<PAGE>

                                                                      EXHIBIT 13

<TABLE>
<CAPTION>
     SELECTED FIVE-YEAR FINANCIAL DATA

     (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)                              YEARS ENDED DECEMBER 31,
     ---------------------------------------------------------------------------------------------------------------------------
                                                                1997           1996         1995          1994            1993
     <S>                                                   <C>            <C>          <C>            <C>             <C>
     Statement of Operations Data:
     Net sales                                             $   10,434          3,797        1,607           331              -
     Operating loss                                           (20,510)       (23,782)     (23,387)      (12,733)         (8,201)
     Net loss                                                 (21,037)       (23,575)     (23,046)      (12,455)        (13,819)
     Net loss per share (1), (2), (3)                           (1.13)         (1.56)       (1.82)        (1.49)          (2.05)
     Weighted average shares outstanding (1), (2)          18,665,837     15,088,493   12,640,212     8,341,021       6,729,636

     Balance Sheet Data:
     Working capital (deficit)                             $   12,509     $    6,649   $    27,123    $   7,413       $    (106)
     Total assets                                              28,662         24,059        36,620       17,393          10,151
     Long-term liabilities                                      8,599          8,582         1,851        1,759           1,502
     Shareholders' equity (deficit)                            13,143          8,674        31,194       11,157         (20,805)
</TABLE>

     (1)  The Company has not paid any dividends since inception.

     (2)  Net loss per share and weighted average shares outstanding for 1993
     are presented on a pro forma basis and reflect the impact of the conversion
     of all Preferred Shares outstanding at the time of the Company's initial
     public offering in June 1994, retroactively as of the date of issuance of
     the Preferred Shares. Also, pursuant to the Securities and Exchange
     Commission regulations, all Common, Redeemable Common and Redeemable
     Convertible Preferred Shares issued and options and warrants granted by the
     Company during the 12-month period preceding the initial filing date of the
     June 1994 public offering have been included in the pro forma calculation
     of weighted average common and common equivalent shares outstanding as if
     they were outstanding for all of 1993 using the treasury stock method and
     the initial public offering price of $6 per share.

     (3)  Basic and diluted loss per share amounts are identical as the effect
     of potential common shares is antidilutive.


     MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
     CONDITION

     SUMMARY

     Diametrics Medical, Inc., which began operations in 1990, is engaged in the
     development, manufacturing and marketing of critical care blood and tissue
     analysis systems which provide immediate or continuous diagnostic results
     at the point of patient care.

     Since its commencement of operations in 1990, the Company has transitioned
     from a development stage company to a full-scale development, manufacturing
     and sales organization. As of December 31, 1997, the primary funding for
     the operations of the Company has been approximately $114 million raised
     through public and private sales of its equity securities and issuance of
     convertible promissory notes, all of which have been repaid or converted
     into common stock.

     During 1997, several significant events occurred which impacted 1997
     operating results and will continue to impact operating results in the
     future. These events were highlighted by the introduction and enhancement
     of key new products, continued market penetration of the Company's products
     and the successful integration and expanded commercialization of the
     continuous monitoring business, purchased from Pfizer Inc. in November
     1996.

     Key among the Company's new product introductions in 1997 was the launch of
     a new combination testing cartridge for the IRMA SL Blood Analysis System.
     The
<PAGE>

     combination cartridge is based upon the Company's new "snapfit" cartridge
     design and gives clinicians the ability to perform all critical blood gas,
     electrolyte and hematocrit tests using one small blood sample on one
     single-use cartridge. The addition of this cartridge extends the system's
     application to all critical care areas in the hospital including the
     operating room. The new "snapfit" cartridge design is smaller than its
     predecessor and facilitates automated assembly, which reduces labor cost,
     while increasing yields and plant capacity, all contributing to lower unit
     product costs and improved margins.

     Another major product and marketing breakthrough in 1997 was the completion
     of an agreement with LifeScan, a Johnson & Johnson company, to incorporate
     blood glucose monitoring into the IRMA SL System by integrating LifeScan's
     SureStep(R) Pro glucose module into the system.  The Company expects to
     commercialize the new integrated workstation during the first half of 1998.
     Diametrics and LifeScan are also collaborating on worldwide sales and
     marketing efforts.

     Fundamental to the expanded commercialization of the continuous monitoring
     business was the Company's receipt of FDA clearance to market its second
     generation sensor platform for continuous monitoring products. The
     Paratrend 7+ is the only multi-parameter sensor for direct continuous
     monitoring of blood gases in critically ill adult and pediatric patients.
     The new technology utilizes a fluorescent optical sensor for monitoring
     oxygen, replacing the electrochemical version of its predecessor. The new
     technology platform has lower material costs and requires less
     manufacturing labor, resulting in lower unit costs. The Paratrend 7+
     technology forms the basis for other new continuous monitoring products,
     including Neotrend. Neotrend is designed specifically to provide continuous
     monitoring of blood gases and temperature in critically ill premature
     babies. Neotrend was introduced in the United Kingdom in November 1997 and
     the Company received FDA clearance to market Neotrend in the United States
     in January 1998.

     Additionally, the Company continued to expand global marketing and
     distribution partnerships during the year, including the initiation of a
     co-marketing  agreement with Marquette Medical Systems, Inc., and the
     expansion of its distribution agreement with Chiron Diagnostics to include
     selected markets in the Far East and southern Europe. Chiron is also a
     distribution partner for the Company's Paratrend 7 system in Japan. The
     co-marketing agreement with Marquette enables Marquette's U.S. sales force
     to quote and sell the IRMA SL Blood Analysis System as part of Marquette's
     monitoring solutions portfolio.  The co-marketing effort is an outgrowth of
     a strategic alliance between the two companies, initiated to develop an
     interface that links the benefits of the IRMA SL Blood Analysis System to
     Marquette's Unity Monitoring Network(R).  The interface will transfer IRMA
     test information immediately into Marquette's bedside monitor or clinical
     information system thus creating a comprehensive, real-time patient record.

     As previously noted, in November 1996, the Company acquired all the
     outstanding capital stock of Biomedical Sensors, Ltd. (BSL), an operating
     unit of Pfizer Inc., and certain assets from Howmedica, Inc., a wholly
     owned subsidiary of Pfizer Inc.  The combined operations of these former
     Pfizer entities are collectively referred to below as "Biomedical Sensors".
     Based in England, the new subsidiary, Diametrics Medical, Ltd. (DML),
     brings a product line which includes indwelling continuous blood monitoring
     systems utilizing a fiber optic technology platform.  Primary products
     include Paratrend 7, Paratrend 7+ and Neotrend, described above.  Each of
     these products consists of a monitoring system and intravascular disposable
     sensors.
<PAGE>

     RESULTS OF OPERATIONS

     SALES  Sales of the Company's products were $10,434,366 for 1997, compared
     to $3,796,816 for 1996 and $1,607,375 in 1995.  1997 revenues reflect the
     first full year of sales from the operations of the Company's subsidiary,
     DML. Compared to pro forma combined Diametrics' and Biomedical Sensors'
     sales for the year ended December 31, 1996, sales increased approximately
     50% in 1997.  The Company's revenues are affected principally by the number
     of instruments, both monitors and IRMA analyzers, placed with customers and
     the rate at which disposable sensors and cartridges are used in connection
     with these products. From inception through December 31, 1997, the Company
     has sold over 2,200 instruments. Compared to pro forma combined Diametrics'
     and Biomedical Sensors' unit sales for 1996, unit sales of instruments in
     1997 increased approximately 40%, while disposable sensor and cartridge
     unit sales increased approximately 80%.

     The Company has targeted 1998 revenue growth in excess of 50% relative to
     1997 as a result of further planned expansion of the blood and tissue
     analysis product lines and continued market penetration of existing
     products.

     COST OF SALES Cost of sales totaled $11,666,142 for 1997, compared to
     $9,860,259 for 1996 and $8,703,859 for 1995. Included in cost of sales for
     1995 was a charge of approximately $1.3 million associated with the write-
     down of inventory to the lower of cost or market as a result of product
     obsolescence and unfavorable manufacturing variances. Cost of sales as a
     percentage of revenue was 112% in 1997, 260% in 1996 and 460% in 1995
     (without the impact of the 1995 charge). On a pro forma combined basis of
     Diametrics' and Biomedical Sensors' operations for 1995 and 1996, cost of
     sales as a percentage of revenue was 281% and 208%, respectively. The
     significant year-to-year improvement in the Company's cost of sales as a
     percentage of revenue reflects increased sensor and cartridge volumes,
     improved manufacturing yields, increased shelf life of cartridges and the
     impact of cost controls and manufacturing process changes. These
     improvements resulted in the Company's first positive quarterly gross
     margin in the fourth quarter of 1997. The Company is targeting a positive
     gross margin for the full year in 1998, as a result of new product
     introductions and continued reductions in unit product costs, stemming from
     increased sales volumes and further expected improvements in manufacturing
     yields, processes and costs.

     OPERATING EXPENSES  Total operating expenses for 1997 increased $1.6
     million or 9% compared to 1996, as a result of the inclusion of a full year
     of expenses for the operations of the Company's subsidiary, DML. Compared
     to pro forma combined Diametrics' and Biomedical Sensors' operating
     expenses for 1996, pre-restructuring operating expenses decreased 18% in
     1997 as a result of work force reductions and cost and process improvements
     implemented during the year. Operating expenses increased by $1.4 million
     or 9% from 1995 to 1996, due primarily to restructuring and other charges
     incurred during 1996 and the inclusion of approximately one month of
     expenses for the operations of DML.

     Research and development expenses increased $872,000 or 14% from 1996 to
     1997, after an increase of $249,000 or 4% from 1995 to 1996.  The increase
     in expense in 1996 reflects the inclusion of one month of expenses for the
     operations of DML.  Compared to pro forma combined Diametrics' and
     Biomedical Sensors' research and development expenses for 1996, expenses
     decreased 22% in 1997 as a result of work force reductions,
<PAGE>

     primarily in the Company's U.S. operations, and cost and process
     improvements implemented during the year.

     Sales and marketing expenses totaled $7,893,284 in 1997, compared to
     $6,781,943 in 1996 and $5,801,363 in 1995. The 17% increase in expenses
     from 1995 to 1996 reflects costs to support the expansion of the Company's
     direct sales force in the U.S., higher commissions on increased sales and
     the inclusion of DML expenses from the date of acquisition. Compared to pro
     forma combined Diametrics' and Biomedical Sensors' sales and marketing
     expenses for 1996, expenses decreased 15% in 1997 due to organizational
     efficiencies and better deployment of resources.

     General and administrative expenses totaled $3,689,036 in 1997, compared to
     $3,242,320 in 1996 and $3,488,874 in 1995.  The 7% reduction in expenses
     from 1995 to 1996 primarily reflects the impact of work force reductions in
     the Company's U.S. operations in the last half of 1996, partially offset by
     the inclusion of DML expenses from the date of acquisition. Compared to pro
     forma combined Diametrics' and Biomedical Sensors' general and
     administrative expenses for 1996, expenses decreased 16% in 1997 as a
     result of additional work force reductions, primarily in the Company's U.S.
     operations,  and cost improvements implemented during the year.

     Restructuring and other charges totaled $463,816 in 1997, compared to
     $1,334,661 in 1996 and $391,834 in 1995. Charges in 1995 reflect severance
     costs associated with a management reorganization in late 1995. Charges in
     1996 consist of approximately $584,000 for severance costs related to
     continued restructuring of the management team in early 1996 and a work
     force reduction, $464,000 for the write-off of purchased in-process
     research and development created from the Biomedical Sensors acquisition,
     and $287,000 for the write-down of excess and obsolete equipment, resulting
     from the work force reductions and process changes. Charges in 1997 consist
     of severance costs associated with work force reductions, primarily in the
     Company's U.S. manufacturing, research and development and general and
     administrative areas, and $145,000 for the write-down of excess and
     obsolete equipment resulting from the work force reductions and further
     process changes.

     OTHER INCOME (EXPENSE)  Net other expense in 1997 was $526,962, compared to
     net other income of $207,117 in 1996 and $340,587 in 1995.  The Company
     realized interest income of $658,625 in 1997, compared to $929,603 in 1996
     and $1,148,352 in 1995.  The year-to-year decline reflects the impact of
     lower average cash balances in 1996 and 1997 as a result of the Company's
     higher level of financing activities during 1994 and 1995, and also due to
     a net use of cash in operations.

     Interest expense totaled $1,017,657 in 1997, compared to $607,342 in 1996
     and $550,607 in 1995.  The year-to-year increase primarily reflects
     interest accrued on a long-term note payable to Pfizer Inc. issued in
     connection with the Company's acquisition of Biomedical Sensors in November
     1996.


     NET LOSS  Net loss for the year ended December 31, 1997 was $21,036,543,
     compared to $23,575,094 in 1996 and $23,046,314 in 1995. Compared to pro
     forma combined Diametrics' and Biomedical Sensors' net loss for the year
     ended December 31, 1996, the net loss decreased 35% in 1997, before the
     impact of restructuring and other charges. The company is targeting
     continued improvement in the 1998 net loss relative to 1997.
<PAGE>

     LIQUIDITY AND CAPITAL RESOURCES

     At December 31, 1997, the Company had working capital of approximately
     $12.5 million, an increase of $5.9 million from the working capital of $6.6
     million reported at December 31, 1996.  The increase is primarily the
     result of the receipt of proceeds of approximately $26 million from the
     issuance of common stock from two private equity placements, warrant
     exercises and employee stock option and stock purchase plans, partially
     offset by capital purchases, debt payments and the net use of cash in
     operations during 1997. Through December 31, 1997, the Company raised
     approximately $114 million through the public and private sales of its
     equity securities and the issuance of convertible promissory notes, all of
     which have been repaid or converted into common stock.

     At December 31, 1997, the Company had property and equipment of
     $18,060,127, up from $16,295,952 at December 31, 1996, less accumulated
     depreciation of $10,674,155 and $8,008,200 at December 31, 1997 and 1996,
     respectively. The $1.8 million net increase in the cost of property and
     equipment is primarily the result of $3.0 million of capital additions,
     consisting primarily of investments in development and production
     equipment, and instruments for internal use in R&D and sales. Since its
     inception in 1990, the Company has financed approximately $5 million of
     capital additions through capital lease obligations. In 1998, the company
     expects capital expenditures and new lease commitments to approximate $2.4
     million, primarily reflecting investments to support new product
     development and production.

     In late 1996 and throughout 1997, the Company entered into long-term debt
     obligations of approximately $8.9 million.  The debt consists of a $7.3
     million senior secured fixed rate loan note issued to Pfizer in connection
     with the Company's acquisition of Biomedical Sensors and approximately
     $1,558,000 in notes payable for equipment financing.  The company's long-
     term debt and capital lease obligations require principal and interest
     repayments of approximately $1.9 million in 1998, $1.1 million in each of
     years 1999, 2000 and 2001, and $8.1 million in 2002.

     At December 31, 1997, the Company had U.S. net operating loss and research
     and development tax credit carryforwards for income tax purposes of
     approximately $91,000,000 and $900,000, respectively. Pursuant to the Tax
     Reform Act of 1986, use of the Company's net operating loss carryforwards
     are limited due to a "change in ownership." (See footnote 12 for further
     discussion and amount of limitation).

     The Company believes that currently available funds and cash generated from
     1998 revenues, supplemented by proceeds from employee stock plans, warrant
     exercises and asset based credit, will meet the Company's working capital
     needs through 1998. If results of operations or capital requirements vary
     materially from those currently planned, the company could require
     additional capital at an earlier time. As a result, the company has and
     will continue to evaluate raising additional capital through, but not
     limited to, alliances with strategic corporate partners and sales of equity
     or debt securities. While there can be no assurance that adequate funds
     will be available when needed or on acceptable terms, management believes
     that the company will be able to raise adequate funding as needed. the
     Company's long-term capital requirements will depend upon numerous factors,
     including the rate of market acceptance of the Company's products and the
     level of resources devoted to expanding the sales and marketing
     organization, manufacturing capabilities and research and development
     activities.
<PAGE>

     YEAR  2000 COMPLIANCE

     The financial impact to the Company of year 2000 compliance has not been
     and is not expected to be material to the Company's financial position or
     results of operations in any given year. The Company's existing information
     system, consisting of hardware and software supplied by third parties, is
     year 2000 compliant. However, because most computer systems are by their
     nature, interdependent, it is possible that non-compliant third party
     computers could "reinfect" the Company's computer systems. The Company
     could be adversely affected by the year 2000 problem if it or unrelated
     parties fail to successfully address this problem. The Company intends to
     develop a plan to communicate with the unrelated parties, including its
     regulatory consultants with whom it deals, to coordinate year 2000
     compliance. The costs incurred in addressing year 2000 compliance will be
     expensed as incurred, in compliance with GAAP.

     Statements regarding the Company's expectations about new and existing
     products, future financial performance and other forward looking statements
     are subject to various risks and uncertainties, including, without
     limitation, demand and acceptance of new and existing products,
     technological advances and product obsolescence, competitive factors and
     the availability of capital to finance growth.  These and other risks are
     discussed in greater detail as an exhibit in the Company's Form 10-k filing
     with the U.S. Securities and Exchange Commission.
<PAGE>

<TABLE>
<CAPTION>

CONSOLIDATED STATEMENTS OF OPERATIONS
                                                            Years ended December 31,
                                                -----------------------------------------------------
DIAMETRICS MEDICAL, INC. AND SUBSIDIARY              1997                 1996               1995
-----------------------------------------------------------------------------------------------------
<S>                                             <C>                  <C>                <C>
Net sales                                       $  10,434,366        $   3,796,816      $   1,607,375
Cost of sales                                      11,666,142            9,860,259          8,703,859
                                                ------------------------------------------------------

    Gross profit (loss)                            (1,231,776)          (6,063,443)        (7,096,484)

Operating expenses:
  Research and development                          7,231,669            6,359,844          6,608,346
  Sales and marketing                               7,893,284            6,781,943          5,801,363
  General and administrative                        3,689,036            3,242,320          3,488,874
  Restructuring and other charges                     463,816            1,334,661            391,834
                                                ------------------------------------------------------
                                                   19,277,805           17,718,768         16,290,417
                                                ------------------------------------------------------

    Operating loss                                (20,509,581)         (23,782,211)       (23,386,901)

Interest income                                       658,625              929,603          1,148,352
Interest expense                                   (1,017,657)            (607,342)          (550,607)
Other expense, net                                   (167,930)            (115,144)          (257,158)
                                                ------------------------------------------------------
    Net loss                                    $ (21,036,543)       $ (23,575,094)     $ (23,046,314)
                                                ------------------------------------------------------
Basic and diluted net loss per common share            ($1.13)              ($1.56)            ($1.82)
                                                ------------------------------------------------------
Weighted average common shares outstanding         18,665,837           15,088,493         12,640,212
                                                ------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

<PAGE>

<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
                                                                                        December 31,
                                                                            --------------------------------
DIAMETRICS MEDICAL, INC. AND SUBSIDIARY                                            1997              1996
------------------------------------------------------------------------------------------------------------
<S>                                                                         <C>                 <C>
ASSETS

CURRENT ASSETS:
  Cash and cash equivalents                                                 $    3,358,684      $  2,451,993
  Marketable securities                                                          8,401,642         3,402,598
  Accounts receivable:
   Trade, net of allowance for doubtful accounts of
    $188,599 in 1997 and $110,000 in 1996                                        3,653,196         2,033,496
   Nontrade                                                                        115,332           556,272
  Inventories                                                                    3,588,218         4,464,099
  Prepaid expenses and other current assets                                        311,173           543,755
                                                                            --------------------------------
    Total current assets                                                        19,428,245        13,452,213
                                                                            --------------------------------

PROPERTY AND EQUIPMENT                                                          18,060,127        16,295,952
  Less accumulated depreciation and amortization                               (10,674,155)       (8,008,200)
                                                                            --------------------------------
                                                                                 7,385,972         8,287,752
                                                                            --------------------------------

OTHER ASSETS                                                                     1,847,316         2,318,674
                                                                            --------------------------------
                                                                            $   28,661,533      $ 24,058,639
                                                                            ================================

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
  Accounts payable                                                          $    2,261,822      $  1,612,390
  Accrued expenses                                                               3,687,597         3,848,248
  Short-term note payable                                                                -            31,934
  Current portion of long-term liabilities                                         969,950         1,310,154
                                                                            --------------------------------
    Total current liabilities                                                    6,919,369         6,802,726
                                                                            --------------------------------
LONG-TERM LIABILITIES:
  Long-term obligations, excluding current portion                               8,477,821         7,795,851
  Capital lease obligations, excluding current portion                              59,921           666,668
  Other liabilities, excluding current portion                                      61,372           119,155
                                                                            --------------------------------
    Total liabilities                                                           15,518,483        15,384,400
                                                                            --------------------------------

SHAREHOLDERS' EQUITY:
  Preferred stock, $.01 par value: 5,000,000 shares
   authorized, none issued                                                               -                 -
  Common stock, $.01 par value: 35,000,000 shares authorized,
   20,889,945 and 15,209,481 shares issued and outstanding on December
   31, 1997 and 1996, respectively                                                 208,899           152,095
  Additional paid-in capital                                                   113,970,247        88,451,972
  Cumulative translation adjustment                                                 19,584            89,309
  Accumulated deficit                                                         (101,055,680)      (80,019,137)
                                                                            --------------------------------
    Total  shareholders' equity                                                 13,143,050         8,674,239
                                                                            --------------------------------
Commitments and contingencies (notes 7, 8, 16, and 17)
                                                                            $   28,661,533      $ 24,058,639
                                                                            ================================
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.



<PAGE>

Consolidated Statements of Shareholders' Equity

<TABLE>
<CAPTION>
                                                                            Additional                   Cumulative       Total
                                Preferred stock         Common Stock         paid-in       Accumulated   translation   shareholders'
                              -------------------------------------------
DIAMETRICS MEDICAL, INC.      Shares     Amount      Shares      Amount      capital        deficit      adjustment       equity
 AND SUBSIDIARY
------------------------------------------------------------------------------------------------------------------------------------
<S>                           <C>        <C>         <C>         <C>        <C>           <C>            <C>           <C>
BALANCE, DECEMBER 31, 1994            -  $     -     9,586,976   $ 95,870   $ 44,458,635  $ (33,397,729) $          -   $11,156,776

Issued common stock
 on February 3, 1995                  -        -     1,754,635     17,546      8,631,244              -             -     8,648,790

Issued common stock
 on August 3 and 10, 1995             -        -     3,450,000     34,500     33,746,032              -             -    33,780,532

Issued common stock under
 employee stock purchase plan         -        -        34,760        347        192,855              -             -       193,202

Issued common stock in lieu
 of salaries and wages                -        -        38,900        389        337,224              -             -       337,613

Exercise of options to
 common stock                         -        -        33,124        331        115,091              -             -       115,422

Exercise of warrants to
 common stock                         -        -         1,746         18          8,311              -             -         8,329

Net loss                              -        -             -          -              -    (23,046,314)            -   (23,046,314)
                              ------------------------------------------------------------------------------------------------------

BALANCE, DECEMBER 31, 1995            -        -    14,900,141    149,001     87,489,392    (56,444,043)            -    31,194,350

Issued common stock under
 employee stock purchase plan         -        -        74,096        741        300,140              -             -       300,881

Exercise of options to
 common stock                         -        -       235,244      2,353        662,440              -             -       664,793

Change in cumulative
 translation adjustment               -        -             -          -              -              -        89,309        89,309

Net loss                              -        -             -          -              -    (23,575,094)            -   (23,575,094)
                              ------------------------------------------------------------------------------------------------------

BALANCE, DECEMBER 31, 1996            -        -    15,209,481    152,095     88,451,972    (80,019,137)       89,309     8,674,239

Issued preferred stock
 on January 30, 1997            750,000    7,500             -          -     11,857,799              -             -    11,865,299

Conversion of preferred
 stock to common stock on
 April 10, 1997                (750,000)  (7,500)    3,000,000     30,000        (22,500)             -             -             -

Issued common stock
 on June 10, 1997                     -        -     1,493,332     14,933      7,840,236              -             -     7,855,169

Issued common stock under
 employee stock purchase plan         -        -        55,394        554        205,574              -             -       206,128

Exercise of options to
 common stock                         -        -       229,121      2,291      1,057,733              -             -     1,060,024

Exercise of warrants to
 common stock                         -        -       902,617      9,026      4,551,025              -             -     4,560,051

Issued stock options in
 lieu of cash compensation            -        -             -          -         28,408              -             -        28,408

Change in cumulative
 translation adjustment               -        -             -          -              -              -       (69,725)      (69,725)

Net loss                              -        -             -          -              -    (21,036,543)            -   (21,036,543)
                               =====================================================================================================

BALANCE, DECEMBER 31, 1997            -  $     -    20,889,945  $ 208,899   $113,970,247  $(101,055,680) $     19,584  $ 13,143,050
                               =====================================================================================================
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>

Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                                          Years ended December 31,
                                                                         -------------------------------------------------------
DIAMETRICS MEDICAL, INC. AND SUBSIDIARY                                         1997                 1996                1995
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                                      <C>                   <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss                                                              $(21,036,543)         $(23,575,094)       $(23,046,314)
   Adjustments to reconcile net loss to net cash
     used in operating activities:
       Depreciation and amortization                                        4,162,997             3,114,293           2,590,022
       Write-off of acquired in-process technology                                  -               464,460                   -
       Common stock and options issued in lieu of cash compensation            28,408                     -             337,613
       (Gain) loss on disposal of property and equipment                      (80,921)               (1,686)            144,192
       Changes in operating assets and liabilities
       (net of effects of acquisition in 1996):
         Receivables, net                                                  (1,178,760)             (580,891)           (665,221)
         Inventories                                                          875,881              (632,551)           (414,089)
         Prepaid expenses and other current assets                            232,582               523,050             135,143
         Accounts payable                                                     649,432               (97,319)            324,951
         Accrued expenses                                                    (231,365)              445,619            (475,130)
                                                                         -------------------------------------------------------
           Net cash used in operating activities                          (16,578,289)          (20,340,119)        (21,068,833)
                                                                         -------------------------------------------------------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchases of property and equipment                                     (2,957,958)           (1,597,218)         (2,715,937)
   Proceeds from sales of property and equipment                              236,577               102,586           1,405,565
   Purchases of marketable securities                                     (26,208,044)           (8,343,433)        (40,907,468)
   Proceeds from maturities of marketable securities                       21,209,000            30,730,100          23,705,369
   Acquisition of BSL, net of cash received                                         -            (1,067,848)                  -
   Other assets                                                               (36,623)              (36,892)            452,483
                                                                         -------------------------------------------------------
           Net cash provided by (used in) investing activities             (7,757,048)           19,787,295         (18,059,988)
                                                                         -------------------------------------------------------

 CASH FLOWS FROM FINANCING ACTIVITIES:
   Principal payments on borrowings                                          (129,714)             (108,477)           (100,502)
   Proceeds from long-term borrowings                                       1,058,626               500,000                   -
   Net proceeds from issuance of preferred stock                           11,865,299                     -                   -
   Net proceeds from issuance of common stock                              13,681,372               965,674          42,746,275
   Payments for redeemable common stock                                             -                     -          (1,000,000)
   Principal payments on capital lease obligations                         (1,165,522)           (1,078,802)           (964,031)
                                                                         -------------------------------------------------------
           Net cash provided by financing activities                       25,310,061               278,395          40,681,742
                                                                         -------------------------------------------------------

CUMULATIVE TRANSLATION ADJUSTMENT                                             (68,033)               24,190                   -

           Net increase (decrease) in cash and cash equivalents               906,691              (250,239)          1,552,921

Cash and cash equivalents at beginning of year                              2,451,993             2,702,232           1,149,311
                                                                         -------------------------------------------------------
Cash and cash equivalents at end of year                                 $  3,358,684          $  2,451,993        $  2,702,232
                                                                         =======================================================

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
   Cash paid during the year for interest                                $    377,849          $    510,399        $    550,607
                                                                         =======================================================
</TABLE>

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
The Company entered into capital lease obligations for equipment of $0, $131,058
 and $1,367,073, during the years ended December 31, 1997, 1996, and 1995,
 respectively.

On November 6, 1996, the Company entered into a senior secured fixed rate loan
 note of $7,300,000 in connection with the acquisition of Biomedical Sensors.


The accompanying notes are an integral part of these consolidated financial
statements.

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1)  DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     DESCRIPTION OF THE BUSINESS  Diametrics Medical, Inc. along with its
     subsidiary (the Company), is a medical device company engaged in the
     development, manufacture and commercialization of critical care blood and
     tissue analysis systems which provide immediate or continuous diagnostic
     results at the point of patient care.

     The Company markets its products primarily to health care organizations
     through a direct sales force in the United States, the United Kingdom and
     Germany and various distributors outside of these countries.

     PRINCIPLES OF CONSOLIDATION  The accompanying consolidated financial
     statements include the accounts of Diametrics Medical, Inc. and Diametrics
     Medical, Ltd., its wholly-owned subsidiary (the Company).  All material
     intercompany accounts and transactions have been eliminated.  The accounts
     of the foreign subsidiary have been consolidated since the date of
     acquisition.  The Company did not have any subsidiaries prior to 1996.

     TRANSLATION OF FOREIGN CURRENCIES  The financial statements of the
     Company's foreign subsidiary were translated in accordance with the
     provisions of Statement of Financial Accounting Standards (SFAS) No. 52.
     Under this Statement, all assets and liabilities are translated using
     period-end exchange rates and statements of operations items are translated
     using average exchange rates for the period.  The resulting translation
     adjustments are recorded as a separate component of shareholders' equity.
     Foreign currency transaction gains and losses are included in determining
     net income, but have not been material in any of the years presented.

     CASH AND CASH EQUIVALENTS  The Company considers highly liquid debt
     instruments purchased with an original maturity of three months or less to
     be cash equivalents.  At December 31, 1997, cash and cash equivalents
     consisted mainly of U.S. government money market funds and investment grade
     commercial paper.

     MARKETABLE SECURITIES  In accordance with the provisions of SFAS No. 115,
     Investment in Certain Instruments in Debt and Equity Securities,
     investments in marketable debt securities have been classified as held to
     maturity and are stated at amortized cost, which approximates estimated
     fair value.  At December 31, 1997, marketable securities consisted mainly
     of investment grade commercial paper, with original maturities ranging from
     three to five months.  These securities are classified as held-to-maturity
     because of the Company's intent and ability to hold its investments to
     maturity.

     INVENTORIES  Inventories are stated at the lower of cost or market using
     the first in, first out method.

     PROPERTY AND EQUIPMENT  Leasehold improvements are recorded at cost and
     amortized over the term of the underlying lease. Furniture and equipment
     are recorded at cost and depreciated on a straight-line basis over their
     estimated useful lives of 2 to 7 years. Maintenance and repairs are
     expensed as incurred.

     OTHER ASSETS  Other assets consist principally of goodwill representing
     purchased completed technology and other intangible assets resulting from
     the excess of the cost of
<PAGE>

     a purchased business over the fair value of the net assets acquired.
     Goodwill is amortized using the straight-line method over five years. The
     recoverability of goodwill is assessed quarterly based upon an analysis of
     undiscounted cash flows projected to be generated by the acquired business.

     REVENUE RECOGNITION  The Company recognizes revenue upon shipment of
     product to customers or, in the case of trial instruments and monitors,
     upon the customer's acceptance of the product.

     NET LOSS PER COMMON SHARE  Effective December 31, 1997, the Company adopted
     SFAS No. 128, Earnings per Share.  SFAS 128 simplifies the computation of
     earnings per share ("EPS") previously required by replacing primary and
     fully diluted EPS with basic and diluted EPS.  Under SFAS 128, basic EPS is
     calculated by dividing net earnings (loss) by the weighted average common
     shares outstanding during the period.  Diluted EPS reflects the potential
     dilution to basic EPS that could occur upon conversion or exercise of
     securities, options, or other such items, to common shares using the
     treasury stock method based upon the weighted average fair value of the
     Company's common shares during the period.  For each period presented,
     basic and diluted loss per share amounts are identical, as the effect of
     potential common shares is antidilutive.

     PRODUCT WARRANTY  The Company, in general, warrants its new hardware and
     software products to the original purchaser to be free from defects in
     material and workmanship under normal use and service for a period of one
     year after date of shipment, and warrants its disposable products to be
     free from defect in material and workmanship under normal use until its
     stated expiration date.  Provisions are made for the estimated cost of
     maintaining product warranties for the hardware, software and disposable
     products at the time the products are sold.

     INCOME TAXES  Deferred tax assets and liabilities are recognized for the
     future tax consequences attributable to differences between the financial
     statement carrying amounts of existing assets and liabilities and their
     respective tax bases.  Deferred tax assets and liabilities are measured
     using enacted tax rates expected to apply to taxable income in the years in
     which those temporary differences are expected to be recovered or settled.
     The effect on deferred tax assets and liabilities of a change in tax rates
     is recognized in income in the period that includes the enactment date.
     Due to historical net losses of the Company, a valuation allowance is
     established to offset the net deferred tax asset.

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

     STOCK BASED COMPENSATION  The Company applies the intrinsic value method
     prescribed in APB Opinion No. 25 to account for the issuance of stock
     incentives to employees and directors and, accordingly, no compensation
     expense related to employees' and directors' stock incentives has been
     recognized in the financial statements.  Effective January 1, 1996, in
     accordance with SFAS No. 123, Accounting for Stock Based Compensation, pro
     forma information reflecting compensation cost for such issuances is
     presented in footnote 9.
<PAGE>

     RECLASSIFICATIONS  Certain 1996 and 1995 amounts in the Consolidated
     Statements of Operations have been reclassified from prior reported
     balances to conform to the 1997 presentation.

(2)  LIQUIDITY

     As reflected in the accompanying consolidated financial statements, the
     Company incurred a net loss of $21,036,543 for the year ended December
     31, 1997.  In addition, the Company has incurred net losses and has had
     negative cash flows from operating activities since inception. Management
     believes current working capital and projected operating revenues,
     supplemented by proceeds from employee stock plans, warrant exercises and
     asset based credit, will provide the Company with sufficient liquidity
     through 1998.  It is probable the Company will be required to raise
     additional capital by early 1999.  Management's intentions are to raise
     this additional capital through alliances with strategic corporate
     partners, issuance of debt, or an equity offering.  If capital requirements
     vary materially from those currently planned, the Company could require
     additional capital at an earlier time.  There can be no assurance that
     adequate funds will be available when needed or on acceptable terms.

(3)  INVENTORIES

     Inventories are summarized as follows:

<TABLE>
<CAPTION>
                                 1997           1996
                             -----------------------------
<S>                          <C>               <C>
Raw materials                   $  957,049     $1,623,243
Work-in-process                    442,527        569,505
Finished goods                   2,188,642      2,271,351
                             =============================
                                $3,588,218     $4,464,099
                             =============================
</TABLE>

(4)  PROPERTY AND EQUIPMENT

     Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                              1997             1996
                                        ---------------------------------
<S>                                     <C>                  <C>
Manufacturing equipment                    $  4,649,831      $ 3,988,933
Laboratory fixtures and equipment             1,956,841        2,024,811
Office furniture and equipment                3,409,351        3,868,944
Leasehold improvements                        3,359,680        3,350,731
Tooling                                       1,870,755        1,333,097
Demonstration instruments                     1,864,042        1,317,378
Capital-in-progress                             949,627          412,058
                                        ---------------------------------
                                             18,060,127       16,295,952

Less accumulated depreciation &
 amortization                               (10,674,155)      (8,008,200)
                                        =================================

                                           $  7,385,972      $ 8,287,752
                                        =================================
</TABLE>
<PAGE>

(5)  OTHER ASSETS

     Other assets consist of the following:

<TABLE>
<CAPTION>
                                   1997           1996
                             ------------------------------
     <S>                     <C>               <C>
     Goodwill                   $1,819,956     $2,259,974
     Other                          27,360         58,700
                             ------------------------------
                                $1,847,316     $2,318,674
                             ==============================
</TABLE>

     Amortization charged to expense for goodwill was $507,981, $45,925 and $0
     in 1997, 1996 and 1995, respectively.

(6)  ACCRUED EXPENSES

     Accrued expenses are summarized as follows:

<TABLE>
<CAPTION>
                                        1997           1996
                                  ------------------------------
     <S>                          <C>               <C>
     Employee compensation           $1,171,572     $1,129,241
     Product upgrades                   711,168      1,138,420
     Acquisition expenses                     -        295,207
     Interest payable                   736,750         96,943
     Other                            1,068,107      1,188,437
                                  ------------------------------
                                     $3,687,597     $3,848,248
                                  ==============================
</TABLE>

(7)  LONG-TERM DEBT

     Long-term debt consists of the following:

<TABLE>
<CAPTION>
                                                     1997            1996
                                             ---------------------------------
     <S>                                     <C>                  <C>
     Senior secured fixed rate loan note          $7,300,000      $7,300,000

     Notes payable                                 1,460,846         500,000
                                             ---------------------------------
                                                   8,760,846       7,800,000
     Less current portion                           (283,025)         (4,149)
                                             ---------------------------------

                                                  $8,477,821      $7,795,851
                                             =================================
</TABLE>

     The aggregate maturities of outstanding long-term debt are:

<TABLE>
     <S>                                              <C>
     Year ending December 31:
     1998                                              $  283,025
     1999                                                 314,514
     2000                                                 349,511
     2001                                                 388,400
     Thereafter                                         7,425,396
                                                      ------------
                                                       $8,760,846
                                                      ============
</TABLE>

<PAGE>

     The senior secured fixed rate loan note of $7,300,000 is payable to Pfizer
     Inc., issued in connection with the Company's acquisition of Biomedical
     Sensors, Ltd. (BSL), an operating unit of Pfizer Inc., on November 6, 1996.
     Interest is payable on December 31, 1997 and quarterly in arrears
     thereafter, at 8.75% per annum. The full principal balance is due November
     4, 2002. The Pfizer note is secured by the issued shares of Diametrics
     Medical, Ltd., 100% of which were purchased by the Company.

     The note agreement with Pfizer Inc. contains provisions which will require
     acceleration of payment of principal in full in the event that prior to
     November 6, 1998, the Company issues securities listed or traded on any
     securities exchange, with aggregate net proceeds to the Company exceeding
     $40 million. If this doesn't occur, then, in the event the Company issues
     securities from November 6, 1998 to November 4, 2002 resulting in
     cumulative net proceeds of more than $5 million, a proportion of the
     outstanding principal balance shall become immediately payable. During this
     period, cumulative net proceeds from a securities issuance of more than $5
     million but less than $10 million would require a $1 million payment of
     principal, while cumulative net proceeds between $10 million and less than
     $20 million and between $20 million and less than $40 million would require
     principal payments of $2.5 million and $4.5 million, respectively.
     Cumulative net proceeds of $40 million or greater would require full
     payment of the note's principal.

     The notes payable balance requires principal and interest payments in
     monthly installments at varying amounts through September 2002, at annual
     interest rates ranging from 10.1% to 10.95%. Maturity dates of the notes
     range from December 1, 2001 to September 25, 2002, and all notes are
     secured by equipment.

(8)  LEASES

     The Company is obligated under various capital leases for furniture and
     equipment that expire at various dates during the next two years. The gross
     amount included in property and equipment and related accumulated
     amortization relating to capital leases is as follows:

<TABLE>
<CAPTION>
                                                  1997            1996
                                             -----------------------------
     <S>                                     <C>               <C>

     Manufacturing equipment                  $ 1,415,465      $ 2,124,241
     Laboratory fixtures and equipment            377,019          599,940
     Office furniture and equipment             1,180,893        1,358,874
     Leasehold improvements                        16,668           16,668
     Tooling                                        7,030            7,030
                                             -----------------------------
                                                2,997,075        4,106,753
     Less accumulated amortization             (2,733,165)      (2,893,465)
                                             -----------------------------
                                              $   263,910      $ 1,213,288
                                             =============================
</TABLE>

<PAGE>

     The present value of future minimum capital lease payments is as follows:

<TABLE>
<CAPTION>
     Year ending December 31:
     <S>                                                               <C>
        1998                                                           $ 747,432
        1999                                                              61,144
                                                                       -----------
        Total minimum lease payments                                     808,576
     Less amount representing interest                                   (61,730)
                                                                       -----------
        Present value of minimum capital lease payments                  746,846
     Less current portion of capital lease obligations                  (686,925)
                                                                       -----------
        Capital lease obligations, excluding current portion           $  59,921
                                                                       ===========
</TABLE>
<PAGE>

(9)  STOCK OPTIONS AND WARRANTS

     Under the terms of the 1990 Stock Option Plan, incentive stock options and
     non-qualified stock options to purchase up to 3,000,000 shares of common
     stock may be granted to Company employees and consultants.

     Additionally, the Directors' Plan provides grants to non-employee directors
     of the Company of non-qualified stock options to purchase up to an
     aggregate of 217,500 shares of common stock.

     Under the plans, the option price is equal to the fair value on the date of
     grant. Under the 1990 Stock Option Plan, options become exercisable over
     varying periods and terminate up to ten years from the date of grant. Under
     the Directors' Plan, options become exercisable over a three year period
     and terminate ten years from the date of grant. At December 31, 1997,
     136,478 and 69,750 additional shares were available for grant under the
     1990 Stock Option Plan and Directors' Plan, respectively.

     The following tables reflect the per share weighted-average fair value of
     stock options granted during 1997, 1996 and 1995 under each of the plans on
     the date of grant using the Black Scholes option-pricing model with the
     following assumptions: annualized volatility of 74.15%, 70.81% and 80.04%
     for 1997, 1996 and 1995, respectively; risk-free interest rate of 5.7% in
     1997 and 5.5% in 1996 and 1995, respectively; and for each year, an
     expected life of five and three years for the 1990 Stock Option Plan and
     Directors' Plan, respectively.

     The status of the Company's stock option plans as of December 31, 1997,
     1996 and 1995 and changes during those years, is summarized as follows:

<TABLE>
<CAPTION>
                                                        1997                         1996                         1995
                                           ----------------------------- ----------------------------- ----------------------------
                                                            WEIGHTED                      WEIGHTED                     WEIGHTED
                                                             AVERAGE                       AVERAGE                      AVERAGE
     1990 STOCK OPTION PLAN                   SHARES      EXERCISE PRICE    SHARES      EXERCISE PRICE    SHARES     EXERCISE PRICE
                                           ------------   -------------- ------------   -------------- ------------  --------------
     <S>                                   <C>            <C>            <C>            <C>            <C>           <C>
     Outstanding at beginning of year         2,290,395   $    5.15         1,450,188   $      4.66       1,175,494  $     4.01
     Granted                                    452,415        5.94         1,322,400          5.47         310,375        7.04
     Exercised                                 (210,621)       4.63          (235,244)         2.83         (25,874)       3.18
     Expired                                   (144,392)       6.57          (246,949)         6.25          (9,807)       5.83
                                           ------------                  ------------                  ------------
     Outstanding at end of year               2,387,797        5.26         2,290,395          5.15       1,450,188        4.66
                                           ============                  ============                  ============

     Options exercisable at year-end          1,258,262        4.85         1,172,405          4.70         941,286        3.78

     Weighted-average fair value of
      options granted during the year      $       3.84                  $       3.44                  $       4.52

     1993 DIRECTORS' STOCK OPTION PLAN

     Outstanding at beginning of year           170,000   $    6.16           126,500   $      6.89          82,500  $     4.82
     Granted                                     40,000        6.00            55,500          4.95          58,500        9.24
     Exercised                                  (18,500)       4.63                 -             -          (7,250)       4.60
     Expired                                    (69,500)       6.53           (12,000)         8.27          (7,250)       4.60
                                           ------------                  ------------                  ------------
     Outstanding at end of year                 122,000        6.13           170,000          6.16         126,500        6.89
                                           ============                  ============                  ============

     Options exercisable at year-end             76,625        5.81           112,000          6.08          59,000        5.25

     Weighted-average fair value of
      options granted during the year      $       3.13                  $       2.50                  $       5.10
</TABLE>
<PAGE>

     The following table summarizes information concerning stock options
     outstanding and exercisable options at December 31, 1997 for the above
     plans:

<TABLE>
<CAPTION>
                               OPTIONS OUTSTANDING                                 OPTIONS EXERCISABLE
      -------------------------------------------------------------------      ---------------------------
                                                   WEIGHTED    WEIGHTED                          WEIGHTED
                                                    AVERAGE    AVERAGE                           AVERAGE
              RANGE OF                 NUMBER      REMAINING   EXERCISE            NUMBER        EXERCISE
           EXERCISE PRICES           OUTSTANDING      LIFE      PRICE            EXERCISABLE      PRICE
      -------------------------------------------------------------------      ---------------------------
      <S>             <C>           <C>            <C>         <C>             <C>               <C>
      $   1.72   -    $  1.72          165,160         3.2     $   1.72              165,160     $   1.72
          3.25   -       3.88          162,050         5.2         3.52              148,050         3.49
          4.19   -       4.88          773,387         7.7         4.64              394,887         4.64
          5.00   -       5.94          419,400         8.5         5.29              194,265         5.34
          6.00   -       6.88          737,350         7.8         6.15              351,875         6.16
          7.00   -       7.95           76,500         8.7         7.34               41,200         7.28
          8.00   -      12.00          175,950         9.0         8.77               39,450        10.27
                                    ----------     ---------   ----------         ----------     --------
                                     2,509,797         7.5         5.30            1,334,887         4.90
                                    ==========                                    ==========
</TABLE>

     The Company applies APB Opinion No. 25, Accounting for Stock Issued to
     Employees, and related interpretations in accounting for its plans.
     Accordingly, no compensation expense has been recognized for its stock-
     based compensation plans as they relate to employees and directors. Had the
     Company determined compensation cost based upon the fair value at the grant
     date for its stock options under SFAS No. 123, the Company's net loss and
     net loss per share would have increased to the pro forma amounts indicated
     below:

<TABLE>
<CAPTION>
                                            1997             1996          1995
                                       ---------------------------------------------
      <S>                              <C>             <C>             <C>
      Net loss as reported             $ (21,036,543)  $ (23,575,094)  $ (23,046,314)
      Net loss pro forma               $ (23,365,049)  $ (26,017,576)  $ (23,738,550)

      Net loss per share as reported   $       (1.13)  $       (1.56)  $       (1.82)
      Net loss per share pro forma     $       (1.25)  $       (1.72)  $       (1.88)
</TABLE>

     Pro forma net loss reflects only options granted in 1997, 1996 and 1995.
     Therefore, the full impact of calculating compensation cost for stock
     options under SFAS No. 123 is not reflected in the pro forma net loss
     amounts presented, because compensation cost is reflected over the options'
     vesting period and compensation cost for options granted prior to January
     1, 1995 is not considered.

     In connection with certain financing and marketing arrangements, the
     Company has granted stock purchase warrants for the purchase of 2,305,394
     shares of common stock. The stock purchase warrants become exercisable over
     varying periods and expire up to 10 years from the date of grant. At
     December 31, 1997, stock purchase warrants representing 961,827 shares were
     exercisable with an additional 66,333 shares becoming exercisable on a
     monthly basis over 28 months (58,333 shares), or upon achieving certain
     purchasing levels of the Company's products (8,000 shares). Stock warrant
     transactions under these arrangements are summarized as follows:
<PAGE>

<TABLE>
<CAPTION>
                                                    1997                         1996                            1995

                                        ---------------------------   --------------------------    -------------------------------
                                                         EXERCISE                    EXERCISE                        EXERCISE
                                                           PRICE                       PRICE                           PRICE
                                           SHARES        PER SHARE      SHARES       PER SHARE        SHARES         PER SHARE
                                        -----------   -------------   ---------    -------------    ----------     ----------------
     <S>                                <C>           <C>             <C>         <C>               <C>            <C>
     Outstanding at beginning of year       786,814   $  1.72 - 6.13   843,314    $  1.72 - 6.13      861,310      $  1.72 - 6.13
     Granted                              1,328,334      4.53 - 6.75    16,000           5.00          20,000             5.25
     Exercised                             (902,617)     4.77 - 6.75       -              -            (1,746)        5.25 - 6.00
     Expired                               (184,371)     4.77 - 5.06   (72,500)           -           (36,250)        5.25 - 6.00
                                          ---------                   --------                       --------
     Outstanding at end of year           1,028,160      1.72 - 6.75   786,814       1.72 - 6.13      843,314         1.72 - 6.13
                                          =========                   ========                       ========

     Warrants exercisable at year-end       961,827      1.72 - 6.75   706,314       1.72 - 6.13      698,314         1.72 - 6.13

</TABLE>

(10) EMPLOYEE STOCK PURCHASE PLAN

     The Company adopted an employee stock purchase plan (the "Plan") effective
     July 3, 1995, under which 300,000 shares of common stock are available for
     sale to employees. The Plan enables all employees, after a 90-day waiting
     period, to contribute up to 10 percent of their wages toward the purchase
     of the Company's common stock at 85 percent of the lower of fair market
     value for such shares on the first business day of each quarter or the last
     business day of each quarter.

     Participant elections resulted in the issuance of 55,394 shares at an
     average price per share of $3.72 in 1997 and 74,096 shares at an average
     price per share of $4.06 in 1996.

(11) EMPLOYEE BENEFIT PLANS

     The Company has a 401(k) savings plan for its U.S. employees. U.S.
     employees of the Company who meet certain age and service requirements may
     contribute up to 20 percent of their salaries to the plan on a pre-tax
     basis. The Company has the discretion to match employee contributions up to
     6 percent of compensation. The Company has not made any contributions to
     the plan.

     As part of its acquisition of the England-based Biomedical Sensors, Ltd.
     (BSL) in November 1996, the Company assumed sponsorship of the subsidiary's
     contributory defined benefit retirement plan, covering the majority of the
     subsidiary's employees. The Plan provides benefits based upon final
     pensionable salary and years of credited service. The Company's funding
     policy for the Plan is to contribute into a trust fund at a rate that is
     intended to remain at a level percentage of total pensionable payroll. The
     assets of the Plan are held separately from those of the Company and
     invested in the London and Manchester Secure Growth Fund, Balanced Fund and
     a small holding in the Performance Fund. A portion of plan assets are also
     invested in the Scottish Equitable Funds.

     Contributions to the Plan are charged to expense so as to spread the cost
     of the pensions over the employees' working lives with the Company. The
     contributions are determined by a qualified actuary on the basis of a
     valuation using the "attained age" valuation method.

     The Company's Statement of Operations for the year ended December 31, 1996
     includes approximately one month of activity for DML, and pension expense
     charged to operations during that period was minimal. Following is the
     net periodic pension cost charged to operations in 1997, along with a
     description of the funded status of the Plan
<PAGE>

     at December 31, and assumptions used in developing the projected benefit
     obligation as of December 31.

     NET PERIODIC PENSION COST

<TABLE>
<CAPTION>
                                                                       Year ended
                                                                   December 31, 1997
                                                                   ----------------
         <S>                                                       <C>
         Service cost                                              $       296,062
         Interest cost                                                     216,988
         Actual return on plan assets                                     (263,016)
         Deferred asset gain                                                16,860
                                                                   ----------------
                                                                   $       266,894
                                                                   ================
</TABLE>

     FUNDED STATUS OF DEFINED BENEFIT RETIREMENT PLAN AT DECEMBER 31, 1997 AND
      1996

<TABLE>
<CAPTION>
                                                                              1997                 1996
                                                                         ------------------------------------
        <S>                                                              <C>                    <C>
        Actuarial present value of obligation:

        Vested benefit obligation                                        $  3,632,740           $  2,585,814
                                                                         -----------------------------------
        Accumulated benefit obligation                                   $  3,665,570           $  2,616,059
                                                                         -----------------------------------
        Projected benefit obligation                                     $  3,954,675           $  2,762,245
                                                                         -----------------------------------

        Plan assets at fair value                                        $  3,234,425           $  2,660,923
                                                                         -----------------------------------
        Excess of projected benefit obligation over plan assets              (720,250)              (101,322)

        Unrecognized loss                                                     658,878                   -
                                                                         -----------------------------------
        Net pension liability recognized in balance sheet                $    (61,372)          $   (101,322)
                                                                         ===================================

        RATE ASSUMPTIONS:
        Discount rate                                                            7.00%                  8.00%
        Rate of salary progression                                               5.00%                  5.75%
        Long-term rate of return on assets                                       7.50%                  9.25%
</TABLE>

     The net pension liability recognized as of December 31, 1996 was part of a
     required purchase accounting fair value adjustment recorded upon the
     acquisition of BSL to reflect the U.K. to U.S. GAAP adjustment relating to
     the accounting for pension costs under the provisions of SFAS No. 87.

(12) INCOME TAXES

     The Company has incurred net operating losses since inception. The Company
     has not reflected any benefit of such net operating loss carryforwards in
     the accompanying financial statements in accordance with Statement of
     Financial Accounting Standards No. 109.

     As of December 31, 1997 the Company has U.S. tax net operating loss and
     research and development tax credit carryforwards of approximately
     $91,000,000 and $900,000, respectively. Pursuant to the Tax Reform Act of
     1986, use of the Company's net operating loss carryforwards may be limited
     if a cumulative "change in ownership" of
<PAGE>

     more than 50 percent occurs within a three-year period. In connection with
     prior sales by the Company of its securities in private and public
     offerings, the Company has experienced a "change in ownership". As a
     result, the utilization of the Company's net operating loss and certain
     credit carryforwards incurred prior to these changes are subject to annual
     limitations.

     The Company estimates that the use of the U.S. net operating losses
     incurred from January 26, 1990 (inception) through February 11, 1991 is
     limited to approximately $418,000 per year; the use of net operating losses
     incurred from February 12, 1991 through December 7, 1992 is limited to
     approximately $1.9 million per year. If not used, these net operating loss
     carryforwards begin to expire in 2005.

     The Company's foreign subsidiary also has a net operating loss carryforward
     of approximately $40,700,000 which can be carried forward indefinitely.

     The tax effects of temporary differences that give rise to significant
     portions of the deferred tax assets and deferred tax liabilities at
     December 31, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
                                                          1997              1996
                                                  -----------------------------------
      <S>                                           <C>               <C>
      Tax credits                                      $    903,000      $    844,000
      Federal net operating loss carryforward            33,643,000        27,787,000
      Foreign net operating loss carryforward            13,428,000        11,828,000
      Fixed asset depreciation                              910,000           587,000
      Amortization of goodwill                              137,000             8,000
      Vacation accrual                                      125,000           117,000
      Inventory reserve                                      34,000            96,000
      Product upgrade accrual                               153,000           286,000
      Other differences                                     114,000           161,000
      Valuation allowance                               (49,447,000)      (41,714,000)
                                                  -----------------------------------
      Net deferred tax asset                           $          -      $          -
                                                  ===================================
</TABLE>

     The provision for income taxes differs from the expected tax expense,
     computed by applying the federal corporate rate of 34% to earnings before
     income taxes as follows:

<TABLE>
<CAPTION>
                                                                             1997             1996
                                                                      --------------------------------
      <S>                                                             <C>                 <C>
      Expected federal benefit                                          $(7,152,000)      $(8,016,000)
      State tax, net of federal benefit                                    (493,000)         (699,000)
      Other                                                                 (88,000)          (42,000)
      Increase in valuation allowance                                     7,733,000        20,585,000
      Decrease in valuation allowance of acquired foreign subsidiary              -       (11,828,000)
                                                                      --------------------------------

                                                                        $        -        $          -
                                                                      ================================
</TABLE>

(13) RESTRUCTURING AND OTHER CHARGES

     In late 1995 and throughout 1996 and 1997, the Company made operational
     changes intended to better align its resources with its evolving strategy,
     improve its efficiency, and achieve a more competitive cost structure.
     Restructuring and other charges totaled $463,816 in 1997, $1,334,661 in
     1996 and $391,834 in 1995. Charges in 1995 reflect
<PAGE>

     severance costs associated with a management reorganization in late 1995.
     Charges in 1996 consist of approximately $584,000 for severance costs
     related to continued restructuring of the management team in early 1996 and
     a work force reduction in November, $464,000 for the write-off of purchased
     in-process research and development created from the BSL acquisition, and
     $287,000 for the write-down of excess and obsolete equipment, resulting
     from the work force reductions and process changes. Charges in 1997 consist
     of severance costs of approximately $319,000, associated with work force
     reductions primarily in the Company's U.S. manufacturing, research and
     development and general and administrative areas, and $145,000 for the
     write-down of excess and obsolete equipment resulting from the work force
     reductions and further process changes. These restructuring activities were
     completed before or shortly after the end of the quarter of the years in
     which charges were incurred, and the Company does not have any material
     future cash obligations relative to the described restructuring activities.
     The impact of work force reductions on future operating results and cash
     flows is not expected to be material in the long term, as savings achieved
     in these areas have been and will continue to be reinvested in other areas
     of the Company, including the Company's international operations.

(14) RELATED PARTY TRANSACTIONS

     Certain equipment used by the Company was leased from late 1990 through mid
     1997 under a sublease arrangement with FIM, an entity that is related to
     the Company through stockholders. FIM leased the equipment from an
     unrelated entity. The Company paid FIM an amount equal to FIM's lease
     payments. The leases were accounted for as capital leases. As of December
     31, 1997, the debt related to the sublease with FIM was fully paid.

     Payments on leases of equipment, under the arrangement with FIM discussed
     above, were guaranteed up to a principal amount of approximately $1,300,000
     by Medical Innovation Fund, a holder of approximately 8% of the Company's
     common stock as of December 31, 1996.

(15) MAJOR CUSTOMERS, EXPORT SALES AND DOMESTIC AND FOREIGN OPERATIONS

     Sales to major customers that exceeded 10% of total net sales for the years
     ended December 31 were as follows:

<TABLE>
<CAPTION>
                            1997       1996        1995
                         ---------------------------------
     <S>                 <C>           <C>         <C>
     Customer A               -           -         14%
     Customer B              22%          -          -
     Customer C               -           -          -
</TABLE>

     The customers from which the above sales were generated are distributors of
     the Company operating in the medical diagnostic device industry.

     The Company's export sales (i.e. sales to unaffiliated customers outside of
     the U.S.) were $6,487,079, $1,248,915 and $318,219 for the years ended
     December 31, 1997, 1996 and 1995, respectively. These sales were primarily
     in Europe and Japan.
<PAGE>

     Information regarding the Company's operations in different geographies for
     the years ended December 31, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
                                                             United                       Adjustments
                                                             States          Europe     and eliminations   Consolidated
                                                        -----------------------------------------------------------------
     <S>                                               <C>              <C>             <C>               <C>
        1997
     Sales to unaffiliated customers                   $    7,102,314   $   3,332,052   $             -   $    10,434,366
     Sales/transfers between geographic areas                  60,232         733,580          (793,812)                -
                                                        -------------    ------------    --------------    --------------
        Total sales                                    $    7,162,546   $   4,065,632   $      (793,812)  $    10,434,366
                                                        -------------    ------------    --------------    --------------
     Operating loss                                    $  (16,033,452)  $  (4,627,653)  $       151,524   $   (20,509,581)
                                                        -------------    ------------    --------------    --------------

     Identifiable assets                               $   21,345,236   $   8,021,957   $      (705,660)  $    28,661,533
                                                        =============    ============    ==============    ==============

        1996
     Sales to unaffiliated customers                   $    3,566,952   $     229,864   $             -   $     3,796,816
     Sales/transfers between geographic areas                       -          48,879           (48,879)                -
                                                        -------------    ------------      ------------    --------------
        Total sales                                    $    3,566,952   $     278,743     $     (48,879)  $     3,796,816
                                                        -------------    ------------      ------------    --------------
     Operating loss                                    $  (23,531,879)  $    (257,952)    $       7,620   $   (23,782,211)
                                                        -------------    ------------      ------------    --------------

     Identifiable assets                               $   17,359,439   $   8,172,640     $  (1,473,440)  $    24,058,639
                                                        =============    ============      ============    ==============
</TABLE>

     The Company did not have operations outside of the United States prior to
     1996.  The Company's European operations are primarily in the United
     Kingdom.  Sales and transfers between geographic areas primarily represent
     intercompany sales and are accounted for based upon established transfer
     prices between the related entities.  Identifiable assets of geographic
     areas are those assets related to the Company's operations in each area.
     United States assets include all of the Company's marketable securities.

(16) COMMITMENTS

     The Company leases its facilities and some of its equipment under non-
     cancelable operating lease arrangements.  The rental payments under these
     leases are charged to expense as incurred.  Rent expense included in the
     accompanying consolidated statements of operations was $829,106, $412,295
     and $376,558 for the years ended December 31, 1997, 1996 and 1995,
     respectively.

     The following is a schedule of future minimum rental payments, excluding
     property taxes and other operating expenses, required under all non-
     cancelable operating leases as of December 31, 1997:

<TABLE>
     Year ending December 31:
     <S>                                                   <C>
        1998                                               $   552,326
        1999                                                   462,136
        2000                                                   298,927
        2001                                                   203,962
        2002 and thereafter                                      4,636
                                                           -----------
        Total minimum lease payments                       $ 1,521,987
                                                           ===========
</TABLE>

<PAGE>

(17) LEGAL PROCEEDINGS

     There are no legal proceedings pending against or involving the Company,
     which, in the opinion of management, will have a material adverse effect
     upon consolidated results of operations or financial condition.

(18) ACQUISITIONS

     On November 6, 1996, the Company acquired all the outstanding capital stock
     of Biomedical Sensors, Ltd. (BSL), an operating unit of Pfizer Inc. and
     certain assets from Howmedica, Inc. (a wholly-owned subsidiary of Pfizer
     Inc.), for $1,500,000 in cash and a $7,300,000 senior secured fixed rate
     loan note, due November 4, 2002 (see footnote 7).  In the purchase of BSL,
     the Company acquired fiberoptic and electrochemical technology for
     monitoring blood gases on a continual basis via sensors that dwell inside
     arterial lines.  Core technology was also purchased for future product
     derivatives under development.

     The Company accounted for the acquisition using the purchase method. As
     such, the excess of the purchase price over the fair value of the
     identifiable assets acquired was recorded as goodwill, which consisted of
     purchased completed technology (70%), purchased in-process technology
     (16%), and the value of the acquired customer base and other unidentifiable
     intangible assets (14%), totaling $2,770,359.  The in-process technology
     ($464,460) was written off to operating expenses, leaving $2,305,899 of
     goodwill on the balance sheet at the acquisition date.  Due to the rapid
     pace of technological change in the medical device industry, the completed
     technology has an estimated life of five years.  The customer base and
     other unidentifiable assets is estimated to have an average useful life of
     five years.  This results in a weighted average amortization period of five
     years for the intangible assets not immediately written off.

     The unaudited pro forma consolidated condensed results of operations for
     the Company for fiscal years 1996 and 1995, had the acquisition occurred at
     the beginning of each fiscal year presented, are as follows:

<TABLE>
<CAPTION>
                                        1996               1995
                                   ---------------------------------
     <S>                           <C>               <C>
     Net sales                     $   7,021,000      $   5,387,000
     Net loss                        (33,586,000)       (35,517,000)
     Net loss per common share             (2.23)             (2.81)
</TABLE>

     Included in total revenue and net loss for 1996 are revenues and net loss
     from the BSL operations of $326,000 and $(421,000), respectively.
<PAGE>

(19) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

<TABLE>
<CAPTION>
                                                FIRST              SECOND             THIRD             FOURTH
                                               QUARTER            QUARTER            QUARTER           QUARTER
                                        -------------------------------------------------------------------------
     <S>                                <C>                     <C>                <C>               <C>
     1997
        Net sales                            $ 1,954,966        $ 2,607,679        $ 2,829,279       $ 3,042,442
        Gross profit (loss)                     (872,980)          (213,895)          (189,668)           44,767
        Operating loss                        (5,602,223)        (5,090,759)        (4,960,888)       (4,855,711)
        Net loss                              (5,772,013)        (5,254,034)        (5,153,267)       (4,857,229)
        Net loss per common share                  (0.38)             (0.29)             (0.25)            (0.23)

     1996
        Net sales                            $   609,571        $   583,530        $   669,848       $ 1,933,867
        Gross profit (loss)                   (1,789,474)        (1,562,377)        (1,510,680)       (1,200,912)
        Operating loss                        (5,743,317)        (6,114,413)        (5,521,395)       (6,403,086)
        Net loss                              (5,548,010)        (6,064,471)        (5,484,272)       (6,478,341)
        Net loss per common share                  (0.37)             (0.40)             (0.36)            (0.43)
</TABLE>
<PAGE>

REPORT  OF INDEPENDENT AUDITORS



THE BOARD OF DIRECTORS AND SHAREHOLDERS
DIAMETRICS MEDICAL, INC.:


We have audited the accompanying consolidated balance sheets of Diametrics
Medical, Inc. and subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the years in the three-year period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Diametrics Medical,
Inc. and subsidiary as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1997, in conformity with generally accepted accounting
principles.



                                /s/ KPMG Peat Marwick LLP

Minneapolis, Minnesota
January 28, 1998
<PAGE>

SHAREHOLDER INFORMATION

     STOCK LISTING

     The Company's common stock is traded on The Nasdaq National Market under
     the symbol DMED.

     STOCK TRANSFER AGENT

     American Stock Transfer & Trust Company
     40 Wall Street
     New York, NY  10005
     Phone: (212) 936-5100

     FORM 10-K

     A copy of the Company's annual report on Form 10-K as filed with the
     Securities and Exchange Commission is available free of charge by writing
     to Diametrics Medical, Inc.

     ANNUAL MEETING

     The annual meeting of Diametrics Medical, Inc. shareholders will be held
     May 13, 1998, at 3:30 p.m. at the Minneapolis Marriott City Center, 30
     South Seventh Street, Minneapolis, Minnesota.  All shareholders and other
     interested parties are invited to attend.

     INVESTOR INQUIRIES

     Please direct all inquiries to Laurence L. Betterley, Senior Vice President
     and Chief Financial Officer, at the Company's corporate offices.

     STOCK INFORMATION

     High and low quarterly closing prices for Diametrics Medical, Inc., common
     stock as quoted on The Nasdaq National Market were:

<TABLE>
<CAPTION>
                                                         1997
                                          High                         Low
     ---------------------------------------------------------------------------
     <S>                               <C>                         <C>
     First Quarter                     $  5 3/4                     $ 3 1/2
     Second Quarter                       9 1/4                       3
     Third Quarter                        9 15/16                     6 9/16
     Fourth Quarter                       10 1/8                      4 5/8
</TABLE>

<TABLE>
<CAPTION>
                                                        1996
                                          High                         Low
     ---------------------------------------------------------------------------
     <S>                               <C>                         <C>
     First Quarter                     $  6 7/8                     $ 4 1/4
     Second Quarter                       8                           4 1/2
     Third Quarter                        5 5/8                       4 1/4
     Fourth Quarter                       4 7/8                       3 1/4
</TABLE>

     There were 545 common shareholders of record and the Company estimates
     approximately 5,800 shareholders holding stock in "street name" accounts as
     of December 31, 1997.  The Company has not paid any stock dividends on its
     common stock since its inception, and management does not anticipate paying
     cash dividends in the foreseeable future.

     CORPORATE ADDRESS                  INTERNATIONAL SUBSIDIARY

     Diametrics Medical, Inc.           Diametrics Medical, Ltd.
     2658 Patton Road                   5 Manor Court Yard, Hughenden Ave.
     St. Paul, Minnesota 55113          High Wycombe, Bucks. HP13 5RE
     Phone: (612) 639-8035              England
     Website:  www.diametrics.com       Phone: +44(0)1494 446651