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

                                  FORM 10-KSB
                                  -----------

(Mark One)
[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
     ACT OF 1934
     [FEE REQUIRED]
     For the fiscal year ended November 30, 1997

[ ]  TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934
     [NO FEE REQUIRED]

     Commission File No. 0-8350
                         ------

                                  STAODYN, INC.
                 ----------------------------------------------
                 (Name of small business issuer in its charter)


          Delaware                                     84-0684224
-------------------------------          ---------------------------------------
(State or other jurisdiction of          (I.R.S. Employer Identification Number)
incorporation or organization)


 1225 Ken Pratt Boulevard, Longmont, CO                    80501
-----------------------------------------               ----------
 (Address of principal executive offices)               (Zip Code)


Issuer's telephone number, including area code:  (303) 772-3631
                                                 --------------


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

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

Common Stock, par value $.01                         NASDAQ SmallCap
----------------------------                     ----------------------
      (Title of Class)                           (Name of each exchange
                                                  on which registered)

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 
                                   ---       ---

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained herein, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.   [X]

State issuer's revenues for its most recent fiscal year.   $21,142,602
                                                           -----------

State the aggregate market value of the voting stock held by nonaffiliates of
the registrant, computed by reference to the price at which the stock was sold,
or the average bid and asked prices of such stock, as of a specified date within
the past 60 days.

                      $14,528,602 as of February 11, 1998

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.

       Common Stock, $.01 par value                           6,708,065
       ----------------------------              -------------------------------
                  Class                          Outstanding at February 11,1998

Documents Incorporated by Reference:  Portions of the definitive Proxy Statement
with respect to the May 21, 1997 Annual Meeting of Stockholders are incorporated
by reference in Part III hereof.

Transitional Small Business Disclosure format (check one):   Yes  X     No 
                                                                 ---       ---

This Form 10-KSB consists of 37 pages.
<PAGE>
 
                                     PART I

ITEM 1.  BUSINESS

GENERAL

  Staodyn, Inc. (the "Company" or "Staodyn") was incorporated in 1975.  Staodyn
designs, develops, manufactures, and markets noninvasive electrotherapeutic
devices, supplies, and accessories for use by physicians, physical therapists,
athletic trainers, and their patients.  The Company's electrotherapeutic
products are used in the treatment of chronic and acute pain and neuromuscular
rehabilitation.  The Company's pain management products treat chronic and acute
pain with transcutaneous electrical nerve stimulation ("TENS") that delivers
carefully controlled pulses of electricity through the skin to sensory nerves,
thereby relieving pain without the side effects often associated with drugs or
surgery.  Staodyn's pulsed direct current ("PDC") and neuromuscular electrical
stimulation ("NMES") devices are used in physical therapy, sports medicine, and
orthopaedics for muscle reeducation and rehabilitation, and to promote healing
of soft tissue injuries.

  The Company operates both a retail sales division, which sells the Company's
products directly to patients, third-party payors, and medical practitioners,
and a wholesale division, which sells primarily to home healthcare dealers.  In
1997 the retail division accounted for 82% of the Company's sales.  The Company
believes that it ranks second in the domestic market for TENS, PDC, and NMES
products, estimated at about $150 million annually.

  The Company is continually seeking to broaden and diversify its products
through internal development, by adding complementary products developed and/or
manufactured by others, through acquisitions, and by entering into selected
marketing arrangements with other manufacturers.  By utilizing its expertise in
electrotherapeutic products, the Company developed SporTX(R), introduced in June
1995, designed primarily to accelerate recovery from athletic injuries.  The
Company has also developed the Dermapulse(R) wound management system, for the
treatment of severe skin wounds such as pressure ulcers. The commercial
opportunity for this product in the U.S. is subject to FDA approval.  The
product is currently being marketed in Germany, and to a lesser extent in France
and England.

PRODUCTS

  The Company's business is composed primarily of electrotherapeutic devices,
supplies, and accessories for pain management and for rehabilitation.

TENS Devices
------------

  Although TENS is not effective for every patient or all types of pain,
physicians and physical therapists have treated their patients with TENS for
over twenty years and have generally accepted TENS as an effective treatment for
acute and chronic pain.  The acceptance of TENS, and its efficacy as a treatment
modality, has led to its use in other applications where drug use may be
undesirable, such as in sports medicine and certain kinds of postoperative
recovery.  TENS has been useful for treatment of a variety of conditions,
including pain from arthritis and back injuries.  The pain relief generally
lasts only as long as the devices are being used.  For this reason, TENS devices
are often needed by patients for several months or years.  Pursuant to FDA
regulations, the sale of TENS devices is restricted to persons who receive a
physician's prescription for their use.

                                       1
<PAGE>
 
  While TENS devices generally offer a safe, noninvasive alternative to drugs,
there are contraindications and precautions for their use.  TENS is
contraindicated in patients with demand-type cardiac pacemakers, over the
carotid sinus nerves, and transcerebrally.  TENS devices have no curative value
and may mask the sensation of pain which would otherwise warn the user that
something is not right physiologically.  TENS devices generally work most
effectively on local (single site) peripheral origin pain as opposed to systemic
or central origin pain.  The safety of TENS for use during pregnancy and
delivery has not been established.  Electronic monitoring equipment, such as EKG
equipment, may not operate properly when TENS is in use.

  TENS devices consist of a small, portable, battery-powered electrical pulse
generator that is connected by wires to electrodes placed on or near the pain
site.  The electrodes are attached to the skin with an intervening layer of
conductive gel.  The stimulator produces low voltage pulses, delivered
continuously or intermittently, in different waveforms.

  The use of TENS for pain relief, when successful, is extremely cost effective
for third-party payors and patients.  When used in a chronic pain situation,
such as chronic lower back pain, TENS generally permits return to a more normal
lifestyle and work, which might not be possible otherwise.  In an acute pain
situation (e.g., TENS used postoperatively), the cost for TENS rental should be
comparable to drug cost, both of which would be nominal relative to the
hospitalization and surgical costs preceding them. As a result of the ease with
which drugs may be administered, TENS in an acute pain setting would normally
only be used where an intolerance for drugs or risk of addiction was present.
TENS selling prices tend to be in the $300-$500 range, and rentals in the $50-
$100 per month range.  Prices for related supplies (leads, electrodes, and gel)
might average $50-$100 per patient per month.  Successful treatment with a TENS
device normally requires a clinician who has been trained in the use of the
device and its variable parameters, such as its intensity, pulse width, rate,
and mode, as well as the different types of electrodes and their placement.
Such training is not difficult for most healthcare professionals.

  The Company's pain management product line consists primarily of four
different products.  The microprocesser-based Maxima(R) III is a multimode unit
that is easy to use.  It offers normal, modulation, and burst modes.  Its
Automatic Power Miser significantly extends the Maxima III's battery life up to
150 hours.  The Maxima III offers strength duration modulation features and soft
turn-on, a patented feature that provides for slow ramp-up of the electrical
current at turn-on or after current interruption.  Maxima III also allows the
patient to alter pulse width without having to readjust the intensity control.
The Maxima(R) II is similar to the Maxima III, without the strength duration
modulation or soft turn-on features.  The Company also offers the Maxima(R) I,
which is equivalent to a Maxima II without burst mode.  The Nuwave(R) electrical
stimulation system is marketed primarily for the treatment of chronic lower back
pain. This product utilizes a patented electrical waveform based on research
directed at improving the effectiveness of TENS for pain management.  Nuwave
does not have the adjustable parameters of the Maxima series, but is therefore
simpler for patient use, and has a waveform which has been optimized for chronic
lower back pain.

  A clinical trial conducted by the Pain Treatment Center of the University of
Tennessee in 1990 concluded that Nuwave TENS often proves to be beneficial in
patients with postlaminectomy or peripheral neuralgic pain, even if they have
not responded to other TENS therapy.  The study sample consisted of 98 patients
suffering from chronic pain of several etiologies, who had previously tried and
been unsuccessful in obtaining relief using TENS therapy.  Fifty-two of the 98
patients obtained relief using a Staodyn Nuwave TENS, and in the case of those
with postlaminectomy pain, the success ratio was 83%--that is, 40 of 48 patients
obtained noticeable relief from pain with the Nuwave.  The Company uses the
results of this study to take to third-party payors on a case by case basis to
differentiate this product and demonstrate the justification for higher
insurance reimbursement levels.  The Company's distribution 

                                       2
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strategy and marketing approach with respect to this product focuses on
physician as well as physical therapy markets.

  TENS devices generally are eligible for insurance reimbursement in whole or in
part by Medicare, Medicaid, workers' compensation, and by most medical insurance
carriers.  Medicare, some workers' compensation, and private insurers have
reduced, limited, and in a few cases, attempted to deny reimbursement.  TENS
devices do not provide pain relief in all cases, and the industry has been
subject to some abuse by medical practitioners prescribing and billing for
unwarranted TENS services, or not properly treating the patient.  TENS therapy
for pain relief is not as widely utilized by the medical profession compared to
drugs, and is more difficult to administer.  Pain relief also tends to be
subjective.

NMES Devices
------------

  The use of electrical stimulation to provide passive muscle exercise and
rehabilitation predates TENS. As a natural extension of its development of
electrical modalities for pain management, the Company developed a line of
portable neuromuscular electrical stimulators (NMES) to assist faster recovery
of normal function in muscle and other soft tissue affected by disease or
trauma.  The Company's NMES devices work noninvasively to activate the motor
nerves which control muscle function.  These devices produce regulated,
involuntary muscle contractions, thereby enabling the patient to begin
rehabilitative exercise before such time as the patient can perform voluntary
muscle contraction.  Clinicians, or other licensed healthcare practitioners,
normally prescribe these products in conjunction with other therapeutic
techniques in orthopaedic, sports, and physical medicine.  The Company's NMES
product line started in 1980 with the Staodyn EMS, which has been modified and
improved several times to its current version, the EMS+2.

  The EMS+2 is a two-channel, two-waveform neuromuscular stimulator designed
primarily for clinical use in a variety of rehabilitative programs, including
muscle exercise against disuse atrophy, gait training, inhibition of spasticity,
and soft tissue management.  The two-channel capability enables opposing muscles
to be exercised reciprocally or separate muscles to be exercised simultaneously;
the second waveform option provides additional flexibility for the clinician.
This is a dual channel device, which utilizes microcomputer-based circuitry,
designed to be simple for the clinician to program and for the patient to
continue using in a nonclinical setting.

  NMES is well accepted as a therapy for rehabilitation, and in general has been
subject to less of the downward pricing pressures or reimbursement problems
encountered in the TENS market.  The Company normally receives full price
reimbursement on NMES devices, including the EMS+2.

  NMES devices in general, and the EMS+2 in particular, have similar
contraindications to TENS devices.  That is, they should not be used on patients
with cardiac demand pacemakers and should not be used transcerebrally or over
the carotid sinus nerves.  In addition, NMES devices are contraindicated for
cancer patients.

Pulsed Direct Current (PDC) Devices
-----------------------------------

  Pulsed direct current utilizes direct current to reduce swelling (or edema),
influence local blood circulation, reduce muscle spasm, and increase range of
motion.

  The Company's SporTX unit was introduced in 1995 and is targeted specifically
at sports medicine applications.  SporTX is an electrotherapeutic product that
combines in one small, portable device, two different electrotherapeutic
waveforms:  (i) the pulsed direct current aspect of the EMS+2 NMES device and
(ii) the unique pain management features of the Nuwave TENS device.

                                       3
<PAGE>
 
  Following various types of injuries or surgeries, the affected tissue or joint
is subject not only to pain, but also to swelling and muscle spasm, which in
turn increase the pain and restrict the use of the affected area.  For example,
after an injury or surgery of the knee, swelling may be severe, lasting a week
or more. Physicians generally want to begin physical therapy of the joint as
soon as possible after injury to speed the rehabilitative process and prevent
disuse atrophy of the muscles.  They may use analgesic drugs to control the
pain, and elevation of the extremity and ice to control the edema.  Drugs often
have problems with side effects, including the potential for addiction, while
the edema reduction measures may not be very effective.

  The Nuwave component is designed for relief of postsurgical and posttraumatic
pain.  The Company believes it may reduce or eliminate the need for analgesic
drugs.  Pulsed direct current is effective for reducing edema and muscle spasm,
and influencing local blood flow.  This effect also contributes to pain
reduction which may promote rapid return to function by increasing range of
motion and preventing disuse atrophy.  The product had significant success in
1997, particularly in sports medicine and orthopaedic applications, as well as
in physical therapy, where treatment of postsurgical and posttraumatic injuries
are common.  The product is currently used by numerous sports teams at the
professional, college, and high school level.  SporTX sales exceeded $2 million
in 1997, and it was the Company's largest selling non-TENS product.

  Dermapulse is a portable, microcomputer-based, pulsed direct current
stimulator.  The technology embodied in this device is the subject of two issued
U.S. patents.  The disposable, single-use treatment electrode is the subject of
patent filings in the United States, Canada, England, Germany, Italy, and three
other European countries.  In 1994 the Company formed a legal subsidiary in the
Netherlands, Staodyn B.V., to possibly facilitate the marketing of Dermapulse in
the European Union.  Through 1997 this subsidiary had not been active.

  Since 1985, when the Company first became aware of the potential use of its
electrical stimulation technology to promote the healing of wounds, it has
pursued the development and approval of proprietary wound healing technology.
In addition to engineering the device and a new single-use, sterile, disposable
electrode, it has conducted animal and human studies to support a PMA
application to the FDA.  A PMA was submitted in December 1990 and was subject to
amendments in 1991 and 1992.  The Company and medical experts met with FDA in
August 1994.  In a subsequent letter, the FDA reiterated their position that the
data previously provided by the Company was not sufficient for them to approve
the Company's PMA and a new clinical study was required.  As a result of this,
the Company withdrew its PMA in November 1994.  In December 1994 the U.S. Agency
for Healthcare Policy and Research issued guidelines for the treatment of
pressure ulcers, which recommended "that a course of electrical stimulation be
considered for Stage III and IV pressure ulcers that do not respond to
conventional therapy."  Total fixed assets related directly to the Dermapulse
system at November 30, 1997 were approximately $166,000, net of accumulated
depreciation.

  The Company conducted two human clinical trials to demonstrate the
effectiveness and safety of the Dermapulse system in the treatment of pressure
ulcers (also known as decubitus ulcers or bedsores).  In management's opinion,
each of the two clinical studies included in the Dermapulse PMA demonstrated
significant improvement in the healing rate of serious pressure ulcers when used
as an adjunct to standard care.  These studies were carried out at a variety of
institutions, including university medical centers, a Veterans Administration
hospital, a hospital's specialized pressure ulcer treatment unit, and nursing
homes.

  The Company has obtained the U.S. and foreign government approvals necessary
to market Dermapulse in Canada and the European Union.  The Company's primary
marketing efforts in 1997 and 1996 were in Germany, and Dermapulse revenues for
those two years were $126,000 and $219,000, respectively.

                                       4
<PAGE>
 
  During 1998 the Company plans to introduce two new PDC devices, the SporTX II,
which substitutes a second PDC channel for the TENS channel in SporTX, and a
Varapulse II, a multifunctional, portable clinical or home unit for increased
circulation and edema reduction.

Accessories and Supplies
------------------------

  Both the pain management and rehabilitation electrotherapeutic products
require accessories and supplies, including electrodes, electrode attachment
systems, conductive media, skin care products, and batteries.  Patients purchase
these accessories and supplies on a recurring basis.  Total sales of accessories
and supplies accounted for approximately 37% of total sales in 1997 and 38% in
1996.  The majority of the Company's electrodes are purchased by the Company
from outside suppliers.  However, the active sterile dressings used in the
Dermapulse wound management system are manufactured by the Company and the
Company believes that this capability will find additional profitable
applications.

SALES AND MARKETING

  The Company distributes its products through its retail division and on a
wholesale basis to independent home healthcare dealers via telemarketing and
independent manufacturers' representatives. The Company supports its sales
efforts with a full line of quality pain management and rehabilitation products,
supported by promotional aids, educational literature, and training programs.
The Company utilizes several methods to promote its products and services,
including advertising in trade publications, product-oriented literature, and
clinical applications literature.  In addition, the Company's products are
exhibited at national and regional trade shows and at Company-sponsored clinical
and technical seminars.

  Most of the Company's foreign sales are in Canada and Europe, and those
accounted for less than 5% of total sales in 1997 and 1996.

  The Company fills all orders for its products promptly as received, and
generally maintains sufficient finished product inventory in most product lines
to fill anticipated orders.  The Company carries significant inventory both in-
stock and at retail clinics to meet rapid delivery requirements, and seldom has
a backlog of orders.

Retail
------

  The retail division presently sells TENS, NMES, other durable medical
equipment, and related supplies to the physician, physical therapy, and
rehabilitation clinic markets throughout the United States. The  retail field
sales force presently calls on approximately 3,000 physical therapy clinics and
physician rehabilitation practices in the U.S.  The Company's retail sales force
grew in 1997 by the addition of sales representatives and independent rep
groups, and through the acquisition of three dealer sales organizations between
May 1996 and March 1997.  The retail division's products (devices) generally are
placed in clinics on a consignment basis, and subsequently used, rented, and/or
sold to patients as needed with the appropriate physician prescription and
supervision.

  The retail division's internal operations are focused on supporting the field
sales activity through (1) a full-service distribution capability, providing
next day service of products and supplies to clinics and patients; (2) a trained
staff who work with physicians, rehabilitation clinics, insurance carriers, and
adjusters to provide billing, collection, and reimbursement services for clinics
and their patients; and (3) a telemarketing sales staff utilizing proprietary
computer software to follow-up with patients to ensure that their product,
supplies, and paperwork needs are met, as well as assisting them in the purchase
process.

                                       5
<PAGE>
 
Wholesale
---------

  The Company's products are also sold "wholesale" via telemarketing and in
limited geographic areas by independent manufacturers' representatives, most of
whom sell the Company's products and other noncompeting medical products to
approximately 400 active home healthcare dealers.  Independent representatives
have exclusive geographic territories and are paid commissions for all sales
within their territories.  Sales commissions to independent sales
representatives for the years ended November 30, 1997 and 1996 totaled about 5%
and 6% of wholesale sales, respectively.  Home healthcare dealers, also known as
durable medical equipment (DME) dealers, sell or rent the products to individual
users, who are referred by a physician, physical therapist, or other medical
professional.  To support its wholesale distribution network, the Company has
employees dedicated to providing clinical and customer support, product
management, training, and education.

MANUFACTURING AND QUALITY ASSURANCE

  The Company manufactures its electrotherapeutic products at its facilities in
Longmont, Colorado. The Company's manufacturing capabilities include a broad
variety of operations required in the development and production of its
electronic devices and accessory items, including manual and automated
electronic assembly equipment, automatic surface mounted device equipment,
electrode fabrication equipment, and design and fabrication of automated test
equipment.  The Company purchases discrete electronic components, printed
circuit boards, batteries, cases and other packaging materials, lead wire and
electrode materials, and other standard items from outside suppliers.  Most
purchased items are tested by the Company before assembly into finished
products.

  The Company believes that product quality and reliability are of critical
importance in medical equipment and takes extensive measures to assure that all
of its products meet the highest standards.  The extensive use of surface mount
technology (SMT) in each of its products contributes to their quality,
reliability, and low energy consumption characteristics.  The Company's surface
mount capability was substantially enhanced during 1997 with the addition of
new, higher-capacity SMT equipment.  Each product is tested at several
subassembly stages during the assembly process.  In addition, all of the
Company's electronic devices are "burned in" for a minimum of 16 hours prior to
final testing.  A final review of each step of the assembly process is conducted
by the quality organization before the devices are released for shipment.

RAW MATERIALS

  The Company's electronic devices involve electromechanical assemblies and
proprietary electronic circuitry.  Most of the raw materials and manufactured
components used in the Company's products are available from a number of
different suppliers.  The Company maintains multiple sources of supply for most
significant items and believes that alternative sources could be developed, if
required, for present single supply sources without a material disruption of its
operations.

RESEARCH AND DEVELOPMENT AND NEW PRODUCTS

  The Company conducts research and development in present and proposed areas of
its business, including the development of new products and product
applications, and the improvement and redesign of its existing products.
Existing devices and accessories are updated and redesigned to improve their
features, performance, reliability, and convenience.

                                       6
<PAGE>
 
  Research and development expenditures have been held relatively constant over
the past several years as part of cost-containment efforts.  Additional
investment in research and development related to the Company's wound healing
technology may occur in the future dependent upon the Company's assessment of
the regulatory climate and the domestic and international market potential.  The
Company also pursues additional new product opportunities in its core business
which require research and development expenditures.

COMPETITION

  Numerous other companies currently manufacture and distribute TENS and NMES
devices and related accessories that compete with the Company's products.  Some
of these competitors have substantially greater capital resources, marketing and
distribution capabilities, research and development staffs, and experience in
obtaining regulatory approvals than the Company.  The largest such direct
competitor is Empi, which is about four times the size of the Company, with an
estimated 50% market share.  In terms of product offerings and marketing and
distribution presence, Empi is by far the dominant competitor of the Company in
the Company's markets.  Other significant competitors are Rehabilicare, Henley
Healthcare, and the TENS division of Sparta Surgical Corporation.

  The TENS market is considered to be a mature market characterized by slow or
limited growth.  This has been accentuated in dollar terms in recent years by
reductions in reimbursement levels and the growth of managed care.  The
Company's pain control products, in addition to competing with the TENS products
of other manufacturers, also in some instances may be deemed to compete against
drugs for pain relief. The wide public acceptance and availability of
nonprescription ibuprofen has served to adversely impact the growth rate of TENS
for pain relief.  See "Business - Third-Party Reimbursement."

PATENTS AND TRADEMARKS

  The Company has maintained the practice, where possible, of obtaining patent
protection on its products and processes.  As of November 30, 1997, the Company
had 25 United States patents and three Canadian patents issued as well as eight
foreign patents pending relating to the design and output of its products.  Of
the patents issued, 19 relate to TENS and related products (seven of which are
for Nuwave), and four relate to Dermapulse.  The Company plans to make
additional patent applications as appropriate. The Company also holds several
registered trademarks in the United States, including "Staodyn(R),"
"Staoderm(R)," "Maxima(R)," "Nuwave(R)," "Dermapulse(R)," "SporTX(R)," "Lo-
Back(R)," and "Cervitrak(R)."

  The Company believes that it owns, has the right to use, or has the right to
license all proprietary technology necessary to manufacture and market its
current products and those under development.  The Company has no knowledge that
it is infringing upon any patents held by others.  The Company may decide for
business reasons to retain a patentable invention as a trade secret.  In such
event, or if patent protection is not available, the Company must rely on trade
secrets, know-how, and continuing technological innovation to develop and
maintain its competitive position.  The Company's key employees and consultants
have access to proprietary information and have signed confidentiality
agreements.

GOVERNMENTAL REGULATION

  Regulation by governmental authorities in the United States and other
countries is a significant factor in the production and marketing of the
Company's products and in its ongoing research and development activities. The
FDA's Center for Devices and Radiological Health (CDRH) regulates medical
devices. This regulation has become increasingly stringent and the approval
process more expensive and time-consuming. The Company's products are subject to
these regulations. The FDA's device regulations

                                       7
<PAGE>
 
categorize devices into three regulatory classifications subject to varying
degrees of regulatory control, with Class I devices being subject to the least
regulatory control and Class III devices being subject to the most control. In
general, Class I devices require compliance with labeling and record-keeping
regulations and are subject to other general controls. Class II devices are
subject to performance standards, in addition to general controls, and Class III
devices, which are products that are life supporting or life sustaining, or are
of substantial importance in preventing impairment of human health, require
clinical testing to assure safety and effectiveness prior to marketing and
distribution.

  The Company's pain management and rehabilitation devices (such as TENS, PDC,
and NMES) are Class II devices, subject to a premarket notification process
pursuant to Section 510(k) of the Federal Food Drug and Cosmetic Act.  This
regulation requires that new products being introduced into commercial
distribution for the first time, or changes in existing products that could
significantly affect the safety or effectiveness of the device, be preceded by a
510(k) notification containing information which establishes that the product is
substantially equivalent to an existing device that is or has been legally
marketed.  Once the FDA determines that the product is substantially equivalent,
the Company is granted clearance to market the product.

  The Company's Dermapulse wound management system is a Class III device,
subject to the Premarket Approval (PMA) regulations.  In order to receive
marketing approval, such devices must undergo preclinical and clinical testing
in compliance with the Investigational Device Exemption (IDE) regulations, which
permit human testing of the device in controlled trials.  If the device is a
"significant risk" device, the sponsor of the research must file an IDE
application and obtain approval from the FDA prior to beginning clinical trials.
If it is a "nonsignificant risk" device (such as Dermapulse), then the sponsor
need not file an IDE, but must adhere to the provisions of the regulation, such
as obtaining approval for the study from an institutional review board (IRB) or
committee established for this purpose, obtaining informed consent from the
patients, and adhering to good study practices, especially with regard to data
integrity and record-keeping.

  FDA regulations pertain not only to human healthcare products and medical
devices, but also to the processes and facilities used to manufacture such
products.  Among the conditions for marketing products cleared by the FDA is the
requirement that the prospective manufacturer's quality control and
manufacturing procedures conform to the FDA's Good Manufacturing Practice (GMP)
regulations.  In complying with standards set forth in these regulations,
manufacturers must continue to expend time, money, and effort in the areas of
production and quality control to ensure full technical compliance.  Good
Manufacturing Practice regulations require adherence to strict quality control
procedures, including documentation of all aspects of the manufacturing process
to demonstrate that products are made by a "controlled" process which ensures
consistency and reliability of the end product.  Significant changes to the
manufacturing process require notification to the FDA, and all changes require
documentation.  The FDA has the right to conduct inspections of the
manufacturing facility at any time at its discretion.   The Company adheres to
these regulations and has full-time quality assurance personnel.  In August 1995
the FDA completed a GMP inspection of the Company's manufacturing facilities and
determined that the Company was in compliance.

  The Company's products are subject to foreign regulatory approval before they
may be marketed abroad.  In some cases, in order to comply with foreign
regulations, products have to be modified in their electronics, appearance, or
labeling.  In January 1996 the Company received ISO 9001 certification to the
European Medical Devices Directive.  Additionally, the Company's SporTX, Nuwave,
and Dermapulse products and associated accessories bear the CE mark.  ISO 9001
certification as well as compliance with CE requirements enable the Company to
market its products in European Union countries.  The Company 

                                       8
<PAGE>
 
successfully completed ISO 9001 certification compliance audits by TUV Product
Service in January 1997 and 1998.

  Compliance with Federal, State, and local provisions, which have been enacted
or adopted regulating the discharge of materials into the environment or
otherwise relating to the protection of the environment, have not had a material
effect upon the capital expenditures, earnings, or competitive position of the
Company, nor are they expected to be significant in the future.

THIRD-PARTY REIMBURSEMENT

  Governmental and other efforts to reduce healthcare spending have affected,
and will continue to affect, the Company's operating results.  The cost of a
significant portion of medical care in the United States is funded by government
and private insurance programs, such as Medicare, Medicaid, health maintenance
organizations, and private insurers, including Blue Cross/Blue Shield plans.
Governmentally imposed limits on reimbursement of hospitals and other healthcare
providers have significantly curtailed their spending budgets.  Under certain
government insurance programs, a healthcare provider is reimbursed a fixed sum
for services rendered in treating a patient, regardless of the actual charge for
such treatment. Private third-party reimbursement plans are also developing
increasingly sophisticated methods of controlling healthcare costs through
redesign of benefits and exploration of more cost-effective methods of
delivering healthcare.  In general, these government and private cost-
containment measures have caused healthcare providers to be more selective in
the purchase of medical products.

  All of the Company's products are subject to reimbursement from third-party
payors, including Medicare.  Reimbursement levels vary among geographic regions
and among payors within a particular region.  Reimbursement levels are partially
dependent on the Company's billing (retail) price for the product, and how the
payor views the comparability of this price to the prices of competitive
products. Reimbursement ranges for the Company's device products tend to be at
70-100% of retail price levels.

  Significant uncertainty exists as to the reimbursement status of newly
approved healthcare products, and there can be no assurance that adequate third-
party coverage will be available.  Limitations imposed by government and private
insurance programs and the failure of certain third-party payors to fully or
substantially reimburse healthcare providers for the use of the Company's
products could have a material adverse effect on the Company.

EMPLOYEES

  On November 30, 1997, the Company employed 199 persons, three of whom were
employed on a part-time basis, compared with a total of 181 on November 30,
1996.  The Company presently has a 1983 Employee Stock Purchase Plan, a 401(k)
Profit Sharing Plan, and a 1992 Stock Option Plan in effect for the benefit of
its employees, which are administered by a Compensation Committee consisting of
outside members of the Board of Directors.  Company contributions to the 401(k)
Profit Sharing Plan are partially dependent upon Company earnings, and the
contributions made for fiscal 1997 and 1996 were $52,000 and $29,000,
respectively.  For additional information concerning these Plans, see Notes 6
and 8 to the Consolidated Financial Statements.

ITEM 2.  PROPERTIES

  The Company's Longmont, Colorado, operations occupy a single two-story
building consisting of approximately 50,000 square feet.  A limited liability
company, of which an officer of the Company is a 16% participant, owns 26,000
square feet and 6.25 acres of related land and leases it back to the 

                                       9
<PAGE>
 
Company. The Company leases the remaining 24,000 square feet from an unrelated
party. The Company has an option to purchase each leased portion at any time
during a five-year period commencing July 1998. The present building sits on a
site of approximately 7.2 acres, and the available building area could be
increased up to a maximum of 125,000 square feet on the existing site. The
Company has no present requirement to expand its facilities.

  The retail division's operations in Tampa, Florida, occupy approximately
11,800 square feet of leased office space, including 2,300 square feet added in
February 1997.  The lease expires in April 2001; the Company has an option to
extend this lease for an additional five years after the initial period.

ITEM 3.  LEGAL PROCEEDINGS

  The Company is a party to ordinary and routine litigation incidental to its
business, none of which is expected to have a material adverse effect on the
Company's results of operation or financial condition.

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

  There were no matters submitted to a stockholder vote during the last quarter
of the fiscal year ended November 30, 1997.

                                       10
<PAGE>
 
                                    PART II
                                    -------


ITEM 5.   MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
  The Company's Common Stock is traded on the NASDAQ SmallCap Market under the
symbol "SDYN."  The following table sets forth, for the periods indicated, the
range of high and low closing prices for the Common Stock as reported by NASDAQ.

  The Company has never paid a dividend and does not anticipate payment of
dividends in the foreseeable future.
<TABLE>
<CAPTION>
 
Fiscal year ended November 30, 1996:     High    Low
                                        ------  ------
<S>                                     <C>     <C>
  First quarter                         $1.750  $1.375
  Second quarter                        $2.125  $1.312
  Third quarter                         $1.750  $1.375
  Fourth quarter                        $1.687  $1.312
 
Fiscal year ended November 30, 1997:
  First quarter                         $1.687  $1.187
  Second quarter                        $1.531  $1.219
  Third quarter                         $1.719  $1.344
  Fourth quarter                        $2.500  $1.375
 
</TABLE>
On February 11, 1998, the closing price of the Common Stock on NASDAQ was $2.19
per share.  As of February 11, 1998 there were approximately 987 holders of
record of the Common Stock.

                                       11
<PAGE>
 
ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

LIQUIDITY AND CAPITAL RESOURCES

  The Company generated cash from operations of $789,000 during fiscal 1997, as
compared to $235,000 in fiscal 1996.  The improvement in cash generation was due
to lower amounts of cash used to finance both accounts receivable and
inventories as well as higher levels of income.  Net income, after adjustments
for non-cash items, provided $1,442,000 in 1997; in 1996, net income as adjusted
provided $1,222,000 of net cash. Accounts receivable increased by $214,000 in
1997; the increase of $661,000 in 1996 was due to much higher sales in the third
and fourth quarter resulting from the May and August 1996 dealer acquisitions.
Similarly, inventory increased by $191,000 in 1997; the much higher increase of
$774,000 in 1996 was related to the inventory purchased in the acquisitions as
well as required for consignment for a larger clinical base.

  Cash of $111,000 was used for investing activities in 1997, as compared to
$617,000 in the prior year. Investments in property, plant and equipment were
comparable to those in the prior year; however, $207,000 was provided by the net
maturity of short-term investments in fiscal 1997 as compared to a usage of
$281,000 in 1996.

  Financing activities used cash of $283,000 in fiscal 1997, as compared to
$204,000.  The Company utilized $109,000 for the purchase of treasury stock in
1997.  The note payable to a related party was satisfied early in 1996, and the
related cash usage of $31,000 was not required to be expended for this purpose
in 1997.

  The Company's net working capital at November 30, 1997 was $11,634,000, with a
current ratio of 8:1, as compared to $10,200,000 and 6:1 at November 30, 1996.
The Company believes that funds on hand are sufficient to support existing and
planned operations for at least the next twelve months.  Should additional
financial resources be required, the Company believes that funds would be
available from the collateralization of accounts receivable and inventory.

  The Company is a party to a proposed Agreement and Plan of Merger, dated
December 1, 1997, between Staodyn, Inc. and Rehabilicare, Inc., a Minnesota
corporation.  Under the Agreement and Plan of Merger, Staodyn will be merged
into Rehabilicare; each share of Staodyn Common Stock would be exchanged for
 .829 shares of Rehabilicare Common Stock.  A Registration Statement on Form S-4
covering this transaction was filed with the Securities and Exchange Commission
on February 11, 1998. Both companies have scheduled shareholder meetings on
March 17, 1998 to vote on the transaction.  If the merger is approved by the
shareholders of both companies, and certain other conditions to the merger are
satisfied or waived, Staodyn will become a wholly-owned subsidiary of
Rehabilicare.  The officers of the combined company will be the officers of
Rehabilicare.  Cost-savings resulting from the merger are expected to ultimately
be approximately $3.2 million (pre-tax).  No assurances can be given with
respect to the ultimate level of cost savings, if any, to be realized.  Costs to
be incurred relative to the merger and subsequent restructuring are estimated to
be $2.5 to $3.5 million (pre-tax).  It is anticipated that substantially all of
these expenses and charges will be incurred in the first year following the
effective date of the merger. The management of Rehabilicare, Inc. has announced
that it will consolidate all manufacturing, warehousing, shipping, and wholesale
sales operations into its New Brighton, Minnesota facility, and that all retail
sales operations will be consolidated into the Staodyn, Inc. Tampa, Florida
facility.  Staodyn's Longmont facility is expected to be closed during 1998.


                                       12
<PAGE>
 
  Statements in this Form 10-KSB which are not historical facts are 
forward-looking as that term is defined in the Private Securities Litigation 
Reform Act of 1995.  The words or phrases "anticipates," "estimates," "expect," 
or expressions of a similar nature denote forward-looking statements.  Those 
statements are subject to risks and uncertainties, including the risk that
shareholder approval of the merger might not be obtained or that other
contingencies set forth in the merger agreement are not satisfied.

RESULTS OF OPERATIONS

Fiscal Year Ended November 30, 1997
-----------------------------------

  Net sales for the fiscal year ended November 30, 1997 were $21,143,000, an
increase of $2,199,000, or 12%, over the prior fiscal year.  Retail net sales
continued to grow, increasing approximately 17% from the prior year, offset by a
decline in wholesale sales of $374,000 or 9% of 1996 sales.  Retail sales growth
is attributed to an expanded sales force, particularly the impact of two
independent representative groups who were active with the Company for the
entire fiscal year.

  Gross profit was $13,666,000 or 65% of net sales; this is comparable to the
$12,311,000 or 65% of net sales generated in 1996.

  Selling, general, and administrative expenses totaled $12,633,000 or 60% of
net sales in the fiscal year ended November 30, 1997.  This represents an
increase of $1,079,000 or 9% over fiscal 1996 expenses of $11,554,000 or 61% of
net sales.  The increase is due primarily to higher commissions paid on higher
levels of sales, as well as increased payroll costs to support the sales
operations.  Research and development expenses remained essentially unchanged.

  Other expenses for the year ended November 30, 1997 were $110,000, an increase
of $55,000 over the fiscal 1996 level of $55,000.  The increase is due to
approximately $55,000 of merger-related expenses incurred during the fourth
quarter (see Note 2 of the financial statements).

  The Company recognized a portion of its deferred tax assets in 1997, reducing
its valuation allowance to approximately 50%. This resulted in a tax benefit of
$762,000. Net income for the fiscal year ended November 30, 1997 was $1,230,000,
or $.19 per share, compared to $257,000 or $.04 per share for the fiscal year
ended November 30, 1996.

Fiscal Year Ended November 30, 1996
-----------------------------------

  Net sales for the fiscal year ended November 30, 1996 were $18,944,000 an
increase of $573,000 or 3% from the prior fiscal year.  Retail sales increased
$655,858 or 5%.  This increase in retail sales was due to the expansion of the
retail sales force, primarily in the second half of the year.  Net sales in the
second half of the year were up 11% over the same period of 1995.  Two
independent representative groups, who had previously been customers of the
wholesale division, were added to the retail distribution network. Wholesale
division sales decreased by $83,000 or 2%.

  Gross profit was $12,311,000 for the year, or 65% of net sales, as compared to
$11,797,000 or 64% of net sales in 1995.  The improvement in gross profit is
attributable to the sales mix improvement between the retail and wholesale
division sales.


                                       13
<PAGE>
 
  Selling, general, and administrative expenses in fiscal 1996 totaled
$11,554,000, as compared to $11,084,000 in fiscal 1995.  The increase of
$470,000, or 5%, is due to several factors.  Sales and marketing expenses were
higher due to a significant expansion of the retail sales force during the year,
as well as higher commissions on the higher sales in the retail division.
Additionally, the Company hired a new President and Chief Executive Officer in
June 1996 in anticipation of the retirement of W. Bayne Gibson in December 1996.
This resulted in increased salary and moving expenses.

  Research and development expenditures remained fairly level.  Research and
development expenses increased by $9,000 or 2%, to $446,000.
 
  Other expenses for the year ended November 30, 1996 were $55,000, as compared
to $73,000 for fiscal 1995.  Other income (expense) consists primarily of
interest earned on short-term cash investments and interest expense on debt and
capital leases.  Interest earned on short-term investments increased by $24,000;
interest expense decreased by $32,000 as related debt principal was decreased.
These improvements, totaling $55,000, were offset by lower other income of
$33,000.  Other income in fiscal 1995 consisted primarily of a rebate of rent
which had been paid in prior years.

  Net income for the fiscal year ended November 30, 1996 was $257,000 or $.04
per share,  compared to $204,000 or $.03 per share for the fiscal year ended
November 30, 1995.

ITEM 7.   FINANCIAL STATEMENTS

  The information required by this item is herein on pages F-1 through F-18.

ITEM 8.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

  There have been no disagreements between the Company and its independent
accountants on any matter of accounting principles or practices or financial
statement disclosure since the Company's inception.


                                    PART III
                                    --------


ITEM 9.   DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
          COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT OF THE REGISTRANT

ITEM 10.  EXECUTIVE COMPENSATION

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  The information called for by Part III, Items 9 through 12, is incorporated by
reference to sections captioned "Election of Directors," "Executive Officers,"
"Executive Compensation," "Security Ownership of Certain Beneficial Owners and
Management," and "Stock Options and Warrants" from the registrant's definitive
proxy statement expected to be filed with the Securities and Exchange Commission
on or before March 30, 1998.


                                       14
<PAGE>
 
ITEM 13.  EXHIBITS, LIST AND REPORTS ON FORM 8-K

  (a)  Exhibits:
       -------- 

       The following documents are filed as exhibits or, where indicated, are
       incorporated by reference:

  No.  Exhibit Document
  ---  ----------------

    3.1  Certificate of Incorporation (1)

    3.2  Bylaws (1)
 
    3.3  Certificate of Merger of Staodynamics, Inc. (a Colorado corporation)
         into Staodynamics, Inc. (a Delaware corporation) (2)

    3.4  Amendments to the Bylaws of the Registrant (3)

    3.5  Certificate of Amendment to Certificate of Incorporation (4)

    3.6  Articles of Association of Staodyn B.V. (16)

    4.1  Specimen Common Stock Certificate (5)

    4.2  Specimen Warrant (11)

    4.3  Warrant Agreement (12)

   10.1  1983 Employee Stock Purchase Plan (6)

   10.2  1982 Incentive Stock Option Plan (7)

   10.3  1992 Stock Option Plan (8)

   10.4  Asset Purchase Agreement dated November 6, 1992 between the Company and
         Technical Medical Devices, Inc. (10)

   10.5  Lease Agreement dated July 16, 1993 between the Company and 1225
         Building, LLC (13)

   10.6  Lease Agreement dated July 16, 1993 between the Company and Pendleton
         Construction Co., Inc. (14)

   10.7  Employment Agreement - John R. South (17)

   10.8  Change of Control Agreement - John R. South*

   10.9  Change of Control Agreement - Michael J. Newman*

   10.10 Change of Control Agreement - John L. Fenstermaker*

   10.11 Change of Control Agreement - David S. Hood*


                                       15
<PAGE>
 
   10.12 Change of Control Agreement - Oscar R. Jones*

   10.13 CIT Group/Equipment Financing Master Lease and Equipment Schedule No.
         01*

   10.14 CIT Group/Equipment Financing Equipment Schedule No. 02, dated
         November 12, 1997*

   10.15 CIT Group/Equipment Financing Equipment Schedule No. 03, dated
         December 4, 1997*

   21.1  Subsidiaries of the Registrant (16)
 
   23.1  Consent of Price Waterhouse LLP, independent accountants, to
         incorporation by reference of their report into Registration Statement
         Nos. 33-74614, 2-96535, 2-87595, and 33-42053, and in the prospectuses
         constituting part of the Registration Statement Nos. 33-46186 and 33-
         74464*

   27.1  Financial Data Schedule*

   (b) Reports on Form 8-K:
       ------------------- 

       On December 3, 1997, the Company filed a Form 8-K covering the 
definitive agreement to merge between Rehabilicare, Inc and Staodyn, Inc.

----------------------------------------------
  (1) Incorporated by reference from Form 10-K for fiscal year ended March 3,
      1990.
  (2) Denoted as Exhibit 3.2 to Registration Statement No. 33-40195 on Form S-1
      and incorporated herein by reference.
  (3) Denoted as Exhibit 3.5 to Registration Statement No. 33-40195 on Form S-1
      and incorporated herein by reference.
  (4) Denoted as Exhibit 3.3 to Registration Statement No. 33-40195 on Form S-1
      and incorporated herein by reference.
  (5) Denoted as Exhibit 4.1 to Registration Statement No. 33-40195 on Form S-1
      and incorporated herein by reference.
  (6) Denoted as Exhibit 4.4 to Registration Statement No. 33-40195 on Form S-1
      and incorporated herein by reference.
  (7) Incorporated by reference from the Company's Registration Statement No. 2-
      87595 on Form S-8 and as amended in Registration Statement No. 2-96535 on
      Form S-8.
  (8) Denoted as Exhibit 10.3 to Company's Annual Report on Form 10-K for fiscal
      year ended February 29, 1992 and incorporated herein by reference.
  (9) Denoted as Exhibit 10.2 to Registration Statement No. 33-40195 on Form S-1
      and incorporated herein by reference.
 (10) Denoted as Exhibit 2.1 to Company's Current Report on Form 8-K dated
      November 15, 1992.
 (11) Denoted as Exhibit 4.2 to Registration Statement No. 33-58074 on Form S-2
      and incorporated herein by reference.
 (12) Denoted as Exhibit 4.3 to Registration Statement No. 33-58074 on Form S-2
      and incorporated herein by reference.
 (13) Denoted as Exhibit 10.7 to Registration Statement No. 33-58074 on Form S-2
      and incorporated herein by reference.
 (14) Denoted as Exhibit 10.8 to Registration Statement No. 33-58074 on Form S-2
      and incorporated herein by reference.

                                       16
<PAGE>
 
 (15) Denoted as Exhibit 10.9 to Registration Statement No. 33-58074 on Form S-2
      and incorporated herein by reference.
 (16) Incorporated by reference from Form 10-KSB for fiscal year ended November
      30, 1994.
 (17) Incorporated by reference from Form 10-KSB for fiscal year ended November 
      30, 1996.

     *  Filed as part of this report.
 

                                       17
<PAGE>
 
                   Index to Consolidated Financial Statements

<TABLE>
<CAPTION>
 
<S>                                                                         <C> 
Report of Independent Accountants.........................................               F-2

 
Consolidated Balance Sheets as of November 30, 1997 and 1996..............          F-3, F-4
 
Consolidated Statements of Operations for the years
 ended November 30, 1997 and 1996.........................................               F-5
 
Consolidated Statements of Changes in Stockholders' Equity for the years
 ended November 30, 1997 and 1996.........................................               F-6
 
Consolidated Statements of Cash Flows for the years
 ended November 30, 1997 and 1996.........................................          F-7, F-8
 
Notes to Consolidated Financial Statements................................  F-9 through F-18
</TABLE>

                                      F-1
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS



To the Board of Directors and
Stockholders of Staodyn, Inc.

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Staodyn, Inc. and its subsidiary at November 30, 1997 and 1996 and the results
of their operations and their cash flows for each of the two fiscal years in the
period ended November 30, 1997, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.



PRICE WATERHOUSE LLP

Boulder, Colorado
January 30, 1998

                                      F-2
<PAGE>
 
                                 Staodyn, Inc.

                          Consolidated Balance Sheets

<TABLE>
<CAPTION>
 
                                                                  NOVEMBER 30
                                                           --------------------------
                                                               1997          1996
                                                           ------------  ------------
<S>                                                        <C>           <C>
 
ASSETS
Current assets:
 Cash and cash equivalents                                 $ 1,419,959   $ 1,025,343
 Short-term investments                                      1,187,630     1,323,706
 Accounts receivable, net of allowance for doubtful
  accounts of $1,334,151 and $950,821, respectively          5,533,377     5,319,749
 Deferred tax assets                                           465,138             -
 Inventories, net                                            4,589,274     4,398,525
 Prepaid expenses and other assets                             225,322       235,220
                                                           -----------   -----------
Total current assets                                        13,420,700    12,302,543
                                                           -----------   -----------
 
 
 
Property, plant, and equipment (at cost)
 Land                                                          156,554       156,554
 Buildings and improvements                                  1,468,709     1,442,839
 Production and laboratory equipment                         2,626,806     2,330,971
 Office furniture and fixtures                               1,073,903       988,799
 Data processing equipment                                   2,499,863     2,206,159
 Automotive equipment                                            8,153         8,153
                                                           -----------   -----------
                                                             7,833,988     7,133,475
 Less accumulated depreciation and amortization             (5,827,856)   (5,204,990)
                                                           -----------   -----------
                                                             2,006,132     1,928,485
                                                           -----------   -----------
 
 
Intangible assets:
 Product supply agreement, net of accumulated
  amortization of $450,000 and $360,000, respectively          450,000       540,000
 Goodwill, noncompete agreement, and other intangibles,
  net of accumulated amortization of $996,642 and
  $732,610, respectively                                       620,875       873,457
Long-term deferred tax assets                                  359,626             -
Other assets                                                    11,960         9,967
                                                           -----------   ----------- 
Total assets                                               $16,869,293   $15,654,452
                                                           ===========   ===========
</TABLE>

See accompanying notes.

                                      F-3
<PAGE>
 
                                 Staodyn, Inc.

                          Consolidated Balance Sheets

                                  (continued)

<TABLE>
<CAPTION>
 
 
                                                              NOVEMBER 30
                                                        -----------------------
                                                           1997        1996
                                                        ----------  -----------
<S>                                                     <C>         <C>
 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Current portion of capitalized lease obligations       $    77,628    $  207,086
 Accounts payable                                           540,474       730,938
 Commissions payable                                        185,195       184,585
 Accrued payroll expense                                    530,089       502,650
 Taxes payable, other than income                           115,868       113,102
 Other accrued liabilities                                  273,917       364,229
 Income taxes payable                                        63,117             -
                                                         ----------    ----------
Total current liabilities                                 1,786,288     2,102,590
                                                         ----------    ----------
 
 
Long-term debt:
 Finance obligation, net of unamortized debt expense
  of $18,409 and $21,681, respectively                    1,256,591     1,253,319
 Capitalized lease obligations, long-term                   340,682         4,827
                                                         ----------    ----------
Total long-term debt                                      1,597,273     1,258,146
                                                         ----------    ----------
 
Commitments and contingencies
 
Stockholders' equity:
 Preferred stock - $0.01 par value; 1,000,000
  shares authorized; none issued                                  -             -
 Common Stock - $0.01 par value; 10,000,000
  shares authorized; 6,708,065 and 6,641,217 shares,
  issued and outstanding, respectively                       67,081        66,412
 Additional paid-in capital                              15,539,518    15,468,439
 Accumulated deficit                                     (2,011,549)   (3,241,135)
                                                        -----------   -----------
                                                         13,595,050    12,293,716
 
 Less treasury stock (at cost) - 74,000 shares             (109,318)            -
                                                        -----------   -----------
                                                         13,485,732    12,293,716
                                                        -----------   -----------
Total liabilities and stockholders' equity              $16,869,293   $15,654,452
                                                        ===========   ===========
</TABLE>
See accompanying notes.

                                      F-4
<PAGE>
 
                                 Staodyn, Inc.

                     Consolidated Statements of Operations

<TABLE>
<CAPTION>
 
 
                                                YEAR ENDED
                                                NOVEMBER 30
                                         -------------------------
                                             1997          1996
                                         ------------  -----------
<S>                                      <C>           <C>
 
Sales                                    $21,142,602   $18,943,519
Cost of sales                              7,476,323     6,632,071
                                         -----------   -----------
Gross profit                              13,666,279    12,311,448
                                         -----------   -----------
 
 
Operating expenses:
 Selling, general, and administrative     12,632,798    11,553,939
 Research and development                    455,800       445,814
                                         -----------   -----------
                                          13,088,598    11,999,753
                                         -----------   -----------
Income from operations                       577,681       311,695
 
 
Other income (expense):
 Interest income                             104,578       121,475
 Other income--related party                   5,822        13,135
 Interest expense                           (163,270)     (186,667)
 Other income (expense), net                 (56,872)       (2,823)
                                         -----------   -----------
                                            (109,742)      (54,880)
 
 
Income before income taxes                   467,939       256,815
Income tax benefit                           761,647             -
                                         -----------   -----------
Net income                               $ 1,229,586   $   256,815
                                         ===========   ===========
 
Net income per common share              $       .19   $       .04
                                         ===========   ===========


Weighted average number of
 common shares outstanding                 6,643,076     6,469,618
                                         ===========   ===========
</TABLE>


See accompanying notes.

                                      F-5
<PAGE>
 
                                 Staodyn, Inc.

           Consolidated Statements of Changes in Stockholders' Equity

<TABLE>
<CAPTION>
 
 
                                                           
                                          Common Stock      Additional  
                                     ---------------------   Paid In     Accumulated    Treasury
                                        Shares     Amount    Capital       Deficit       Stock
                                     ------------  -------  -----------  ------------  ----------
<S>                                  <C>           <C>      <C>          <C>           <C>
 
Balance at November 30, 1995            6,325,036  $63,250  $15,106,068  $(3,497,950)  $       -
 Issuance of Common Stock
  for acquisition of distribution
  channels                                264,357    2,644      300,583            -           -
 Issuance of Common Stock for
  employee stock bonus and
  employee stock purchase plans            31,824      318       40,988            -           -
 Issuance of Common Stock
  as compensation to directors             20,000      200       20,800            -           -
 Net income                                     -        -            -      256,815           -
                                        ---------  -------  -----------  -----------   ---------
Balance at November 30, 1996            6,641,217  $66,412  $15,468,439  $(3,241,135)  $       -
 
 Issuance of Common Stock for
  employee stock bonus and
  employee stock purchase plans            41,848      419       47,811            -           -
 Issuance of Common Stock as
  compensation to directors                25,000      250       23,268            -           -
 Purchase of treasury stock
  (74,000 shares)                               -        -            -            -    (109,318)
 Net income                                     -        -            -    1,229,586           -
                                        ---------  -------  -----------  -----------   ---------
Balance at November 30, 1997            6,708,065  $67,081  $15,539,518  $(2,011,549)  $(109,318)
                                        =========  =======  ===========  ===========   =========
 
</TABLE>



See accompanying notes.

                                      F-6
<PAGE>
 
                                 Staodyn, Inc.

                     Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
 
 
                                                                       YEAR ENDED
                                                                       NOVEMBER 30
                                                               --------------------------
                                                                   1997          1996
                                                               ------------  ------------
<S>                                                            <C>           <C>
 
OPERATING ACTIVITIES
Net income                                                     $ 1,229,586   $   256,815
Adjustments to reconcile net income to net cash provided by
 operating activities:
  Depreciation and amortization                                  1,013,657       997,842
  Income tax benefit                                              (761,647)            -
  Stock compensation                                                22,888        22,416
  Loss on sale of equipment                                          8,941         2,582
  Accrued interest                                                 (70,995)      (58,000)
Increase (decrease) from changes in assets and liabilities:
  Accounts receivable, net                                        (213,628)     (660,534)
  Inventories, net                                                (190,749)     (773,615)
  Prepaid expenses and deposits                                      2,456       (85,924)
  Other assets                                                      (1,993)        2,819
  Accounts payable                                                (190,464)      261,348
  Commissions payable                                                  610        37,691
  Accrued payroll expense                                           27,439        97,534
  Taxes payable, other than income                                   2,766         7,678
  Other accrued liabilities                                        (90,312)      126,623
                                                               -----------   -----------
Net cash provided by operating activities                          788,555       235,275
                                                               -----------   -----------
 
 
INVESTING ACTIVITIES
Payments for purchases of property, plant, and equipment          (306,342)     (325,783)
Payments for other noncurrent assets                               (11,450)      (18,055)
Purchases of short-term investments                             (2,379,929)   (2,796,097)
Maturities of short-term investments                             2,587,000     2,515,000
Proceeds from sale of equipment                                          -         8,000
                                                               -----------   -----------
Net cash used in investing activities                             (110,721)     (616,935)
                                                               -----------   -----------
 
</TABLE>



See accompanying notes.

                                      F-7
<PAGE>
 
                                 Staodyn, Inc.

                     Consolidated Statements of Cash Flows

                                  (continued)

<TABLE>
<CAPTION>
 
 
                                                               YEAR ENDED
                                                               NOVEMBER 30
                                                        -------------------------
                                                           1997          1996
                                                        -----------  ------------
<S>                                                     <C>          <C>
 
FINANCING ACTIVITIES
Proceeds from issuances of Common Stock                 $   48,230    $   41,306
Principal payments of note payable--related party                -       (31,170)
Principal payments under capital lease obligations        (222,130)     (213,773)
Purchases of treasury stock                               (109,318)            -
                                                        ----------    ----------
Net cash used in financing activities                     (283,218)     (203,637)
                                                        ----------    ----------
 
 
Net increase (decrease) in cash and cash equivalents       394,616      (585,297)
Cash and cash equivalents at beginning of period         1,025,343     1,610,640
                                                        ----------    ----------
Cash and cash equivalents at end of period              $1,419,959    $1,025,343
                                                        ==========    ==========
 
Supplemental information:
 Interest paid                                          $  163,270    $  186,667
 
Supplemental schedule of noncash investing activities
 Equipment acquisitions through capital lease 
  obligations                                           $  428,527    $        -
 Stock issued as compensation                               23,518        21,000
 Stock issued for acquisition of distribution channels           -       295,975
 Stock issued for purchase of inventory                          -         7,252
 
</TABLE>

See accompanying notes.

                                      F-8
<PAGE>
 
                                 Staodyn, Inc.

                   Notes to Consolidated Financial Statements



1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF CONSOLIDATION

    In 1994 the Company incorporated a subsidiary in the Netherlands (Staodyn
B.V.) in anticipation of marketing products to the European Community.  The
consolidated financial statements include the accounts of this wholly-owned
subsidiary.  All significant intercompany accounts and transactions have been
eliminated.

CASH, CASH EQUIVALENTS, AND SHORT-TERM INVESTMENTS

    The Company considers all highly liquid debt instruments purchased with
original maturities of three months or less to be cash equivalents.  Short-term
investments at November 30, 1997 represent investments in commercial paper of
approximately $1,188,000, whose amortized cost approximates fair market value.
These securities mature within six months or less.  Under Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," these securities are carried at amortized cost as the
Company has both the ability and intent to hold to maturity.

FAIR VALUE OF FINANCIAL INSTRUMENTS

    The Company's financial instruments consist of cash and cash equivalents,
short-term investments, accounts receivable, payables, and accrued liabilities
whose fair values approximates the carrying amounts due to the short maturities
of these instruments.

INVENTORIES

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

INCOME TAXES

    Deferred income taxes are provided for the difference between the book and
tax basis of assets and liabilities.

DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT, AND EQUIPMENT

    Depreciation is calculated using the straight-line method over the estimated
useful lives of the assets. Property, plant, and equipment held under capital
leases are amortized using the straight-line method over the shorter of the
lease term or estimated useful lives of the assets.  The estimated useful lives
of property, plant, and equipment for purposes of computing depreciation are:

               Buildings                                 30 years
               Leasehold improvements                  5 to 15 years
               Production and laboratory equipment     3 to 5 years
               Office furniture and fixtures           3 to 5 years
               Data processing equipment               3 to 5 years
               Automotive equipment                      3 years
                                 

                                      F-9
<PAGE>
 
                                 Staodyn, Inc.

                   Notes to Consolidated Financial Statements


1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT, AND EQUIPMENT (CONTINUED)

    Depreciation expense totaled approximately $648,000 and $698,000 for the
fiscal years ended November 30, 1997 and 1996, respectively.

INTANGIBLE ASSETS

    Intangible assets are amortized using the straight-line method over the
following estimated useful lives:

               Product supply agreement      10 years
               Goodwill                   3 to 20 years
               Noncompete agreement          5 years

RESEARCH AND DEVELOPMENT

    The Company expenses all research and development costs as incurred.

EARNINGS PER SHARE

    Earnings per common share are based on the weighted average number of common
and common equivalent shares, including dilutive Common Stock options and
warrants outstanding during the year. Options and warrants outstanding during
the fiscal years ended November 30, 1997 and 1996 are not included in the
computation of weighted average shares outstanding as their inclusion results in
a dilution of less than three percent.

    In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). SFAS
128 requires dual presentation of basic earnings per share and diluted earnings
per share and is required to be adopted by the Company during fiscal 1998.
Implementation of SFAS 128 is not expected to have a material impact on reported
earnings per share.

STOCK-BASED COMPENSATION

    Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation" encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has chosen to present required disclosures and
to continue to account for employee stock-based compensation using the method
prescribed in Accounting Principles Board Opinion 25 ("APB 25"), "Accounting for
Stock Issued to Employees." Accordingly, compensation cost for stock options and
other stock-based compensation is measured as the excess, if any, of the quoted
market price of the Company's stock at the date of grant over the amount an
employee must pay to acquire the stock.

                                      F-10
<PAGE>
 
                                 Staodyn, Inc.

                   Notes to Consolidated Financial Statements


1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

CONCENTRATION OF CREDIT RISK

    The Company's accounts receivable are due from a large number of insurance
carriers and individuals throughout the United States and from approximately 500
active medical product dealers and distributors.

USE OF ESTIMATES

    The preparation of the Company's consolidated financial statements in
conformity with generally accepted accounting principles requires the Company's
management to make estimates and assumptions that affect the amounts reported in
these financial statements and accompanying notes.  The more significant areas
requiring the use of management estimates relate to accounts receivable and
inventory reserves, the estimated useful lives of intangible assets, and the
valuation allowance for deferred tax assets. Actual results could differ from
those estimates.

2.  SUBSEQUENT EVENT

    On December 1, 1997, the Company reached a definitive agreement to merge
with Rehabilicare, Inc., a Minnesota-based company. Under the Agreement and Plan
of Merger (the "Merger Agreement"), each outstanding share of Staodyn Common
Stock will become the right to receive .829 shares of Rehabilicare, Inc. Common
Stock, and Staodyn would become a wholly-owned subsidiary of Rehabilicare.
Completion of the Agreement is subject to several conditions, including, but not
limited to, approval of the transaction by the Securities and Exchange
Commission and shareholder approval by a majority of the stockholders of both
companies, respectively, entitled to vote. Additionally, the Agreement may be
terminated if the market price of Rehabilicare, Inc. Common Stock falls below
$3.00, on average, for a specified period of time prior to the closing date.
Rehabilicare, Inc. has announced that it intends to close the Company's
Longmont, Colorado facility by approximately June 30, 1998. The merger is to be
accounted for as a pooling of interests.

3.  ASSET ACQUISITIONS

    On November 15, 1992, the Company purchased substantially all of the assets,
excluding accounts receivable, of Technical Medical Devices, Inc. (TMD), a
wholly-owned medical products distribution subsidiary of Pharmacy Management
Services, Inc. (PMSI).  In conjunction with the purchase, the Company entered
into a transition support agreement with PMSI whereby PMSI agreed to provide
operating facilities and support services subsequent to the purchase.  These
support services were terminated in 1996.  During fiscal 1996, expenses totaling
approximately $42,250 were paid to PMSI for support services under this
agreement.

    PMSI's ownership percentage is approximately 17% as of November 30, 1997.
The shareholder agreement granted PMSI demand registration rights after June 30,
1994. PMSI was acquired by Beverly Enterprises in June 1995.

                                      F-11
<PAGE>
 
                                 Staodyn, Inc.

                   Notes to Consolidated Financial Statements


3.  ASSET ACQUISITIONS (CONTINUED)

    In connection with the purchase of two distribution channels during 1996,
the Company issued 264,357 shares of unissued, restricted Common Stock.
Approximately 71,000 shares are subject to a contingent guarantee which provides
that the number of shares issued may be adjusted as of August 12, 1998. Such
shares will be increased proportionately should the value of these shares fall
below $87,500, or decreased proportionately if the value exceeds $125,000.

4.  INVENTORIES

    Inventories at November 30 include the following components:
<TABLE>
<CAPTION>
 
                                            1997         1996
               <S>                       <C>          <C>
                                  
               Raw materials             $  616,599   $  684,860
               Work in process               72,552       46,450
               Finished goods             3,900,123    3,667,215
                                         ----------   ----------
                                         $4,589,274   $4,398,525
                                         ==========   ==========
</TABLE> 

5.  LONG-TERM DEBT
 
    Long-term debt at November 30 consists of the following:
<TABLE> 
<CAPTION> 
 
                                            1997         1996
                                         
          <S>                            <C>          <C> 
          Finance obligation, net        $1,256,591   $1,253,319
          Capitalized lease obligations     418,310      211,913
                                         ----------   ----------
                                          1,674,901    1,465,232
          Less current portion              (77,628)    (207,086)
                                         ----------   ----------
                                         $1,597,273   $1,258,146
                                         ==========   ==========
</TABLE>

FINANCE OBLIGATION--SALE AND LEASEBACK OF BUILDING

    In July 1993 the Company completed a sale and leaseback transaction on the
owned portion of its facilities and related land in Longmont, Colorado.  The
property was sold to a limited liability company (LLC) for $1,275,000 in cash.
The sale and leaseback transaction is accounted for as a financing; the sales
price (net of unamortized debt expenses) is reflected as a long-term financing
obligation and the operating lease payments as interest until the earlier of the
end of the lease term or the exercise of the purchase option included in the
lease.  The building and related improvements are carried as assets on the
Company's books and depreciated.  One of the officers of the Company is a
minority (16%) participant in the LLC.

    The financing obligation will mature in July 2003.

                                      F-12
<PAGE>
 
                                 Staodyn, Inc.

                   Notes to Consolidated Financial Statements



5.  LONG-TERM DEBT (CONTINUED)

CAPITALIZED LEASE OBLIGATIONS

    The capitalized lease obligations relate to certain production, data
processing, and office equipment. Original cost and accumulated depreciation of
assets under capital leases at November 30, 1997 are:
<TABLE>
<CAPTION>
 
               <S>                                         <C>
               Cost                                        $460,147
               Less accumulated depreciation                (40,944)
                                                           --------
                                                           $419,203
                                                           ========
 
</TABLE> 

    Future minimum lease payments at November 30, 1997 for these leases are 
as follows:
<TABLE> 
<CAPTION> 
               <S>                                         <C> 
               1998                                        $108,908
               1999                                         106,194
               2000                                         104,804
               2001                                         104,804
               2002                                          82,071
                                                           --------
               Total minimum lease payments                 506,781
               Less amounts representing interest           (88,471)
                                                           --------
               Present value of lease payments              418,310
               Less current portion                         (77,628)
                                                           --------
                                                           $340,682
                                                           ======== 
 </TABLE>           
                                                   

6.  PROFIT SHARING PLAN

    All full-time employees who have completed at least one year of service are
eligible to participate in the Company's 401(k) Plan.  The Plan meets the
requirements of Section 401(k) of the Internal Revenue Code, and total Company
contributions are limited to 50% of the aggregate employee contributions to the
Plan, subject to a maximum amount of 3% of regular compensation for each
employee.  The rules applicable to Section 401(k) may also serve to further
limit the Company's contributions to the Plan, particularly with respect to
highly compensated employees.  Company expense for contributions to the Plan was
approximately $60,500 and $28,500 for fiscal 1997 and 1996, respectively.

7.  COMMITMENTS AND CONTINGENCIES

OPERATING LEASES

    The Company leases land and a building in Longmont, Colorado, under two
operating leases expiring in July 2003.  The leases call for payments totaling
$219,500 per year; the annual payments may be adjusted in fiscal 1998 based upon
the prime rate at the anniversary date of the leases.  Each lease gives the
Company the option to purchase the respective property at any time after the
fifth year of the lease (July 1998); the purchase option prices vary based upon
the year exercised and range from 110% of an established price in the fifth year
to 120% in the tenth year (the established price is $1,275,000 for the portion
which was sold and leased back; $720,000 for the second lease).  Total interest
expense in fiscal

                                      F-13
<PAGE>
 
                                 Staodyn, Inc.

                   Notes to Consolidated Financial Statements



7.  COMMITMENTS AND CONTINGENCIES (CONTINUED)

OPERATING LEASES (CONTINUED)

1997 and 1996 was $140,250 in each year for the portion sold and leased back.
Total rent expense was $79,200 for the remaining portion in both fiscal 1997 and
1996.

    The Company subleased building space for its operation in Tampa, Florida,
from PMSI under an operating lease which expired in March 1996. Total rent
expense under this lease was $41,068 in fiscal 1996. Additionally, the Company
leased a separate warehouse facility under an operating lease which expired in
February 1996. A portion of this facility was subleased to PMSI in September
1995 for approximately $2,700 per month, or a total of $17,242 in 1996. Rent
expense under this lease, net of sublease income, was $3,025 in fiscal 1996.

    The Company leased new office facilities for its operation in Tampa,
Florida, in May of 1996. This lease was amended to include additional office
space in January of 1997. The lease, which expires in April of 2001, calls for
total monthly payments of approximately $12,000. Total rent expense under this
lease was $130,802 and $60,713 for fiscal 1997 and 1996, respectively.

    The Company also leases certain office equipment under noncancelable
operating leases. Total rent expense under these leases was approximately $9,200
and $11,500 in each of the years ended November 30, 1997 and 1996, respectively.

    Future minimum lease payments for all noncancelable operating leases and
subleases having remaining terms in excess of one year as of November 30, 1997
are as follows:
<TABLE>
<CAPTION>
 
               <S>                                <C>
               1998                               $  373,033
               1999                                  377,963
               2000                                  383,845
               2001                                  295,752
               2002                                  222,285
               Thereafter                            137,156
                                                  ----------
               Total minimum lease obligations    $1,790,034
                                                  ==========
</TABLE>
8. STOCKHOLDERS' EQUITY

STOCK OPTIONS

    The Company maintains the 1982 and 1992 Stock Option Plans (SOP) which
provide for the granting of incentive and nonincentive options to employees,
directors, and consultants of the Company. The Company's 1982 SOP expired on May
31, 1992. The 1992 SOP permits options to be granted to purchase a maximum of
400,000 shares of the Company's Common Stock. The term of the options granted
may not exceed 10 years. All options are granted at the fair market value as of
the date of the grant, and vest over a period of two to five years.

                                      F-14
<PAGE>
 
                                 Staodyn, Inc.

                   Notes to Consolidated Financial Statements



8.   STOCKHOLDERS' EQUITY (CONTINUED)
 
STOCK OPTIONS (CONTINUED)
 
     Stock option activity was as follows:
<TABLE> 
<CAPTION> 
                                                                           WEIGHTED-AVERAGE
                                                            WEIGHTED          GRANT-DATE   
                                                          AVERAGE PRICE       FAIR VALUE     
                                               SHARES       PER SHARE         PER SHARE       
                                               -------    -------------    ----------------
      <S>                                      <C>        <C>              <C> 
      Outstanding at November 30, 1995         272,500        $2.727 
       Granted                                 138,000         1.770          $0.955
       Canceled                                 (4,001)        1.636 
                                               -------                 
                                                                       
      Outstanding at November 30, 1996         406,499         2.413 
       Granted                                  34,000         1.399          $0.741
       Canceled                                (45,000)        2.352 
                                               -------                 
                                                                       
      Outstanding at November 30, 1997         395,499        $2.333 
                                               =======                 
                                                                       
      At November 30, 1997:                                            
       Number of shares exercisable            241,119        $2.748 
       Number of shares authorized and                                 
        available for future grant             260,001                  
 
</TABLE>

Information regarding options outstanding and exercisable by exercise price
range as of November 30, 1997 is as follows:
<TABLE>
<CAPTION>
 
                                 Outstanding                 Exercisable
                    ====================================  =================
                                  Weighted      Weighted           Weighted
                                  Average       Average            Average
     Range of        No. of       Remaining     Exercise           Exercise
 Exercise Prices     Shares   Contractual Life   Price     Shares   Price
-----------------   -------   ----------------  --------  -------- --------
<S>                 <C>       <C>               <C>       <C>      <C>
$1.25 - $1.74        98,166         3.58          $1.389    28,161   $1.373
 1.75 -  2.49       169,833         2.78           1.915    90,494    1.945
 2.50 -  3.49        68,500         2.03           2.741    63,464    2.749
 3.50 -  5.25        59,000         2.89           4.635    59,000    4.635
                    -------         ----          ------   -------   ------
 
                    395,499         2.84          $2.333   241,119   $2.748
                    =======         ====          ======   =======   ======
 
</TABLE>

                                      F-15
<PAGE>
 
                                 Staodyn, Inc.

                   Notes to Consolidated Financial Statements



8.  STOCKHOLDERS' EQUITY (CONTINUED)

STOCK PURCHASE PLAN

    The 1983 Employee Qualified Stock Purchase Plan (the ESPP) permits employees
to purchase a maximum of 600,000 shares of the Company's Common Stock.  Eligible
employees are offered the right to purchase shares semiannually in June and
December at a purchase price equal to 85% of the lesser of the fair market value
on either the first or the last business day of the purchase period.
Participants may contribute up to 10% of their regular base pay toward the
purchase of the shares.  During the fiscal years ended November 30, 1997 and
1996, 39,548 and 29,424 shares were purchased at an average price of $1.23 and
$1.26 per share, respectively.  At November 30, 1997 there were 214,391 shares
authorized and available for issuance under the ESPP.

    Participation in the ESPP was temporarily discontinued as of December 31,
1997, due to the pending merger transaction (see Note 2).

STOCK WARRANTS

    In connection with the Company's November 1993 public offering, underwriters
were granted Unit Purchase Options entitling the underwriters to purchase up to
130,000 units for $6.75 per unit.  Each unit originally consisted of one share
of Common Stock of the Company and one redeemable Series II Common Stock
Purchase Warrant.  The underlying purchase warrants expired in November of 1996.
These options are currently exercisable and expire in November 1998.

STOCK-BASED COMPENSATION

    The Company applies APB 25 and related interpretations in accounting for
stock option grants to employees under its stock option plans. Because the
exercise price of the options is equal to the market price of the underlying
stock on the date of grant, no compensation cost has been recognized in the
Company's financial statements. Pro forma disclosures assuming compensation cost
had been determined based on the fair value of stock options (including the
issuance of shares under the ESPP) at the grant dates in accordance with SFAS
123 as follows:
<TABLE>
<CAPTION>
 
                                      Net Income          Earnings Per Share
                                As Reported  Pro Forma  As Reported  Pro Forma
                                -----------  ---------  -----------  ---------
<S>                             <C>          <C>        <C>          <C>
 
Year ended November 30, 1996        256,815    217,553      .04        .03
Year ended November 30, 1997        467,939    412,113      .07        .06
 
</TABLE>

                                      F-16
<PAGE>
 
                                 Staodyn, Inc.

                   Notes to Consolidated Financial Statements



8.  STOCKHOLDER'S EQUITY (CONTINUED)

STOCK-BASED COMPENSATION (CONTINUED)

The estimates of weighted average grant date fair values of options granted and
option compensation has been estimated using the Black-Scholes option-pricing
model (single option approach) with the following weighted-average assumptions
for grants:
<TABLE>
<CAPTION>
 
                                           1997      1996
<S>                                       <C>       <C>
 
               Volatility                 57%       56%
               Risk-free interest rate    6.8%      6.3%
               Expected life              5 years   5 years
               Dividend yield             None      None
</TABLE>

9.  INCOME TAXES

    The Company has general business tax credit carryforwards of approximately
$252,000 expiring from 1998 to 2005.  Utilization of credits may be subject to
an annual limitation due to the ownership change limitations provided by the
Internal Revenue Code of 1986.  The annual limitation may result in the
expiration of credits before utilization.

    A valuation allowance is recorded against deferred tax assets to the extent
that management considers that it is unlikely whether such deferred tax assets
will be realized.  Management has considered a variety of factors, both positive
and negative evidence, in reaching this conclusion, which is based primarily on
the cumulative operating loss over the last four years.  Significant components
of the Company's deferred tax assets and liabilities at November 30 are as
follows:
<TABLE>
<CAPTION>
 
                                                    1997          1996     
<S>                                             <C>          <C>           
Deferred tax assets:                                                       
 Sale and leaseback                             $  312,312   $   311,091   
 Accounts receivable reserves and allowances       497,639       484,049   
 Inventory                                         246,221       245,753   
 Accrued liabilities                                95,276       108,110   
 Contribution carryforwards                              -        16,629   
 Property and equipment                            122,384        59,817   
 Intangible assets                                  29,012             -   
 Alternative minimum tax credits                    50,199         5,729   
 General business tax credits                      252,486       296,486   
 Net operating loss carryforwards                        -       517,256   
                                                ----------   -----------   
     Subtotal                                    1,605,529     2,044,920   
 Valuation allowance                              (780,765)   (2,044,920)
                                                ----------   -----------   
     Total deferred tax assets, net             $  824,764   $         -   
                                                ==========   ===========   
</TABLE>

                                      F-17
<PAGE>
 
                                 Staodyn, Inc.

                   Notes to Consolidated Financial Statements



9.  INCOME TAXES (CONTINUED)

    A reconciliation between the Company's actual income tax benefit and income
taxes computed by applying the federal statutory rate of 34% at November 30 is
as follows:
<TABLE>
<CAPTION>
 
                                                         1997         1996     
<S>                                                  <C>           <C>         
Computed income tax expense at the statutory rate    $   159,100   $  87,300   
                                                                               
Release of valuation allowance                          (700,200)          -   
Effect of net operating losses                          (293,700)   (130,700)  
Goodwill amortization                                      9,500      21,800   
Nondeductible T & E                                       19,100      13,400   
Nondeductible merger costs                                17,000           -   
Effect of state income taxes                              27,600       8,500   
Other                                                          -        (300)  
                                                     -----------   ---------   
                                                     $  (761,600)  $       -   
                                                     ===========   =========   
</TABLE>
10. RELATED PARTY TRANSACTIONS

    The Company sells products to PMSI under the terms of the Product Supply
Agreement entered into in conjunction with the acquisition of TMD.  Sales to
PMSI under this agreement totaled approximately $124,000 and $228,000 in the
years ended November 30, 1997 and 1996, respectively.

    Additionally, the Company provided services related to the collection
of pre-acquisition accounts receivable for PMSI for which fees are received.
Total income under this agreement was approximately $6,000 and $13,000 for the
years ended November 30, 1997 and 1996, respectively.

                                      F-18