<PAGE>

                                                                    EXHIBIT 13.1

SELECTED FIVE-YEAR FINANCIAL DATA

<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)                          YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------------------------------
                                                          1996          1995         1994         1993         1992
<S>                                                 <C>          <C>           <C>          <C>          <C>
Statement of Operations Data
Net sales                                           $    3,797   $     1,607   $      331   $      -       $    -
Operating loss                                         (23,782)      (23,387)     (12,733)      (8,201)      (4,030)
Net loss                                               (23,575)      (23,046)     (12,455)     (13,819)      (4,305)
Net loss per share (1),(2)                               (1.56)        (1.82)       (1.49)       (2.05)         -
Weighted average shares outstanding (1),(2)         15,088,493    12,640,212    8,341,021    6,729,636          -

Balance Sheet Data
Working capital (deficit)                           $    6,649   $    27,123   $    7,413   $     (106)  $   10,578
Total assets                                            24,059        36,620       17,393       10,151       14,751
Long-term liabilities                                    8,582         1,851        1,759        1,502          957
Common shareholders' equity (deficit)                    8,674        31,194       11,157      (20,805)      (6,704)
</TABLE>

(1) Due to significant capital structure changes, earnings per share and
weighted average shares outstanding for 1992 are not presented. In addition, 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.

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 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 manufacturing and sales
organization. As of December 31, 1996, the primary funding for the operations of
the Company has been approximately $87.2 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.

Operating results for 1996 were highlighted by the introduction of a number of
key new products and the acquisition of Biomedical Sensors, Ltd. (BSL), an
operating unit of Pfizer Inc.

In the third quarter of 1996, the second generation IRMA blood analyzer, the
IRMA SL and the IRMA Data Management System (IDMS) were introduced. The IRMA SL
features an expanded test menu that includes testing for blood gases,
electrolytes and hematocrit, three of the most frequently ordered critical care
diagnostic tests. The IDMS is an advanced data management software program that
provides a comprehensive data management system for point of care testing
technologies.
<PAGE>

The Company also expanded its product line in July with the initiation of an
exclusive U.S. distributor agreement with A-VOX Systems, Inc., to distribute the
AVOXimeter 4000, the only battery operated, portable system for comprehensive
co-oximetry measurements, which measures the levels of hemoglobin and calculated
oxygen content in a patient's blood.

In November, the Company purchased Biomedical Sensors, Ltd. (BSL) from Pfizer
Inc. for $1.5 million cash and a $7.3 million six-year interest-bearing
promissory note. Based in England, the new subsidiary, Diametrics Medical, Ltd.,
brings an existing product line which includes the only indwelling continuous
blood gas monitoring system and utilizes a world class fiber optic and
electrochemical technology platform. Current products include Paratrend 7, an
intravascular blood gas monitoring system and Neocath, a continuous oxygen
monitoring system for newborns. In addition, Tissutrak, a system for monitoring
tissue oxygenation of muscle flaps during plastic reconstructive surgery, is
being marketed in Europe. Tissutrak is not yet FDA cleared for sale in the
United States.

Additionally, the Company continued to expand its international sales coverage
for its products with the signing of various partnership agreements. Primary
among those finalized in 1996 was a distribution agreement with Century Medical,
which markets the IRMA system and associated products in Japan through its
critical care business division. International revenues accounted for
approximately 40% of total revenues in 1996, 20% in 1995 and 30% in 1994.

RESULTS OF OPERATIONS

SALES  Sales of the Company's products were $3,796,816 for 1996, compared to
$1,607,375 for 1995 and $331,495 in 1994, the first year of sales activity. The
Company's revenues are affected principally by the number of IRMA Systems placed
with customers and the rate at which disposable IRMA cartridges are used in
connection with the IRMA System. As of December 31, 1996, the Company had placed
over 900 IRMA Systems at customer locations, compared to 450 and 91 systems as
of December 31, 1995 and 1994, respectively. 1996 sales generated from IRMA
Systems increased over 100% from 1995, while cartridge sales increased over 130%
and represented 40% of total revenue.

The Company's 1997 revenues could significantly more than double the level
achieved in 1996, as a result of continued market penetration, further planned
expansion of the blood analysis product line and the inclusion of a full year of
sales related to the operations of the Company's new subsidiary, Diametrics
Medical, Ltd.

COST OF SALES  Cost of sales totaled $9,591,358 for 1996, compared to $8,795,153
for 1995 and $3,070,272 for 1994. 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. Without the impact of the 1995 charge, 1996
cost of sales increased approximately $2 million from 1995. Cost of sales in
1996 declined significantly as a percentage of revenue as a result of improved
manufacturing yields, lower production costs, increased cartridge volumes and
increased shelf life of the Company's cartridges. The Company expects unit costs
to continue to decline in 1997 as sales volumes increase and continued
improvements are realized in manufacturing yields, processes, costs and product
design. Depending upon product mix and production volumes, gross margins are
expected to approximate break-even levels for the full year 1997.
<PAGE>

OPERATING EXPENSES  Total operating expenses for 1996 increased $1.8 million or
11% compared to 1995, primarily due to restructuring and other charges incurred
during 1996 and the inclusion of expenses for the operations of Biomedical
Sensors, Ltd. (BSL), acquired by the Company in November 1996. Without the
impact of the above, operating expenses increased approximately $370,000 or 2%
from 1995, due to investments made in sales and marketing. Operating expenses
increased by $6.2 million or 62% from 1994 to 1995, due to increased research
and development expenses associated with the expansion of the test menu for the
IRMA System and development of the next generation system, the IRMA SL, as well
as increased investments in sales and marketing and general and administrative
expenses to support expanded operating activities.

Research and development expenses decreased $264,000 or 4% from 1995 to 1996,
after an increase of $1.2 million or 23% from 1994 to 1995. The increase in
expense from 1994 to 1995 reflects costs to support the continued expansion of
the test menu for the IRMA System and development of the Company's next
generation system, IRMA SL. Research and development expenses declined in 1996
primarily as a result of the completion during 1996 of development of the
IRMA SL, partially offset by the inclusion of research and development expenses
for BSL operations.

Sales and marketing expenses totaled $6,655,240 in 1996, compared to $5,681,334
in 1995 and $2,215,349 in 1994. Expansion of the direct sales force, addition of
marketing personnel, and increased advertising and promotional activities
produced the increase in sales and marketing expenses from 1994 to 1995. The
smaller increase in 1996 expenses is associated with costs to support the
increased direct sales force base established during 1995, higher commissions on
increased sales during 1996, and the inclusion of BSL expenses from the date of
acquisition.

General and administrative expenses totaled $3,941,522 in 1996, compared to
$3,805,216 in 1995 and $2,659,313 in 1994. The 1994 to 1995 increase reflects
the Company's requirement for administrative personnel and services to support
expanded operating activities. The smaller increase from 1995 to 1996 is
primarily attributed to the inclusion of expenses related to BSL operations.

Restructuring and other charges totaled $1,334,661 in 1996, compared to $391,834
in 1995 and no charges in 1994. 1995 charges reflect severance costs associated
with a management reorganization in late 1995. 1996 charges consist of
approximately $580,000 for severance costs related to continued restructuring of
the management team in early 1996 and a work force reduction, $450,000 for the
write-off of purchased in-process research and development created from the BSL
acquisition, and $300,000 for the write-down of excess and obsolete equipment,
resulting from the work force reductions and process changes.

Excluding the impact of 1996 restructuring and other charges, operating expenses
in 1997 are expected to increase approximately 20% from 1996, due to the
acquisition of BSL. Without the impact of additional operating expenses related
to BSL operations, operating expenses are expected to decline by approximately
25%, as a result of staff reductions in late 1996, primarily affecting research
and development and general and administrative functions and better cost
containment and alignment of resources with the Company's strategy.

OTHER INCOME (EXPENSE)  Net other income declined approximately $133,000 from
1995 to 1996, after an increase of $63,000 from 1994 to 1995. The Company
realized interest income of $929,603 in 1996, compared to $1,148,352 in 1995 and
$369,044 in 1994. The increase from 1994 to 1995 reflects the impact of higher
average cash
<PAGE>

balances resulting from the Company's financing activities during 1994 and 1995.
Interest income declined in 1996 from 1995 due to lower average cash balances
resulting from a net use of cash in operations.

Interest expense totaled $607,342 in 1996, compared to $550,607 in 1995 and
$237,635 in 1994. The increase from 1994 to 1995 reflects the impact of
increased capital lease financing, while the increase from 1995 to 1996
primarily reflects interest accrued on a long-term note payable to Pfizer Inc.
issued in connection with the Company's acquisition of BSL in November 1996.

Other expense decreased from 1995, primarily due to a reduction in losses on
disposal of property and equipment.

NET LOSS  Net loss for the year ended December 31, 1996 was $23,575,094,
compared to $23,046,314 in 1995 and $12,454,760 in 1994. Net of restructuring
and other charges and the impact of BSL operations, the 1996 net loss was
approximately $800,000 less than the 1995 net loss. The Company expects a
reduced net loss in 1997 relative to 1996.

LIQUIDITY AND CAPITAL RESOURCES

Most of the major changes from 1995 to 1996 in the Company's working capital
balance sheet accounts (excluding cash, cash equivalents and marketable
securities), were the result of the consolidation of BSL's operating assets and
liabilities.

At December 31, 1996, the Company had working capital of approximately $6.6
million, a decrease of $20.5 million from the working capital of $27.1 million
reported at December 31, 1995. The decrease is primarily the result of the net
use of cash in operations during 1996, following the Company's receipt of $42.4
million in net proceeds from the private and public issuance of common stock in
the first and third quarters of 1995. Based upon the Company's projections of
cash requirements, additional capital was not raised until early 1997 (see
footnote 19). Through December 31, 1995, the Company raised approximately $87.2
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, 1996, the Company had property and equipment of $16,295,952, up
from $10,840,323 at December 31, 1995, less accumulated depreciation of
$8,008,200 and $5,000,597 at December 31, 1996 and 1995, respectively. The $5.5
million increase in the cost of property and equipment is the result of the
consolidation of BSL property and equipment balances of $3.9 million upon the
acquisition of BSL, and $1.6 million of capital additions, consisting primarily
of investments in development and production equipment, and IRMA analyzers for
internal R&D and sales use to bring new products to market and facilitate sales.
Since its inception in 1990, the Company has financed approximately $5 million
of capital additions through capital lease obligations, including $103,000 in
1996. In 1997, the Company expects capital expenditures and new lease
commitments to approximate $3 million, primarily reflecting investments to
support new product development and production.

In late 1996, the Company entered into long-term debt obligations of $7.8
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 BSL and a
$500,000 note payable for equipment financing. The Company's long-term debt and
capital lease obligations require principal and interest repayments of
approximately $2.2 million in 1997, $1.5
<PAGE>

million in 1998, $850,000 in 1999, $790,000 in both 2000 and 2001, and $7.9
million thereafter.

At December 31, 1996, the Company had U.S. net operating loss and research and
development tax credit carryforwards for income tax purposes of approximately
$75,000,000 and $844,000, 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).

With the completion of a private equity placement in January 1997 of 750,000
shares of convertible preferred stock, resulting in net proceeds of
approximately $11.9 million (see footnote 19), the Company believes that
currently available funds and cash generated from 1997 revenues, supplemented by
proceeds from employee stock plans, warrant exercises and receivable based
credit, will meet the Company's working capital needs through early 1998. If
capital requirements vary materially from those currently planned, the Company
could require additional capital at an earlier time. Additional funds may also
be required for the Company to meet significantly greater than anticipated
demand for its products. As a result, the Company has and will continue to
evaluate raising additional capital through, but not limited to, public or
private sales of equity or debt securities. There can be no assurance that
adequate funds will be available when needed or on acceptable terms. The
Company's long-term capital requirements will depend upon numerous factors,
including the rate of market acceptance of the Company's products, the level of
resources devoted to expanding the sales and marketing organization,
manufacturing capabilities and the Company's research and development
activities.

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 Securities and Exchange Commission.
<PAGE>

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                               Years ended December 31,
                                                 -------------------------------------------------
Diametrics Medical, Inc.                                1996             1995             1994
--------------------------------------------------------------------------------------------------
<S>                                              <C>              <C>               <C>
Net sales                                        $   3,796,816    $    1,607,375    $     331,495

Cost of sales                                        9,591,358         8,795,153        3,070,272
                                                 -------------------------------------------------

     Gross profit (loss)                            (5,794,542)       (7,187,778)      (2,738,777)

Operating expenses:
  Research and development                           6,056,246         6,320,739        5,119,133
  Sales and marketing                                6,655,240         5,681,334        2,215,349
  General and administrative                         3,941,522         3,805,216        2,659,313
  Restructuring and other charges                    1,334,661           391,834                -
                                                 -------------------------------------------------

     Total operating expenses                       17,987,669        16,199,123        9,993,795
                                                 -------------------------------------------------

Operating loss                                     (23,782,211)      (23,386,901)     (12,732,572)

Interest income                                        929,603         1,148,352          369,044
Interest expense                                      (607,342)         (550,607)        (237,635)
Lawsuit settlement and related legal fees                    -                 -          488,426
Other expense, net                                    (115,144)         (257,158)        (342,023)
                                                 -------------------------------------------------

     Net loss                                    $ (23,575,094)   $  (23,046,314)   $ (12,454,760)
                                                 -------------------------------------------------

Net loss per common share                        $       (1.56)   $        (1.82)   $       (1.49)
                                                 -------------------------------------------------

Weighted average common shares outstanding          15,088,493        12,640,212        8,341,021
                                                 -------------------------------------------------
</TABLE>

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

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                          December 31,
                                                                                --------------------------------
DIAMETRICS MEDICAL, INC.                                                           1996                1995
----------------------------------------------------------------------------------------------------------------
<S>                                                                             <C>                <C>
ASSETS

CURRENT ASSETS:
     Cash and cash equivalents                                                  $  2,451,993       $  2,702,232
     Marketable securities                                                         3,402,598         25,789,265
     Accounts receivable:
       Trade, net of allowance for doubtful
       accounts of $110,000 in 1996 and $80,876 in 1995                            2,033,496            562,409
       Nontrade                                                                      556,272            400,639
     Inventories                                                                   4,464,099          1,114,332
     Prepaid expenses and other current assets                                       543,755            128,374
                                                                                --------------------------------
       Total current assets                                                       13,452,213         30,697,251
                                                                                --------------------------------

PROPERTY AND EQUIPMENT                                                            16,295,952         10,840,323
     Less accumulated depreciation and amortization                               (8,008,200)        (5,000,597)
                                                                                --------------------------------
                                                                                   8,287,752          5,839,726
                                                                                --------------------------------

OTHER ASSETS                                                                       2,318,674             82,624
                                                                                --------------------------------
                                                                                $ 24,058,639       $ 36,619,601
                                                                                ================================
LIABILITIES AND COMMON SHAREHOLDER'S EQUITY

CURRENT LIABILITIES:
     Accounts payable                                                           $  1,612,390       $  1,554,573
     Accrued expenses                                                              3,848,248            847,544
     Short-term note payable                                                          31,934             44,608
     Current portion of long-term liabilities                                      1,310,154          1,127,175
                                                                                --------------------------------
      Total current liabilities                                                    6,802,726          3,573,900
                                                                                --------------------------------
LONG-TERM LIABILITIES:
     Long-term obligations, excluding current portion                              7,795,851                  -
     Capital lease obligations, excluding current portion                            666,668          1,803,982
     Other liabilities, excluding current portion                                    119,155             47,369
                                                                                --------------------------------
       Total liabilities                                                          15,384,400          5,425,251
                                                                                --------------------------------
COMMON SHAREHOLDERS' EQUITY:
     Undesignated preferred stock, $.01 par value: 5,000,000 shares
       authorized, no shares issued and outstanding                                        -                  -
     Common stock, $.01 par value 20,000,000 authorized, 15,209,481
       and 14,900,141 shares issued and outstanding on December 31, 1996
       and 1995, respectively                                                        152,095            149,001
     Additional paid-in capital                                                   88,451,972         87,489,392
     Cumulative translation adjustment                                                89,309                  -
     Accumulated deficit                                                         (80,019,137)       (56,444,043)
                                                                                --------------------------------
       Total common shareholders' equity                                           8,674,239         31,194,350
                                                                                --------------------------------
Commitments and contingencies (notes 7, 8, 16 and 17)                           $ 24,058,639       $ 36,619,601
                                                                                ================================

</TABLE>

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

<PAGE>

CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
                                                                                                                    Total
                                                                         Additional                 Cumulative      common
                                                    Common stock           paid-in    Accumulated   translation   shareholders'
                                                 -------------------
Diametrics Medical, Inc.                         Shares       Amount       capital     deficit      adjustment   equity (deficit)
--------------------------------------------------------------------------------------------------------------------------------
<S>                                          <C>          <C>         <C>           <C>           <C>            <C>
BALANCE, December 31, 1993                       885,945  $    8,859  $     27,141  $(20,840,566) $         -    $(20,804,566)

Adjustment to reflect redemption
  value of preferred stock                             -           -             -      (102,403)           -        (102,403)

Issued common stock upon the exercise
  of stock purchase warrants                      79,750         798       549,477             -            -         550,275

Issued common stock pursuant to the
  Company's initial public offering            2,875,000      28,750    15,681,252             -            -      15,710,002

Conversion of preferred stock
  to common stock                              5,743,745      57,438    28,196,428             -            -      28,253,866

Exercise of options common stock                   2,536          25         4,337             -            -           4,362

Net loss                                               -           -             -   (12,454,760)           -     (12,454,760)
                                             -----------------------------------------------------------------------------------
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
                                             -----------------------------------------------------------------------------------
</TABLE>

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

<PAGE>

Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                                   Years ended December 31,
                                                                      -------------------------------------------------
Diametrics Medical, Inc.                                                    1996             1995             1994
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                    <C>              <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss                                                             $(23,575,094)    $(23,046,314)    $(12,454,760)
  Adjustments to reconcile net loss to net cash
   used in operating activities:
     Depreciation and amortization                                        3,114,293        2,590,022        1,640,198
     Write-off of acquired in-process technology                            464,460                -                -
     Common stock issued in lieu of salaries and wages                            -          337,613                -
     (Gain) loss on disposal of property and equipment                       (1,686)         144,192          138,183
     Changes in operating assets and liabilities
     (net of effects of BSL acquisition):
       Receivables, net                                                    (580,891)        (665,221)        (225,767)
       Inventories                                                         (632,551)        (414,089)         (18,893)
       Prepaid expenses and other current assets                            523,050          135,143          206,326
       Accounts payable                                                     (97,319)         324,951          923,781
       Accrued expenses                                                     445,619         (475,130)      (3,211,923)
                                                                      -------------------------------------------------
         Net cash used in operating activities                          (20,340,119)     (21,068,833)     (13,002,855)
                                                                      -------------------------------------------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property and equipment                                    (1,597,218)      (2,715,937)      (2,090,629)
  Proceeds from sales of property and equipment                             102,586        1,405,565        1,983,025
  Purchases of marketable securities                                     (8,343,433)     (40,907,468)     (15,489,358)
  Proceeds from sales of marketable securities                           30,730,100       23,705,369        6,902,192
  Acquisition of BSL, net of cash received                               (1,067,848)               -                -
  Other assets                                                              (36,892)         452,483         (347,077)
                                                                      -------------------------------------------------
         Net cash provided by (used in) investing activities             19,787,295      (18,059,988)      (9,041,847)
                                                                      -------------------------------------------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Principal payments on short-term note payable                            (108,477)        (100,502)        (109,971)
  Proceeds from long-term borrowings                                        500,000                -                -
  Net proceeds from issuance of common stock                                965,674       42,746,275       20,290,169
  Payments for redeemable common stock                                            -       (1,000,000)               -
  Principal payments on capital lease obligations                        (1,078,802)        (964,031)        (515,107)
                                                                      -------------------------------------------------
         Net cash provided by financing activities                          278,395       40,681,742       19,665,091
                                                                      -------------------------------------------------

CUMULATIVE TRANSLATION ADJUSTMENT                                            24,190                -                -

         Net increase (decrease) in cash and cash equivalents              (250,239)       1,552,921       (2,379,611)

Cash and cash equivalents at beginning of year                            2,702,232        1,149,311        3,528,922
                                                                      -------------------------------------------------

Cash and cash equivalents at end of year                               $  2,451,993     $  2,702,232     $  1,149,311
                                                                      =================================================

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Cash paid during the period for interest                             $    510,399     $    550,607     $    181,232
                                                                      =================================================
</TABLE>

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

The Company entered into capital lease obligations for equipment of $131,058,
  $1,367,073, $1,983,025 during the years ended December 31, 1996, 1995, and
  1994, 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 BSL.

During 1994, $28,253,866 of preferred stock was converted into common stock.

The accompanying notes are an integral part of these 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. (the Company), a
     medical device company, was incorporated in the state of Minnesota on
     January 26, 1990 and commenced operation in June 1990. The Company
     develops, manufactures and markets critical care blood analysis systems
     which provide immediate or continuous diagnostic results at the point-of-
     patient care. The Company emerged from development stage in the third
     quarter of 1994.

     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
     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, 1996, 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 Statement of
     Financial Accounting Standards 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, 1996, marketable
     securities consisted mainly of investment grade commercial paper, with
     original maturities ranging from six to twelve 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.
<PAGE>

     OTHER ASSETS Other assets consist principally of goodwill representing
     purchased technology and other intangible assets resulting from the excess
     of the cost of 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, upon the customer's
     acceptance of the product.

     NET LOSS PER COMMON SHARE Net loss per common share is computed based upon
     the weighted average number of common shares outstanding.

     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.
     Under SFAS No. 109, 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.

     IMPAIRMENT OF LONG-LIVED ASSETS Effective January 1, 1996, the Company
     adopted Statement of Financial Accounting Standards No. 121, Accounting for
     the Impairment of Long-Lived Assets and for Long-Lived Assets To Be
     Disposed Of, which prescribes accounting and reporting standards when
     circumstances indicate that the carrying amount of an asset may not be
     recoverable. No cumulative effect adjustment occurred as a result of this
     change in accounting principle.

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

     RECLASSIFICATIONS Certain 1995 and 1994 amounts in the Consolidated
     Statements of Operations have been reclassified from prior reported
     balances to conform to the 1996 presentation. The reclassifications had no
     impact on the net loss or loss per share as reported in 1995 and 1994.

(2)  LIQUIDITY

     As reflected in the accompanying consolidated financial statements, the
     Company has incurred a net loss of $23,575,094 for the year ended December
     31, 1996. In addition, the Company has incurred net losses and has had
     negative cash flows from operating activities since inception. During
     January 1997 the Company completed a private placement which generated net
     cash proceeds to the Company of approximately $11.9 million (see footnote
     19). Management believes proceeds from this offering combined with current
     working capital and projected operating revenues, supplemented by proceeds
     from employee stock plans, warrant exercises and receivable based credit,
     will provide the Company with sufficient liquidity through 1997 and into
     early 1998. It is probable the Company will be required to raise additional
     capital by early 1998. 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>
                                                         1996            1995
                                                      -------------------------
     <S>                                              <C>           <C>
     Raw materials                                    $  1,623,243  $   782,287
     Work-in-process                                       569,505      238,930
     Finished goods                                      2,271,351       93,115
                                                      -------------------------
                                                      $  4,464,099  $ 1,114,332
                                                      =========================
</TABLE>

(4)  PROPERTY AND EQUIPMENT

     Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                              1996             1995
                                                           --------------------------
     <S>                                                   <C>           <C>
     Manufacturing equipment                               $  3,988,933  $  3,159,579
     Laboratory fixtures and equipment                        2,024,811     1,170,995
     Office furniture and equipment                           3,656,348     2,979,547
     Leasehold improvements                                   3,350,731     2,752,341
     Tooling                                                  1,333,097       574,543
     Demonstration instruments                                1,317,378       203,318
     Vehicles                                                   212,596             -
     Capital-in-progress                                        412,058             -
                                                           --------------------------
                                                             16,295,952    10,840,323

     Less accumulated depreciation & amortization            (8,008,200)   (5,000,597)
                                                           --------------------------
                                                           $  8,287,752  $  5,839,726
                                                           ==========================
</TABLE>
<PAGE>

(5)  OTHER ASSETS

     Other assets consist of the following:

<TABLE>
<CAPTION>
                                                              1996             1995
                                                           --------------------------
     <S>                                                   <C>           <C>
     Goodwill                                              $  2,259,974  $          -
     Other                                                       58,700        82,624
                                                           --------------------------
                                                           $  2,318,674  $     82,624
                                                           ==========================
</TABLE>

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

(6)  ACCRUED EXPENSES

     Accrued expenses are summarized as follows:

<TABLE>
<CAPTION>
                                                              1996             1995
                                                           --------------------------
     <S>                                                   <C>           <C>
     Employee compensation                                 $  1,129,241  $    721,606
     Product upgrades                                         1,138,420             -
     Acquisition expenses                                       295,207             -
     Other                                                    1,285,380       125,938
                                                            -------------------------
                                                            $ 3,848,248  $    847,544
                                                            =========================
</TABLE>

(7)  LONG-TERM DEBT

     Long-term debt consists of the following:

<TABLE>
<CAPTION>
                                                              1996             1995
                                                           --------------------------
     <S>                                                   <C>            <C>
     Senior secured fixed rate loan note                   $  7,300,000   $         -

     Note payable                                               500,000             -
                                                           --------------------------
                                                              7,800,000             -
     Less current portion                                        (4,149)
                                                           --------------------------
                                                           $  7,795,851   $         -
                                                           ==========================
</TABLE>

The aggregate maturities of outstanding long-term debt are:

<TABLE>
     <S>                                                            <C>
     year ending December 31:
     1997                                                           $       4,149
     1998                                                                 106,059
     1999                                                                 117,297
     2000                                                                 129,726
     Thereafter                                                         7,442,769
                                                                    -------------
                                                                    $   7,800,000
                                                                    =============
</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 BSL, 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 $500,000 note payable requires principal and interest payments in
     monthly installments beginning on January 1, 1997 at an annual interest
     rate of 10.1%. The note matures December 1, 2001 and is 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 three years. The
     gross amount included in property and equipment and related accumulated
     amortization relating to capital leases is as follows:

<TABLE>
<CAPTION>
                                                              1996             1995
                                                          ---------------------------
     <S>                                                  <C>           <C>
     Manufacturing equipment                              $  2,124,241  $  2,520,423
     Laboratory fixtures and equipment                         599,940       969,530
     Office furniture and equipment                          1,358,874     1,440,333
     Leasehold improvements                                     16,668        16,668
     Tooling                                                     7,030         7,030
                                                          ---------------------------
                                                             4,106,753     4,953,984
     Less accumulated amortization                          (2,893,465)   (2,419,791)
                                                          ---------------------------
                                                          $  1,213,288  $  2,534,193
                                                          ===========================
</TABLE>

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

<TABLE>
     <S>                                                               <C>
     Year ending December 31:
          1997                                                         $  1,525,255
          1998                                                              667,257
          1999                                                               61,144
                                                                       ------------
               Total minimum lease payments                               2,253,656
     Less amount representing interest                                     (341,288)
                                                                       ------------
               Present value of minimum capital lease payments            1,912,368
     Less current portion of capital lease obligations                   (1,245,700)
                                                                       ------------
               Capital lease obligations, excluding current portion    $    666,668
                                                                       ============
</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, 1996,
     479,901 and 40,250 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 1996 and 1995 under each of the plans on the
     date of grant using the Black Scholes option-pricing model with the
     following assumptions: 1996 - annualized volatility of 70.81%, risk-free
     interest rate of 5.5%, and an expected life of five and three years for the
     1990 Stock Option Plan and Directors' Plan, respectively; 1995 - annualized
     volatility 80.04%, risk-free interest rate of 5.5% and 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, 1996,
     1995 and 1994 and changes during those years, is summarized as follows:

<TABLE>
<CAPTION>
                                                  1996                         1995                         1994
                                          -----------------------------------------------------------------------------------------
                                                         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       1,450,188  $         4.66   1,175,494   $        4.01      922,570      $         3.30
     Granted                                1,286,500            5.45     310,375            7.04      259,500                6.53
     Exercised                               (235,244)           2.83     (25,874)           3.18       (2,536)               1.72
     Expired                                 (246,449)           6.24      (9,807)           5.83       (4,040)               3.93
                                           -----------                 -----------                   -----------
     Outstanding at end of year             2,254,995            5.13   1,450,188            4.66    1,175,494                4.01
                                           -----------                 -----------                   -----------

     Options exercisable at year-end        1,158,730            4.68     941,286            3.78      722,419                3.26


     Weighted-average fair value of
     options granted during the year      $      3.43                  $     4.52                          -

     1993 DIRECTORS' STOCK OPTION PLAN

     Outstanding at beginning of year         126,500  $         6.89      82,500   $        4.82       72,500      $         4.60
     Granted                                   55,500            4.95      58,500            9.24       10,000                6.40
     Exercised                                    -               -        (7,250)           4.60          -                   -
     Expired                                  (12,000)           8.27      (7,250)           4.60          -                   -
                                            ----------                 -----------                   -----------
     Outstanding at end of year               170,000            6.16     126,500            6.89       82,500                4.82
                                            ==========                 ===========                   ===========

     Options exercisable at year-end          112,000            6.08  $   59,000            5.25

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

     At December 31, 1996, the range of exercise prices and weighted average
     remaining contractual life of outstanding options for the above plans were
     $1.72 - $12.00 and eight years, respectively.

     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. 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>
                                                                1996                  1995
                                                       --------------------------------------------
     <S>                                                 <C>                  <C>
     Net loss as reported                                $     (23,575,094)   $      (23,046,314)
     Net loss pro forma                                  $     (26,072,231)   $      (23,738,550)

     Net loss  per share as reported                     $           (1.56)   $            (1.82)
     Net loss per share pro forma                        $           (1.73)   $            (1.87)
</TABLE>

     Pro forma net loss reflects only options granted in 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 977,060
     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, 1996, stock purchase warrants representing 706,314 shares were
     exercisable with an additional 80,500 shares becoming exercisable upon
     achieving certain purchasing levels of the Company's products. Stock
     warrant transactions under these arrangements are summarized as follows:

<TABLE>
<CAPTION>
                                                            1996                      1995                      1994

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

                                                                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              843,314    $1.72 - 6.13    861,310    $1.72 - 6.13    921,110   $1.72 - 6.13

     Granted                                        16,000            5.00     20,000            5.25     19,950           6.00

     Exercised                                         -               -       (1,746)    5.25 - 6.00    (79,750)          6.00

     Expired                                       (72,500)            -      (36,250)    5.25 - 6.00        -              -

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

     Outstanding at end of year                    786,814     1.72 - 6.13    843,314     1.72 - 6.13    861,310    1.72 - 6.13

                                                 ==========                  =========                  ========



     Warrants exercisable at year-end              706,314     1.72 - 6.13    698,314     1.72 - 6.13    537,000    1.72 - 6.13



     Weighted-average fair value of

     warrants granted during the year            $    2.86                   $   3.26                       -
</TABLE>
<PAGE>

(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 74,096 shares at an
     average price per share of $4.06 in 1996 and 34,760 shares at an average
     price per share of $5.56 in 1995. The fair value expense of these purchases
     is included in the pro forma information in footnote 9.

(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), the Company assumed sponsorship of BSL's defined benefit retirement
     plan. The Plan covers the majority of the new subsidiary's employees and
     provides benefits based upon final pensionable salary. 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 BSL, and pension expense
     charged to operations during that period was minimal. The net periodic
     pension cost and related assumptions are shown in the following table on a
     pro forma basis for 1996, as if the Company had included a full year of BSL
     activity in its 1996 results. The second table reflects a description of
     the funded status of the plan.

<PAGE>

     NET PERIODIC PENSION COST

<TABLE>
<CAPTION>
                                                                   Pro forma
                                                                  year ended
                                                               December 31, 1996
                                                               -----------------
       <S>                                                     <C>
       Service cost                                              $     258,430
       Actual return on plan assets                                    (51,387)
                                                               -----------------

                                                                 $     207,043
                                                               =================

       RATE ASSUMPTIONS:
       Discount rate                                                      8.50%
       Rate of salary progression                                         6.25%
       Long-term rate of return on assets                                 9.25%
</TABLE>

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

<TABLE>
       <S>                                                     <C>
       Actuarial present value of obligation:

       Vested benefit obligation                                 $   2,585,814
                                                               =================
       Accumulated benefit obligation                            $   2,616,059
                                                               =================
       Projected benefit obligation                              $   2,762,245
                                                               =================

       Plan assets at fair value                                 $   2,660,923
                                                               =================

       Net pension liability recognized in balance sheet         $    (101,322)
                                                               =================
</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, 1996 the Company has U.S. tax net operating loss and
     research and development tax credit carryforwards of approximately
     $75,000,000 and $844,000, 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 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
<PAGE>

     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 $35,800,000 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, 1996 and 1995 are as follows:

<TABLE>
<CAPTION>
                                                          1996            1995
                                                      -------------------------------
     <S>                                              <C>               <C>
     Tax credits                                      $    844,000      $    701,000
     Federal net operating loss carryforward            27,787,000        19,590,000
     Foreign net operating loss carryforward            11,828,000                 -
     Fixed asset depreciation                              587,000           173,000
     Vacation accrual                                      117,000           134,000
     Inventory reserve                                      96,000           471,000
     Product upgrade accrual                               286,000                 -
     Other differences                                     169,000            60,000
     Valuation allowance                               (41,714,000)      (21,129,000)
                                                      -------------------------------
     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>
                                                          1996            1995
                                                      -------------------------------
     <S>                                              <S>                <C>
     Expected federal benefit                         $ (8,016,000)     $ (7,836,000)
     State tax, net of federal benefit                    (699,000)         (691,000)
     Other                                                 (42,000)         (116,000)
     Increase in valuation allowance                    20,585,000         8,643,000
     Increase in valuation allowance of acquired
     foreign subsidiary                                (11,828,000)                -
                                                      -------------------------------
                                                      $          -      $          -
                                                      -------------------------------
</TABLE>

(13) RESTRUCTURING AND OTHER CHARGES

     In late 1995 and throughout 1996, 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 $1,334,661 in 1996 and $391,834 in
     1995. 1995 charges reflect severance costs associated with a management
     reorganization in late 1995. 1996 charges consist of approximately $580,000
     for severance costs related to continued restructuring of the management
     team in early 1996 and a work force reduction in November, $450,000 for the
     write-off of purchased in-process research and development created from the
     BSL acquisition, and $300,000 for the write-down of excess and obsolete
     equipment, resulting from the work force reductions and process changes.

(14) RELATED PARTY TRANSACTIONS

     Certain equipment used by the Company is leased under a sublease
     arrangement with FIM, an entity that is related to the Company through
     stockholders. FIM leases the
<PAGE>

     equipment from an unrelated entity. The Company pays FIM an amount equal to
     FIM's lease payments. The leases are accounted for as capital leases.

     Payments on leases of equipment, under the arrangement with FIM discussed
     above, are 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>
                                        1996           1995           1994
                                     -------------------------------------
     <S>                             <C>               <C>            <C>
     Customer A                           -              14%            -
     Customer B                           -              -             27%
     Customer C                           -              -             18%
</TABLE>

     The Company's export sales (i.e. sales to unaffiliated customers outside of
     the U.S.) were $1,248,915, $318,219, and $100,639 for the years ended
     December 31, 1996, 1995, and 1994, respectively. These sales were primarily
     in Europe and Asia.

     Information regarding operations in different geographies for the year
     ended December 31, 1996 is as follows:

<TABLE>
<CAPTION>
                                                   United                    Adjustments
                                                   States      Europe     and eliminations   Consolidated
                                              ------------------------------------------------------------
     <S>                                      <C>            <C>          <C>                <C>
     Sales to unaffiliated customers          $  3,566,952   $  278,743   $    (48,879)      $  3,796,816
     Operating loss                            (23,531,879)    (257,952)         7,620        (23,782,211)
     Other income (expense)                        214,255       (7,138)          -               207,117
     Net loss                                  (23,317,624)    (265,090)         7,620        (23,575,094)

     Identifiable assets at December 31, 1996   22,866,059    8,172,640     (6,980,060)        24,058,639
</TABLE>

     The Company did not have operations outside of the United States prior to
     1996.

(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 $412,295, $376,558
     and $337,254 for the years ended December 31, 1996, 1995, and 1994,
     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, 1996:
<PAGE>

<TABLE>
<CAPTION>
     <S>                                    <C>
     Year ending December 31:
       1997                                 $    442,705
       1998                                      395,028
       1999                                      361,045
       2000                                      246,442
       2001                                      186,229
                                            ------------

          Total minimum lease payments      $  1,631,449
                                            ------------
</TABLE>

(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). The Company has 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 technology and other
     intangible assets totaling $2,305,899.

     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.

(19) SUBSEQUENT EVENT

     In January 1997, the Company completed a private placement of 750,000
     shares of Series I Junior Participating Convertible Preferred Stock at
     $16.00 per share, resulting in net proceeds to the Company of approximately
     $11.9 million. Each share of Preferred Stock will automatically convert
     into four shares of common stock upon shareholder approval of additional
     authorized common shares. In addition, each purchaser received a warrant to
     purchase one share of common stock, at a purchase price of $5.062, for each
     share of Preferred Stock purchased, providing additional future funding
     potential of approximately $3.8 million. The warrants can be exercised at
     any time during the five year period ending January 29, 2002. Additionally,
     the Company can call the warrants and require their exercise, after a six
     month waiting period, if the Company's Common Stock trades for any
     consecutive 20 trading days at $7.062 or greater in the first 12 months, or
     $8.50, $9.00, $9.50 and $10.00 in each subsequent year, respectively.

     The Company expects to use the net proceeds from this private placement for
     product development, sales and marketing and other general corporate
     purposes.
<PAGE>

(20) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

<TABLE>
<CAPTION>
                                         First       Second        Third          Fourth
                                       Quarter      Quarter      Quarter         Quarter
                                    -----------------------------------------------------
     1996
     <S>                            <C>          <C>          <C>          <C>
       Net sales                    $   609,571  $   583,530  $   669,848  $   1,933,867
       Gross profit (loss)           (1,681,794)  (1,534,417)  (1,442,690)    (1,135,641)
       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)

     1995
       Net sales                    $   332,767  $   310,176  $   377,708  $     586,724
       Gross profit (loss)           (1,250,774)  (1,294,328)  (1,302,464)    (3,340,212)
       Operating loss                (4,889,945)  (4,982,599)  (5,161,202)    (8,353,155)
       Net loss                      (4,891,269)  (4,996,918)  (5,096,393)    (8,061,734)
       Net loss per common share          (0.45)       (0.44)       (0.38)         (0.54)
</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, 1996 and 1995, and the related
consolidated statements of operations, common shareholders' equity (deficit) and
cash flows for each of the years in the three-year period ended December 31,
1996. 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 the Company as of
December 31, 1996 and 1995, and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 1996, in
conformity with generally accepted accounting principles.



                                              /s/ KPMG Peat Marwick LLP

Minneapolis, Minnesota
January 24, 1997
<PAGE>

SHAREHOLDER INFORMATION

  STOCK LISTING

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

  STOCK TRANSFER AGENT

  Norwest Bank Minnesota, N.A.
  Stock Transfer Department
  161 North Concord Exchange
  P.O. Box 738
  South St. Paul, MN 55075-0738

  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
  7, 1997, at 3:30 p.m. at the Hilton Hotel & Tower, 1001 Marquette Avenue,
  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 Stock Market were:

<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

<CAPTION>
                                                  1995
                                             High      Low
----------------------------------------------------------------
<S>                                         <C>      <C>
First Quarter                               $ 8 7/8  $  4 7/8
Second Quarter                               10 1/4     4 15/16
Third Quarter                                13 3/8     8 1/4
Fourth Quarter                               11 1/2     4 3/8
</TABLE>

  There were 440 common shareholders of record and the Company estimates
  approximately 4200 shareholders holding stock in "street name" accounts as of
  December 31, 1996.  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

  Diametrics Medical Incorporated
  2658 Patton Road
  St. Paul, Minnesota 55113
  Phone: (612) 639-8035