating performance.


LIQUIDITY AND CAPITAL RESOURCES


   At July 7, 1996, the Company had cash, cash equivalents, and marketable
   securities of approximately $74.4 million compared to $149.2 million at the
   end of fiscal 1995.

      The Company's fiscal 1996 operating activities provided positive cash
   flows of $61.2 million, exclusive of merger-related cash outlays.
   Depreciation and amortization were significant non-cash operating activities
   for all years presented.

      Of the $108.9 million in merger and related charges which were recorded
   during the first and fourth quarters of fiscal 1996, approximately $45.4
   million resulted in a cash outlay and $31.0 million was utilized for non-cash
   charges during the year. Approximately $31 million of the remaining merger
   and related costs are expected to result in cash outlays during fiscal 1997.
<PAGE>   29
      Sales and maturities of marketable securities were significant investing
   activities during fiscal 1996. Capital expenditures were approximately $29.7
   million in fiscal 1996, primarily reflecting additional investments in
   business computer systems and production machinery and equipment. The Company
   expects that capital expenditures will be slightly higher in fiscal 1997,
   principally due to the construction of a new distribution facility and
   leasehold improvements as part of the consolidation of certain manufacturing
   and distribution operations into the Company's Carlsbad location.

      Shares of Company common stock issued under the Company's stock option
   plans were significant sources of cash from financing activities in fiscal
   1996. Additionally, the Company retired approximately $75.4 million in notes
   payable and debt that it assumed as part of its merger with Puritan-Bennett.
   To initially consolidate a portion of this debt, during fiscal 1996 the
   Company borrowed $40 million against a $50 million credit facility that it
   has in place with a group of four banks. This borrowing was subsequently
   repaid during the third quarter of fiscal 1996, and the Company was in
   compliance with all credit facility covenants at July 7, 1996.

      The Company's inventories have increased to $128.1 million at July 7,
   1996, from $95.3 million at July 2, 1995. Much of the increase in inventory
   occurred from February 1, 1995 and is comprised primarily of an increase in
   Puritan-Bennett inventory. The increase in Puritan-Bennett inventory was due
   primarily to production levels across several product lines which exceeded
   customer demands, and in part resulted from inventory build-ups associated
   with several new product introductions within the Global Sleep Solutions
   Group. Additionally, inventory levels across several hospital and home care
   product lines were increased in line with higher sales demands.

      The Company anticipates that current capital resources combined with cash
   to be generated from operating activities will be sufficient to meets its
   liquidity and capital expenditure requirements at least through the end of
   fiscal 1997. The Company may use debt to fund certain capital and other
   strategic opportunities when deemed necessary and financially advantageous.
<PAGE>   30
NELLCOR PURITAN BENNETT INCORPORATED

Report of Independent Accountants

   To the Board of Directors
   of Nellcor Puritan Bennett Incorporated

   In our opinion, based upon our audits and the reports of other auditors, the
   accompanying consolidated balance sheet and the related consolidated
   statements of operations, of stockholders' equity, and of cash flows present
   fairly, in all material respects, the financial position of Nellcor Puritan
   Bennett Incorporated and its subsidiaries at July 7, 1996 and July 2, 1995,
   and the results of their operations and their cash flows for each of the
   three years in the period ended July 7, 1996 in conformity with generally
   accepted accounting principles. These financial statements are the
   responsibility of the Company's management; our responsibility is to express
   an opinion on these financial statements based on our audits. We did not
   audit the consolidated financial statements of Puritan-Bennett Corporation
   and its subsidiaries, which statements reflect total assets of $273,135,000
   at January 31, 1995, and total revenues of $336,026,000, and $309,255,000 for
   each of the two years in the period ended January 31, 1995, respectively, or
   Infrasonics, which statements reflect total assets of $26,954,000 at June 30,
   1995, and total revenues of $23,000,000 and $19,906,000 for each of the two
   years in the period ended June 30, 1995, respectively. Those statements were
   audited by other auditors whose reports thereon have been furnished to us,
   and our opinion expressed herein, insofar as it relates to the amounts
   included for Puritan-Bennett Corporation and its subsidiaries and
   Infrasonics, is based solely on the reports of the other auditors. 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 and the reports of other auditors provide a
   reasonable basis for the opinion expressed above.

   /s/ Price Waterhouse LLP


   San Francisco, California
   July 31, 1996
<PAGE>   31
   SELECTED QUARTERLY DATA


<TABLE>
<CAPTION>
                                                                           Year ended July 7, 1996

   Unaudited (in thousands except per share amounts)         1st quarter   2nd quarter    3rd quarter   4th quarter
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>           <C>            <C>           <C>     
   Net revenue                                                 $162,506      $168,481       $175,638      $199,506
   Gross profit                                                  81,669        86,519         90,898       101,025
   Income (loss) from operations                                (70,356)(1)    26,832         28,201        15,276(2)
   Net income (loss)                                            (58,999)(1)    18,626         19,778        11,235(2)
   Net income (loss) per share                                     (.97)(1)       .30            .32          .192


                                                                           Year ended July 2, 1995

   Unaudited (in thousands except per share amounts)           1st quarter   2nd quarter    3rd quarter   4th quarter
-----------------------------------------------------------------------------------------------------------------------------------

   Net revenue                                                 $140,714      $153,661       $159,873      $168,818
   Gross profit                                                  68,835        76,643         79,463        85,155
   Income from operations                                        13,405        17,569         20,960        21,470
   Net income                                                     9,588        11,648         10,994        15,882
   Net income per share                                             .16           .20            .19           .27

-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


   (1) Includes pretax merger and related charges of $92.6 million, $74.0
       million after-tax, or ($1.26) per share.

   (2) Includes pretax merger and related charges of $16.3 million, $10.3
       million after-tax, or ($0.17) per share.