<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

(Mark One)

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
     EXCHANGE ACT OF 1934

     For the quarterly period ended  SEPTEMBER 30, 1997
                                     ------------------

                                       OR

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

    For the transition period from ________________ to _______________

                        Commission file number 0-16752


                          MEDSTONE INTERNATIONAL, INC.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)


                 DELAWARE                                     66-0439440
--------------------------------------------------------------------------------
         (State or other jurisdiction                      (I.R.S. Employer
       of incorporation or organization)                  Identification No.)


  100 COLUMBIA, SUITE 100, ALISO VIEJO, CALIFORNIA            92656-4114
--------------------------------------------------------------------------------
      (Address of principal executive offices)                (Zip Code)


Registrant's telephone number, including area code:      (714) 448-7700
                                                    ------------------------

                                 NOT APPLICABLE
--------------------------------------------------------------------------------
              (Former name, former address and former fiscal year,
                         if changed, since last report)

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

                                 Yes  X    No   
                                     ---      ---

The number of shares of the Common Stock of the registrant outstanding as of
November 6, 1997 was 5,354,249.



<PAGE>   2

                          MEDSTONE INTERNATIONAL, INC.

                               INDEX TO FORM 10-Q


                          PART I. FINANCIAL INFORMATION


<TABLE>
<CAPTION>
                                                                                    Page No.
                                                                                    --------
<S>         <C>                                                                        <C>
Item 1.     Financial Statements:

            Condensed Consolidated Balance Sheets
                     September 30, 1997 (Unaudited) and December 31, 1996               3

            Condensed Consolidated Statements of Operations (Unaudited)
                     Three and Nine Months Ended September 30, 1997 and 1996            4

            Condensed Consolidated Statement of Stockholders' Equity (Unaudited)
                     Nine Months Ended September 30, 1997                               5

            Condensed Consolidated Statements of Cash Flows (Unaudited)
                     Nine Months ended September 30, 1997 and 1996                      6

            Notes to Unaudited Condensed Consolidated Financial Statements              7

Item 2.     Management's Discussion and Analysis of Financial Condition
                     and Results of Operations                                         11


                                PART II. OTHER INFORMATION


Item 1.     Legal Proceedings                                                          15

Item 2.     Changes in Securities and Use of Proceeds                                  15

Item 3.     Defaults Upon Senior Securities                                            15

Item 4.     Submission of Matters to a Vote of Security Holders                        15

Item 5.     Other Information                                                          15

Item 6.     Exhibits and Reports on Form 8-K                                           15

Signatures                                                                             16
</TABLE>


                                       2
<PAGE>   3
                          MEDSTONE INTERNATIONAL, INC.

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                 SEPTEMBER 30,     DECEMBER 31,
                                                                                     1997              1996
                                                                                 -------------     ------------
                                                                                  (Unaudited)
                                               ASSETS
<S>                                                                               <C>               <C>
Current assets:
         Cash and equivalents                                                     $ 1,250,744       $ 3,906,961
         Short-term investments                                                     8,582,006         7,102,170
         Accounts receivable, less allowance for doubtful accounts of
           $474,918 and $190,000 in 1997 and 1996, respectively                     4,126,935         2,686,985
         Inventories                                                                2,491,294         2,459,779
         Deferred tax assets                                                          691,891         1,061,000
         Note receivable                                                              375,000         1,250,000
         Prepaid expenses and other current assets                                    226,485           243,271
                                                                                  -----------       -----------
              Total current assets                                                 17,744,355        18,710,166

Property and equipment:
         Lithotripters                                                              7,766,127         7,289,845
         Equipment                                                                    968,910           876,809
         Furniture and fixtures                                                     1,040,506         1,007,292
         Leasehold improvements                                                       101,276            89,764
                                                                                  -----------       -----------
                                                                                    9,876,819         9,263,710
Less accumulated depreciation and amortization                                     (4,850,794)       (3,740,973)
                                                                                  -----------       -----------
             Net property and equipment                                             5,026,025         5,522,737
                                                                                  -----------       -----------

Goodwill, net                                                                       3,287,179         1,118,583
Other assets, net                                                                     140,425            43,805
                                                                                  -----------       -----------
                                                                                  $26,197,984       $25,395,291
                                                                                  ===========       ===========

                                    LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
         Accounts payable                                                         $   407,448       $ 1,760,922
         Accrued expenses                                                             206,968           209,512
         Accrued income taxes                                                         352,057           376,172
         Accrued payroll expenses                                                     463,508           338,461
         Deferred revenue                                                             946,243         1,042,043
                                                                                  -----------       -----------
             Total current liabilities                                              2,376,224         3,727,110

Deferred tax liabilities                                                              392,000           392,000
Minority interest                                                                     336,987           111,172
Commitments and contingencies (Note G)

Stockholders' equity:
         Common stock - $.004 par value, 20,000,000 shares authorized, 
           5,614,853 and 5,578,403 shares issued and outstanding at
           September 30, 1997 and December 31, 1996, respectively                      22,458            22,314
         Additional paid-in capital                                                18,836,883        18,715,068
         Accumulated earnings                                                       6,505,165         3,471,965
         Stock purchase notes receivable                                             (134,800)         (134,800)
         Unrealized gain (loss) on short-term investments                                  12            (1,168)
         Treasury stock (262,400) shares at cost at September 30, 1997
           and 112,800 shares at cost at December 31, 1996)                        (2,136,945)         (908,370)
                                                                                  -----------       -----------
             Total stockholders' equity                                            23,092,773        21,165,009
                                                                                  -----------       -----------
                                                                                  $26,197,984       $25,395,291
                                                                                  ===========       ===========
</TABLE>
                             See accompanying notes


                                       3

<PAGE>   4
                          MEDSTONE INTERNATIONAL, INC.

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)


<TABLE>
<CAPTION>
                                                               THREE MONTHS ENDED             NINE MONTHS ENDED
                                                                 SEPTEMBER 30,                  SEPTEMBER 30,
                                                           -------------------------     --------------------------
                                                              1997           1996            1997          1996
                                                           ----------     ----------     -----------    -----------
<S>                                                        <C>            <C>            <C>            <C>
Revenues:
    Net equipment sales.................................   $  473,550     $  116,000     $ 2,076,850    $ 1,407,000
    Procedures, maintenance fees and fee-for-service....    5,048,102      4,106,762      13,820,204     10,829,209
    Interest income.....................................      133.447        125,988         385,023        544,403
                                                           ----------     ----------     -----------    -----------
    Total revenues......................................    5,655,099      4,348,750      16,282,077     12,780,612

Costs and expenses:
    Cost of equipment sales.............................      328,239        131,718       1,511,810        814,142
    Costs of procedures and maintenance fees............    1,974,357      1,820,863       5,396,725      4,959,570
    Research and development............................      248,410         94,799         653,413        344,964
    Selling   ..........................................      541,588        472,480       1,787,279      1,583,473
    General and administrative..........................      536,108        471,920       1,726,728      1,151,471
    Settlement costs....................................          ---            ---             ---      5,500,000
    Goodwill amortization...............................       22,087          7,125          55,278         14,250
    Legal and other expense ............................          ---          7,580             ---        803,674
                                                           ----------     ----------     -----------    -----------
    Total costs and expenses............................    3,650,789      3,006,485      11,131,233     15,171,544
                                                           ----------     ----------     -----------    -----------
Income/(loss) before provision for/(benefit from) 
  income taxes .........................................    2,004,310      1,342,265       5,150,844     (2,390,932)
Provision for (benefit from) income taxes...............      733,000        504,000       1,782,000       (885,000)
Minority interest.......................................      121,061         25,879         335,644         94,928
                                                           ----------     ----------     -----------    -----------
Net income (loss).......................................   $1,150,249     $  812,386     $ 3,033,200    $(1,600,860)
                                                           ==========     ==========     ===========    ===========

Earnings per share:

    Primary   ..........................................   $     0.21     $     0.15     $      0.55    $     (0.29)
                                                           ==========     ==========     ===========    ===========
    Fully diluted.......................................   $     0.21     $     0.15     $      0.54    $       ---
                                                           ==========     ==========     ===========    ===========
Number of shares used in the computation of 
  earnings per share:

    Primary   ..........................................    5,532,980      5,570,771       5,489,753      5,528,594
                                                           ==========     ==========     ===========    ===========
    Fully diluted.......................................    5,532,980      5,570,771       5,566,313            ---
                                                           ==========     ==========     ===========    ===========
</TABLE>

                            See accompanying notes.

                                       4

<PAGE>   5


                          MEDSTONE INTERNATIONAL, INC.

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                   (Unaudited)



<TABLE>
<CAPTION>
                                         COMMON STOCK                                        
                                    ----------------------    ADDITIONAL
                                    NUMBER OF                  PAID-IN    ACCUMULATED    STOCK PURCHASE
                                     SHARES        AMOUNT      CAPITAL      EARNINGS     NOTE RECEIVABLE
                                    ---------     --------   -----------  -----------    ---------------
<S>                                 <C>           <C>        <C>           <C>             <C>
BALANCE AT DECEMBER 31, 1996        5,465,603     $ 22,314   $18,715,068   $3,471,965      $ (134,800)

Common stock options exercised         36,450          144       121,815          ---             ---

Treasury stock repurchased           (149,600)         ---           ---          ---             ---

Unrealized loss on short-term
   investments                            ---          ---           ---          ---             ---

Net income                                ---          ---           ---    3,033,200             ---
                                    ---------     --------   -----------   ----------      ----------
BALANCE AT SEPTEMBER 30, 1997       5,352,453     $ 22,458   $18,836,883   $6,505,165      $ (134,800)
                                    =========     ========   ===========   ==========      ==========
</TABLE>


<TABLE>
<CAPTION>
                                   UNREALIZED LOSS
                                    ON SHORT-TERM       TREASURY
                                     INVESTMENTS         STOCK             TOTAL
                                   ---------------    -----------       -----------
<S>                                   <C>             <C>               <C>
BALANCE AT DECEMBER 31, 1996          $ (1,168)       $  (908,370)      $21,165,009

Common stock options exercised             ---                ---           121,959

Treasury stock repurchased                 ---         (1,228,575)       (1,228,575)

Unrealized loss on short-term
   investments                           1,180                ---             1,180

Net income                                 ---                ---         3,033,200
                                      --------        -----------       -----------
BALANCE AT SEPTEMBER 30, 1997         $     12        $(2,136,945)      $23,092,773
                                      ========        ===========       ===========
</TABLE>


                                       5
<PAGE>   6
                          MEDSTONE INTERNATIONAL, INC.

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                  Nine Months Ended September 30, 1997 and 1996
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                       1997                       1996
                                                                                ------------------         ------------------
    <S>                                                                         <C>                       <C>
    Cash flows from operating activities:
         Net income ..........................................................  $        3,033,200         $      (1,600,860)
         Adjustments to reconcile net income to net
             cash provided (used) by operating activities:
                 Depreciation and amortization................................           1,186,994                   846,346
                 Minority interest in partnership.............................             335,644                    94,928
                 Provision for doubtful accounts..............................             191,000                    30,000
                 Changes in assets and liabilities:
                     Accounts receivable......................................          (1,630,950)               (1,052,014)
                     Inventories..............................................             (31,515)                 (750,585)
                     Notes receivable.........................................             875,000                       ---
                     Deferred tax assets......................................             369,109                  (855,000)
                     Prepaid expenses and other current assets................              16,786                  (822,532)
                     Accounts payable and accrued expenses....................          (1,085,881)                1,356,936
                     Accrued income taxes.....................................            (169,205)                 (101,293)
                     Deferred revenue.........................................             (95,800)                  233,828
                     Customer deposits........................................                 ---                       ---
                     Other, net...............................................             (96,620)                 (195,690)
                                                                                 -----------------         -----------------

                     Net cash provided by (used in) operating activities......           2,897,762                (2,845,936)
                                                                                 -----------------         -----------------
    Cash flows from investing activities:
         Purchase of marketable securities....................................         (24,704,084)              (11,775,967)
         Sale of marketable securities........................................          23,225,428                19,095,310
         Purchase of subsidiary...............................................          (2,300,000)               (1,350,000)
         Investment by minority in partnership................................             201,963                  (195,028)
         Distribution of minority interest....................................            (234,500)                   45,867
         Purchase of property and equipment...................................            (637,458)               (3,267,424)
         Disposals of property and equipment                                                 1,288                       ---
                                                                                ------------------         -----------------

         Net cash provided by (used in) investing activities..................          (4,447,363)                2,552,758
                                                                                ------------------         -----------------
    Cash flows from financing activities:
         Proceeds from issuance of common stock ..............................             121,959                    91,234
         Purchase of Treasury Stock...........................................          (1,228,575)                 (505,067)
         Dividends paid.......................................................                 ---                (1,000,000)
                                                                                ------------------         -----------------

         Net cash provided by (used in) financing activities..................          (1,106,616)               (1,413,833)
                                                                                ------------------         -----------------
    Net increase (decrease) in cash and cash equivalents......................          (2,656,217)               (1,707,011)
    Cash and cash equivalents at beginning of period..........................           3,906,961                 3,108,741
                                                                                ------------------         -----------------
    Cash and cash equivalents at end of period................................  $        1,250,744         $       1,401,730
                                                                                ==================         =================
    Supplemental cash flow disclosures: 
         Cash paid during the period for:
             Income taxes.....................................................  $        1,437,699         $         520,540
             Interest.........................................................  $                0         $               0
</TABLE>

                            See accompanying notes.


                                       
                                       6

<PAGE>   7
                          MEDSTONE INTERNATIONAL, INC.

         NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 1997

A.       ORGANIZATION AND OPERATIONS OF THE COMPANY

         Medstone International, Inc. ("Medstone" or the "Company") was
incorporated in Delaware in October 1984. The Company designs, manufactures and
markets the Medstone STSTM Shockwave Therapy System (the "System") for the
noninvasive disintegration of kidney stones in human patients. In addition to
sales of the System, Medstone generates recurring revenue from procedure fees
and fee for service arrangements for use of the System and from repairs and
maintenance of the Systems. The Company, as a manufacturer of capital medical
devices, has been vertically integrating by offering its medical devices
directly to providers on a fee-per-procedure basis. Medstone currently offers
mobile lithotripsy services to customers in the United States on a "wholesale"
fee-per-procedure basis under which consolidated billings are rendered to
providers. Medstone intends to expand efforts to grow this medical service side
of its business.

         Northern Nevada Lithotripsy Associates, LLC ("Northern Nevada"), is
owned 60% by Medstone. Medstone acquired its 60% interest for $1.35 million as
of April 1, 1996. The operating results of Northern Nevada are included in the
consolidated financial statements of the Company as of the acquisition date.

         United Physicians Resources, Inc. ("UPR") was incorporated in June
1996, to expand the Company's service orientation to the urologist practitioner.
UPR provides billing, practice management, and consulting services as an
additional service line once the initial physician relationship has been
established. UPR purchased the operations of Integrated HealthCare Systems, Inc.
in July 1996 for $30,000. The operating results of UPR are included in the
consolidated financial statements of the Company since its incorporation.

         As of March 1, 1997, Medstone acquired a 60% interest in Southern Idaho
Lithotripsy Associates, LLC ("Southern Idaho") for $2.3 million in cash. The
operating results of Southern Idaho are included in the consolidated financial
statements of Medstone as of March 1, 1997.

B.       BASIS OF PRESENTATION

         In the opinion of the Company's management, the accompanying unaudited
condensed consolidated financial statements include all adjustments (which
consist only of normal recurring adjustments) necessary for a fair presentation
of its consolidated financial position at September 30, 1997 and consolidated
results of operations and cash flows for the periods presented. Certain prior
period balances have been reclassified to conform with current period
presentation. Although the Company believes that the disclosures in these
financial statements are adequate to make the


                                       7

<PAGE>   8

information presented not misleading, certain information and disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted and should be read
in conjunction with the Company's audited financial statements included in the
Company's 1996 Annual Report on Form 10-K filed with the Securities and Exchange
Commission on March 27, 1997. Results of operations for the nine months ended
September 30, 1997 are not necessarily indicative of results to be expected for
the full year.

C.       PER SHARE INFORMATION

         Per share information is presented in the accompanying consolidated
statements of income based upon the weighted average number of common and common
equivalent shares outstanding. Common equivalent shares result from the assumed
exercise of outstanding dilutive securities when applying the treasury stock
method. Fully diluted per share information is not presented for periods in
which the effect is antidilutive.

D.       USE OF ESTIMATES

         The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates. Significant estimates made in preparing these financial statements
include the allowance for doubtful accounts. 

E.       INVENTORIES

         At September 30, 1997 and December 31, 1996, inventories consisted of
the following:

<TABLE>
<CAPTION>
                                    SEPTEMBER 30,   DECEMBER 31,
                                        1997          1996
                                    ------------    ------------
<S>                                  <C>            <C>       
         Raw materials               $1,383,710     $1,353,993
         Work in process                301,676        255,776
         Finished goods                 805,908        850,010
                                     ----------     ----------
                                     $2,491,294     $2,459,779
                                     ==========     ==========
</TABLE>

F.       SHORT-TERM INVESTMENTS

         Effective January 1, 1995, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." The adoption did not have a
significant impact on the Company's consolidated financial statements.
Management determines the appropriate classification of such securities at the
time of purchase and reevaluates such classification as of each balance sheet
date. Based on its intent, the Company's investments are classified as
available-for-sale and are carried at fair value, with unrealized gains and
losses, net of tax, reported as a separate component of stockholders' equity.
The investments


                                       8
<PAGE>   9
are adjusted for amortization of premiums and discounts to maturity and such
amortization is included in interest income. Realized gains and losses and
declines in value judged to be other than temporary are determined based on the
specific identification method and are reported in the consolidated statements
of operations.

G.       CONTINGENCIES

         From time to time, the Company is subject to legal actions and claims
for personal injuries or property damage related to patients who use its
products. The Company has obtained a liability insurance policy providing
coverage for product liability and other claims. Management does not believe
that the resolution of any current proceedings will have a material financial
impact on the Company or the consolidated financial statements.

H.       STOCK REPURCHASE PLAN

         On March 29, 1996 the Company announced a stock repurchase program of
up to 500,000 shares of its Common Stock. For the quarter ended September 30,
1997, the Company has repurchased 16,000 shares at a cost of $149,221. Since
inception of the repurchase program, the Company has repurchased a total of
262,400 shares at a cost of $2,136,945.

I.       EARNINGS PER SHARE

         In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, Earnings per Share, which is required to be adopted on
December 31, 1997. At that time, the Company will be required to change the
method currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per share,
the dilutive effect of stock options will be excluded. Under Statement 128, for
the three months ended September 30, 1997 and 1996, there would be no impact on
either primary or fully diluted earnings per share. For the nine months ended
September 30, 1997, primary earnings per share would be $.56 with no impact for
the first nine months ended September 30, 1996. The impact of Statement 128 on
the calculation of fully diluted earnings per share for these nine months ended
September 30, 1997 and 1996 is not expected to be material.


                                       9

<PAGE>   10
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
         RESULTS OF OPERATIONS

         GENERAL

         Medstone is a provider of extracorporeal shockwave therapy. Medstone
manufactures, markets and maintains extracorporeal shockwave therapy (ESWT)
devices, and continues to expand its Fee-for-Service Program to supply such
devices to providers on a per procedure basis. To date, the Company's
consolidated revenues have come primarily from Medstone's lithotripsy business.

         The Company as a manufacturer of capital medical devices has been
vertically integrating by offering its medical devices directly to providers.
Medstone sells its ESWT devices as well as providing them on fee-for-service
procedure basis. Medstone intends to continue the growth of this manufacturer
direct business.

         The Company's extracorporeal shockwave therapy (ESWT) device has
received pre-market approval (PMA) from the U.S. Food and Drug Administration
(FDA) to treat renal stones, as described below, and has filed for approval to
treat gallstones. Medstone also is investigating the use of ESWT in the
treatment of orthopedic and other diseases.

         On September 4, 1997, the Company announced that it had submitted to
the FDA an application for a PMA to treat gallstones using the Company's
non-invasive lithotripter in conjunction with Actigall(R), a gallstone
dissolution medication from Novartis Pharmaceuticals Corporation. The submission
was based on an analysis of clinical trials for Actigall monotherapy and
separate clinical trials for combination therapy with a Medstone lithotripter
and Actigall. An analysis of these separate trials indicated that the
combination therapy of the device and drug can speed up clearance of the
gallstones and result in higher success rates when compared to drug therapy
alone.

         In 1996, the Company acquired a 60% interest in Northern Nevada, a
lithotripsy partnership which deals directly with patients and insurers, and
also founded UPR as a majority-owned subsidiary of the Company, to expand the
Company's service orientation to the urologist practitioner. In March 1997, the
Company acquired a 60% interest in Southern Idaho Lithotripsy Associates, LLC,
another provider of lithotripsy services.



                                       10

<PAGE>   11
RESULTS OF OPERATIONS

Three Months Ended September 30, 1997 Compared to Three Months Ended 
September 30, 1996

         The Company recognized revenue of $5.7 million in the third quarter of
1997, or a 30% increase, compared to $4.3 million in the corresponding period of
1996. Equipment revenues increased by 308 % as one equipment unit and one
equipment upgrade package was shipped in the third quarter of 1997 compared to
shipment of no equipment and one upgrade package in the third quarter of 1996.
Also increasing by 23% were the revenues from the Company's maintenance,
procedure and fee-for-service activities as the number of patients treated on
the Company's lithotripters in the United States increased by 15% in the third
quarter of 1997 compared to the same period of 1996.

         Interest income increased by 6% in the third quarter of 1997 compared
to the same period in 1996 due to higher overall market rates on a slightly
lower average invested balance.

         Cost of sales on equipment and equipment upgrade sales decreased to 69%
of sales in the three months ended September 30, 1997, compared to 113% of sales
in the comparable period of the prior year due to this year's equipment
shipment. Recurring revenue costs of sales decreased to 39% in the three months
ended September 30, 1997, compared to 44% in the same period in the prior year
due to the increasing equipment utilization for the mobile lithotripsy services.
Overall cost of sales, as a percentage of revenue (excluding interest),
decreased to 42% in the third quarter of 1997 compared to 46% in the third
quarter of 1996.

         Research and development costs increased by 162%, or $154,000, in the
third quarter of 1997 compared to the same quarter of 1996 due to increased
expenditures in connection with development of new lithotripsy products.

         Sales expenses increased by $69,000 or 14% in the third quarter of 1997
when compared to the same period of 1996 due to commission expense on higher
revenues and expenses for increasing bad debt reserves.

         General and administrative expenses increased by $64,000, or 14%, in
the third quarter of 1997 when compared to the third quarter of 1996 due to
clinical expenses associated with regulatory projects and higher professional
fees for registration of the 1997 Stock Incentive Plan.

         Legal and other expenses increased by $7,000 in the three months ended
September 30, 1997 when compared to the same period of 1996 as legal expenses
are no longer being incurred in connection with the class action securities suit
and goodwill is amortized over its expected life.


                                       11

<PAGE>   12
         Provision for (benefit from) income taxes for the third quarter of 1997
represents an expected statutory rate in the current year, compared to a
reduction of an NOL benefit in the third quarter of 1996.

         Minority interest in subsidiaries' income increased to $121,000 in the
third quarter of 1997, compared to $26,000 in the three months ended September
30, 1996, due to the acquisition of 60% of the Southern Idaho operation.

Nine Months Ended September 30, 1997 Compared to Nine Months Ended 
September 30, 1996

         The Company recognized revenue of $16.3 million in the nine months
ended September 30,1997 compared to revenue of $12.8 million in the
corresponding period of 1996, or a 27% increase. Equipment revenues increased by
48% as five lithotripsy systems have been shipped in 1997 compared to shipment
of three lithotripsy systems in 1996, with only a slight decrease in the average
unit sales price. Also increasing was the Company's maintenance, procedure and
fee-for-service revenues which rose almost $3.0 million in the nine months ended
September 30,1997 compared to the same period of the prior year, or an increase
of 28%. The number of patients treated in the first nine months of 1996
increased by 13%, or more than 2,100 patients, over the same period of 1996.

         Interest income decreased by 29% in the first nine months of 1997
compared to the same period in 1996 due to slightly lower market rates for
investments and a decrease in average invested balances as the Company had
settled the class action litigation in 1996.

         Cost of sales on equipment and equipment upgrades increased to 73% of
sales in the nine months ended September 30, 1997, compared to 58% of sales in
the comparable period of the prior year due to product option mix and a slightly
lower average unit selling price. Recurring revenue costs of sales decreased to
39% in the first nine months of 1997, compared to 46% in the same period in the
prior year due to the increased utilization of the Company's expanded mobile
lithotripsy fleet. Overall cost of sales, as a percentage of revenue (excluding
interest), decreased to 43% in the first nine months of 1997 compared to 47% in
the same period of the prior year.

         Research and development costs increased by $308,000, or 89%, in the
first nine months of 1997 compared to the same period of 1996 due to the payroll
and project expenses as the Company concentrates its efforts on new lithotripsy
products.

         Sales expenses increased by $204,000 or 13% in the nine months ended
September 30, 1997 when compared to the same period of 1996 due to commission
expenses for expanded mobile lithotripsy revenue.

         General and administrative expenses increased by $575,000, or 50% in
the first nine months of 1997 when compared to the first nine months of 1996 due
to expanded payroll

                                       12

<PAGE>   13
expense to support United Physicians Resources and bad debt expense for Northern
Nevada and Southern Idaho.

         Settlement expense of $5.5 million was recorded in the first nine
months of 1996 to end the class action securities litigation against the Company
and current and former officers. There was no comparable expense in the current
year.

         Legal and other expense decreased by $803,000 in the nine months ended
September 30, 1997 when compared to the same period of 1996 due to the
settlement in the second quarter of 1996 of the class action securities suit.

         Minority interest expense increased to $336,000 in the first nine
months of 1997, compared to $95,000 in the first nine months of 1996, due to the
acquisition in April 1996 of Northern Nevada and Southern Idaho in March 1997.

         Provision for (benefit from) income taxes went from a benefit from
income taxes of $885,000 in the first nine months of 1996 to a provision for
income taxes of $1,782,000 for the first nine months of 1997, due to the loss
from settlement of the class action securities suit in 1996 and tax consequences
therefrom. .

LIQUIDITY AND CAPITAL RESOURCES

         At September 30, 1997, the Company had cash and short-term investments
of approximately $9.8 million. These funds were generated from operating
activities and from the Company's initial public offering in June 1988.

         Accounts receivable have increased substantially, $1.4 million, due to
the acquisition of Southern Idaho's retail receivables and timing of shipments
near the end of the quarter, along with a shift in customers to more
partnerships, which experience a longer payment pattern.

         Accounts payable decreased by $1.4 million as the Company paid costs
incurred in the attempted acquisition of the lithotripsy operations of Coram
Healthcare.

         The Company's long-term capital expenditure requirements will depend on
numerous factors, including the progress of the Company's research and
development programs, the time required to obtain regulatory approvals, the
resources that the Company devotes to the development of self-funded products,
proprietary manufacturing methods and advanced technologies, the costs of
acquisitions and/or new revenue opportunities, the ability of the Company to
obtain additional licensing arrangements and to manufacture products under those
arrangements, and the demand for its products if and when approved and possible
acquisitions of products, technologies and companies.


                                       13

<PAGE>   14
         The Company believes that its existing working capital and funds
anticipated to be generated from operations will be sufficient to meet the cash
needs for continuation of its present operations during 1997.

SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

         Forward-looking statements in this report, including without
limitation, statements relating to the Company's plans, strategies, objectives,
expectations, intentions and adequacy of resources, are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Investors are cautioned that such forward-looking statements involve risks and
uncertainties including without limitation the following: (i) the Company's
plans, strategies, objections, expectations and intentions are subject to change
at any time at the discretion of the Company, (ii) the Company's plans and
results of operations will be affected by the Company's ability to manage its
growth; (iii) the Company's businesses are highly competitive and the entrance
of new competitors into or the expansion of the operations by existing
competitors in the Company's markets and other changes could adversely affect
the Company's plans and results of operations; and (iv) other risks and
uncertainties indicated from time to time in the Company's filings with the
Securities and Exchange Commission.




                                       14

<PAGE>   15
                          MEDSTONE INTERNATIONAL, INC.

                           PART II. OTHER INFORMATION

Item 1. Legal Proceedings

        None

Item 2. Changes in Securities and Use of Proceeds

        None

Item 3. Defaults upon Senior Securities

        None

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

        None

Item 5. Other Information

        None

Item 6. Exhibits and Reports on Form 8-K

        (a) The following exhibits are included herein:

             3.3          Amendment of By-laws

            11.1          Computation of Per Share Information

            27            Financial Data Schedule

        (b) Reports on Form 8-K.

            During the quarterly period ended September 30, 1997, the
            Company filed the following Current Report on Form 8-K:

            1. A report dated September 4, 1997 reporting that the 
               Company submitted an application for a pre-market 
               approval (PMA) to the U.S. Food & Drug Administration 
               (FDA) to treat gallstones using the Company's 
               non-invasive lithotripter in conjunction with 
               Actigall(R), a gallstone dissolution medication from 
               Novartis Pharmaceuticals Corporation.


                                       15
                                        
<PAGE>   16
                                   SIGNATURES


         Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.



                                           MEDSTONE INTERNATIONAL, INC.
                                           A Delaware corporation

Date: November 11, 1997                    /s/ MARK SELAWSKI
                                           -------------------------------------
                                               Mark Selawski
                                               Chief Financial Officer
                                               (Principal financial and
                                               accounting officer)













                                       16

<PAGE>   17
                                 EXHIBIT INDEX

                                                                 Sequentially
     Exhibit                                                       Numbered
     Number                       Description                        Page
     -------                      -----------                    ------------
       3.3         Amendment of By-laws
      11.1         Computation of Per Share Information
      27           Financial Data Schedule