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

                                   FORM 10-K

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

For the year ended December 31, 1997              Commission File Number 0-13617

                            LIFELINE SYSTEMS, INC.
            (Exact name of registrant as specified in its charter)

        MASSACHUSETTS                                        04-2537528
     (State or other jurisdiction of                      (I.R.S. Employer
     incorporation or organization)                      Identification No.)

  640 MEMORIAL DRIVE, CAMBRIDGE, MASSACHUSETTS               02139-4851
     (Address of principal executive offices)                (Zip Code)

                                (617) 679-1000
             (Registrant's telephone number, including area code)
             ----------------------------------------------------

Securities registered pursuant to Section 12(b) of the Act:  NONE
Securities registered pursuant to Section 12(g) of the Act:

                         Common stock $0.02 par value
                         ----------------------------
                               (Title of Class)

Indicate by check mark whether the registrant (i) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (ii) has been subject to such filing
requirements for the past 90 days.  Yes   X    No _____
                                        -----    

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]

As of February 27, 1998, 5,792,862 shares of the Registrant's Common Stock were
outstanding and the aggregate market value as of such date of such Common Stock
held by non-affiliates of the Registrant was approximately $125,300,000.

                              __________________

                      DOCUMENTS INCORPORATED BY REFERENCE

(1)  Portions of the Registrant's proxy statement for the Annual Meeting of
     Stockholders to be held on May 20, 1998 are incorporated by reference into
     Part III hereof.

Exhibit index is located on pages 40 through 44 of this Report.
<PAGE>
 
                                    PART I


ITEM 1.   BUSINESS

  GENERAL

     Lifeline Systems, Inc. (the "Company") provides 24-hour personal response
  monitoring services to its subscribers, primarily elderly individuals with
  medical or age-related conditions as well as physically challenged
  individuals. These subscribers communicate with the Company through products
  designed, manufactured and marketed by the Company, consisting principally of
  a communicator which connects to the telephone line in the subscriber's home
  and a personal help button, which is worn or carried by the individual
  subscriber and which, when activated, initiates a telephone call from the
  subscriber's communicator to the Company's central monitoring facilities. The
  Company believes it is a major provider of such services.

  BUSINESS DEVELOPMENTS

     In November, 1997, the Company entered into a ten-year lease for an 84,000
  square foot facility in Framingham, MA which will serve as its corporate
  headquarters. The Company intends to move from its current headquarters to
  this facility in late 1998. Annual rental payments under the lease approximate
  $775,000. The lease contains two five-year options to renew at the end of the
  initial lease term. The Company is currently evaluating possible alternatives
  to minimize the remaining obligations under its existing lease.

     In December, 1997, the Company announced a one-time reorganization charge
  of approximately $4.3 million, or $0.43 per diluted share on an after-tax
  basis, to account for its approximately $11 million investment in technology
  for a new call center platform, the relocation of the Company's corporate
  headquarters from its current Cambridge, MA facility to a new facility in
  Framingham, MA, and other initiatives to lower operating costs. The
  reorganization charge reflected costs associated with decommissioning the
  current call center system, rental commitments and other costs associated with
  its current facility, employee severance and benefits, and the write down of
  impaired goodwill.

  INDUSTRY SEGMENTS

     The Company operates in one industry segment. Its operations consist of
  providing personal response services associated with those products it
  designs, manufactures, and markets. Foreign revenues, from Canada, comprised
  less than 10% of the Company's total revenues in 1997, and the Company has no
  significant tangible assets in foreign countries.

  THE LIFELINE SERVICE

     The Company's principal offering, called LIFELINE(R), consists of a
  monitoring service utilizing equipment manufactured by the Company. The
  Company's monitoring service is a personal response service which provides 24-
  hour monitoring and personalized support to elderly individuals with medical
  or age-related conditions and to physically challenged individuals throughout
  the United States and Canada. Through use of the LIFELINE service, individuals
  in need of help are able to signal monitoring personnel in one of the
  Company's response centers. These trained monitors identify the nature and
  extent of the

                                      -2-

<PAGE>
 
  subscriber's particular need and manage the situation by notifying the
  subscriber's friends, neighbors, and/or emergency personnel, as set forth in a
  predetermined protocol established by the subscriber. The Company also offers
  a supportive home monitoring service which emphasizes social support for
  elderly individuals who live alone.

     The equipment used for the LIFELINE service includes a communicator, which
  connects to the telephone line in the subscriber's home and a personal help
  button, which is worn or carried by the individual subscriber. When pressed,
  the personal help button sends a radio signal to the communicator; the
  communicator automatically dials a response center where monitoring personnel
  answer the call and dispatch the designated responders, typically a friend or
  relative of the subscriber and/or emergency service, when help is needed. Most
  of the time, however, subscribers' calls require reassurance and support as a
  result of isolation or loneliness.

     The Company's primary monitoring center in Cambridge, Massachusetts is
  supported by its proprietary CORMIS software,. CORMIS receives incoming
  signals from subscribers' communicators, matches and retrieves the appropriate
  subscriber data records from a central database, and routes both the call and
  the data record to monitoring personnel in the Lifeline Response Center. The
  Company has made a significant investment in a new call center platform to
  replace CORMIS. This new call center platform is expected to become
  operational in late 1998.

     In the past, the Company offered its customers, typically healthcare
  providers which established their own Lifeline programs, two alternatives for
  providing the LIFELINE monitoring service: they could utilize the Lifeline
  Response Center to perform their monitoring or they could perform their own
  monitoring locally using equipment and software manufactured by the Company.
  Although the Company continues to service equipment for customers who perform
  their own monitoring, the Company no longer markets the equipment necessary
  for new providers to monitor their own subscribers. New providers outsource
  their monitoring activities to a Lifeline monitoring center to service their
  subscribers.

     Lifeline also provides its local programs with a comprehensive set of
  monitoring and business support services which reduce the program management
  responsibilities and administrative burden associated with a local monitoring
  center. In addition, the Company also provides the LIFELINE service directly
  to subscribers in the United States and to subscribers in Canada who do not
  have access to a local Lifeline program.

     The Company offers several versions of its communicators. All models
  currently available provide two-way voice communication over a speaker between
  the subscriber and the response center as well as other features. All of the
  Company's current models also offer the RSVP feature, which allows the
  subscriber to answer routine telephone calls by pushing the personal help
  button. The Company believes that the product line offers customers
  flexibility in terms of price and functionality.

  CUSTOMERS

     The Company primarily markets its services and products to hospitals,
  institutions, and other service providers in a variety of healthcare related
  fields. Hospitals, however, have historically been the Company's primary
  market. The Company believes that hospitals offer Lifeline's services and
  products to capture revenues from the sale of the service, improve healthcare
  for the communities they serve, enhance community relations, market other
  hospital services to the subscriber base, and/or contain healthcare costs by
  facilitating early discharge from the hospital and reducing the need for
  nursing home care.

                                      -3-
<PAGE>
 
  SALES AND MARKETING

     The Company sells its services and products through a direct sales
  organization in the United States and Canada.

     In support of the sales effort, the Company's sales professionals assist
  the Company's institutional customers in developing a marketing plan for the
  Lifeline program, monitoring progress against that plan, and providing
  training to the customer's staff on the management of their local Lifeline
  program. Programs' marketing plans typically address the introduction of
  Lifeline's services to key decision makers and service providers within the
  customer's organization; the planning and delivery of presentations to
  community responders such as police, fire, and medical emergency
  professionals; and the development of local referral networks of elder care
  and other service organizations to position the LIFELINE service as part of a
  continued care plan. Lifeline personnel also provide continuing operational
  support, ongoing consultation, and program evaluations.

  SOURCE OF RAW MATERIALS

     The Company manufactures all of its products, relying on outside vendors
  for components and enclosures. Any difficulties in obtaining these parts will
  have a direct effect on the Company's ability to meet shipment targets.
  Although the Company does generally have two or more suppliers for its
  proprietary components, it has no assurance that it will not encounter
  component shortages in the future, which may adversely affect the results of
  operations.

  PATENTS, LICENSES AND TRADEMARKS

     The Company considers its proprietary know-how with respect to the
  development, manufacture, and marketing of its personal response services to
  be a valuable asset. Due to rapid technological changes that characterize the
  industry, the Company believes that continued development of new services and
  products, the improvement of existing services and products, and patent and
  license protection are important in maintaining a competitive advantage.

     Although the Company owns numerous patents and patent applications in the
  United States, Canada, and other countries, the Company does not believe that
  its business as a whole is or will be materially dependent upon the protection
  afforded by its patents.

     The Company's LIFELINE trademark and servicemark are registered at the
  United States Patent and Trademark Office and in most states and some foreign
  countries. The Company also has a number of other trademarks.

  RESEARCH AND DEVELOPMENT

     Research and development continues to be an important strategic element for
  the Company and is geared toward enhancing and augmenting the Company's
  products and services. Research and development expenses were $1,709,000,
  $1,771,000, and $1,701,000, for the years ended December 31, 1997, 1996, and
  1995, respectively.

                                      -4-
<PAGE>
 
  BACKLOG/SEASONALITY

     Because of the nature of the Company's products, it endeavors to minimize
  the time which elapses from the receipt of a purchase order to the date of
  delivery of the products. Accordingly, the Company's backlog as of the end of
  any period represents only a portion of the Company's expected sales for the
  succeeding period and is not significant in understanding the Company's
  business. The Company does not believe that the industry in which it operates
  is seasonal.

  GOVERNMENT REGULATION

     The Company's products are registered with the Federal Communication
  Commission ("FCC") and comply with FCC regulations pertaining to radio
  frequency devices (Part 15) connected to the telephone system (Part 68). The
  Company has also received registrations of equipment from Canadian agencies.
  As new models are developed, they are submitted to appropriate agencies as
  required.

     The Company has registered its communicator products with the United States
  Food and Drug Administration.

     None of the Company's business is subject to renegotiation of profits or
  termination of contract by the government, nor is it impacted by any existing
  environmental laws.

  COMPETITION

     The Company believes that it is a major provider of personal response
  services and products. Other companies offer services and products competitive
  with those offered by the Company. These companies offer personal response
  services on a regional or national basis through both healthcare providers and
  directly to the subscribers themselves.

     Although price is a competitive factor, the Company believes that its
  customers' main considerations in choosing a personal response service are the
  high quality of service and product performance and reliability; customer
  support and service; and reputation and experience in the industry. The
  Company believes it competes favorably with respect to these factors.

  EMPLOYEES

     As of February 28, 1998 the Company employed approximately 535 full-time
  and permanent part-time employees. None of the Company's employees is
  represented by a collective bargaining unit, and the Company believes its
  relations with its employees are good.


ITEM 2.   PROPERTIES

     The Company leases a portion of a facility in Cambridge, Massachusetts
  which serves as its corporate headquarters including its manufacturing and
  U.S.-based monitoring operations. The lease includes two five-year options to
  renew at the end of the initial ten-year lease term. The Company leases
  facilities in other locations to support its field and Canadian operations.

                                      -5-
<PAGE>
 
     In November, 1997, the Company entered into a ten-year lease for an 84,000
  square foot facility in Framingham, MA for its corporate headquarters. The
  Company intends to occupy this new facility in late 1998 and to vacate its
  Cambridge facility at that time. Annual rental payments under the lease
  approximate $775,000. The lease contains two five-year options to renew at the
  end of the initial lease term. The Company is currently evaluating possible
  alternatives for its existing lease.


ITEM 3.   LEGAL PROCEEDINGS

  The Company is not party to any material litigation.

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

  None.

  EXECUTIVE OFFICERS OF THE REGISTRANT

  The following table sets forth certain information regarding the executive
officers of the Company as of December 31, 1997:

<TABLE>
<CAPTION>
       Name                             Position                      Age
------------------  ------------------------------------------------  ---
<S>                 <C>                                               <C>
 
L. Dennis Shapiro   Chairman of the Board                              64   
Ronald Feinstein    President, Chief Executive Officer                      
                    and Director                                       51   
Dennis M. Hurley    Vice President, Finance,                                
                    Chief Financial Officer, Treasurer                 51   
Heather E. Edelman  Vice President, Human Resources                    50   
John D. Gugliotta   Vice President, Operations                         50   
Thomas E. Loper     Vice President, Customer Care                      48   
Richard M. Reich    Vice President, Technology and Advanced Services   50   
Donald G. Strange   Vice President, Sales and Marketing                51   
Norman B. Asher     Clerk                                              71   
</TABLE>

  L. Dennis Shapiro, Chairman of the Board, has served the Company in this
capacity since 1978, and at various times, has served as President and Chief
Financial Officer.

  Ronald Feinstein became an employee of the Company in September, 1992 and
became Executive Vice President and Chief Operating Officer in October, 1992. He
was appointed President and Chief Executive Officer in January, 1993. Mr.
Feinstein has served as a director of the Company since 1985. From January, 1991
until September, 1992, he was President and Chief Executive Officer of
International Business Interiors.

  Dennis M. Hurley joined the Company in March, 1995 as Vice President, Finance;
Chief Financial Officer; and Treasurer. From November, 1994 to February, 1995,
Mr. Hurley was Corporate Controller for C.P. Clare Corp. which is an electronics
manufacturer. From 1977 to 1994, Mr. Hurley held various senior financial
management positions with Avery Dennison, most recently as Group Controller for
the Office Products Group.

                                      -6-
<PAGE>
 
  Heather E. Edelman joined the Company in June, 1993 as Vice President, Human
Resources. From 1989 through 1992, Ms. Edelman was Manager, Human Resources
Programs for ROLM, which manufactures, markets and services telecommunications
products and services.

  John D. Gugliotta has been Vice President, Operations since June, 1990. Mr.
Gugliotta had served as Vice President, Manufacturing since he joined the
Company in August, 1987.

  Thomas E. Loper serves as Vice President, Customer Care. He joined the Company
in September, 1995 as Vice President, Subscriber Services. From 1993 until 1995,
Mr. Loper served as Area Vice President for Herman Miller, manufacturer of
office furniture. Prior to that, he was President of Business Interiors, a
division of International Business Interiors, from 1991 until 1993.

  Richard M. Reich has been Vice President, Technology and Advanced Services
since August, 1994. From June, 1990 to August, 1994, Mr. Reich had served as
Vice President, Product Planning and Development. Since joining the Company in
April, 1986 he had held the position of Vice President, Engineering.

  Donald G. Strange is the Vice President, Sales and Marketing. He joined the
Company in February, 1993 as Vice President, Sales. From September, 1992 to
January, 1993, Mr. Strange was Senior Vice President and General Manager of
American Distribution System, which manages the distribution of prescription
drugs and controlled substances. From 1969 to 1992, he was employed by Hoffman-
La Roche, Inc., where he held various management positions in sales and
marketing, most recently as National Director of Sales for its Roche Home
Healthcare Services division.

  Norman B. Asher has been the Clerk of the Company since July, 1978 and from
1965 until December, 1997 was a partner of the law firm of Hale and Dorr LLP,
which has been general counsel to the Company since 1976.

                                      -7-
<PAGE>
 
                                    PART II

ITEM 5.   MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
          MATTERS


Quarterly Market Information and Related Matters

The Company's common stock is traded on the Nasdaq Stock Market under the symbol
"LIFE." On February 27, 1998, the Company had 473 shareholders of record.

The table below reflects the high and low sales prices for 1997 and 1996.

<TABLE> 
<CAPTION> 
                                                            High         Low
<S>                                                      <C>          <C> 
1997      First Quarter                                  $  19.13     $  16.50
          Second Quarter                                    20.50        16.00
          Third Quarter                                     20.50        17.00
          Fourth Quarter                                    25.25        18.00

1996      First Quarter                                  $  12.75     $  10.50
          Second Quarter                                    14.63        11.88
          Third Quarter                                     19.25        11.50  
          Fourth Quarter                                    20.50        15.00
</TABLE> 

During the periods presented, the Company has not paid or declared any cash 
dividends on its common stock. While the payment of dividends is within the 
discretion of the Company's Board of Directors, the Company presently expects to
retain all of its earnings for use in financing the future growth of the 
Company.

The Company from time to time issues shares to its employees as part of its
bonus program. In 1997, a total of 500 shares were issued under this program.

                                      -8-
<PAGE>
 
ITEM 6.   SELECTED FINANCIAL DATA

Selected Financial Data

<TABLE> 
<CAPTION> 
                                                  Years Ended December 31,
                                        ------------------------------------------------ 
(In thousands, except per share data)    1997      1996     1995      1994      1993 
                                         ----      ----     ----      ----      ----
<S>                                     <C>        <C>      <C>       <C>       <C>        
OPERATING RESULTS

     Total revenues                     $ 56,964  $ 50,223  $ 43,379  $ 36,141  $ 30,059
     Income before taxes                   3,921     7,078     5,505     3,413     1,870    
     Net income                            2,298     4,176     3,148     1,980     1,085
     Net income per share, diluted      $   0.37  $   0.67  $   0.51  $   0.34  $   0.19      
     Diluted weighted average
      shares outstanding                   6,232     6,197     6,115     5,776     5,680  
</TABLE> 


FINANCIAL POSITION(1)

<TABLE> 
<CAPTION> 
                                                       December 31,
                                        ------------------------------------------------ 
                                         1997      1996     1995      1994      1993  
                                         ----      ----     ----      ----      ---- 
<S>                                     <C>        <C>      <C>       <C>       <C>  
     Working capital                    $ 12,320  $ 14,003  $ 15,253  $ 14,971  $ 10,469 
     Total assets                         42,269    37,909    31,961    28,883    28,327
     Long-term debt                           16        25        32        85       397
     Stockholders' equity                 29,717    27,620    24,289    21,208    19,421
</TABLE> 

(1)  There were no cash dividends paid or declared during any of the periods
     presented.

                                      -9-
<PAGE>
 
ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
          FINANCIAL CONDITION

This and other reports, proxy statements, and other communications to
stockholders, as well as oral statements by the Company's officers or its
agents, may contain forward-looking statements within the meaning of Section 21E
of the Securities Exchange Act of 1934, as amended, with respect to, among other
things, the Company's future revenues, operating income, or earnings per share.
Without limiting the foregoing, the words "believes," "anticipates," "plans,"
"expects," and similar expressions are intended to identify forward-looking
statements. There are a number of factors of which the Company is aware that may
cause the Company's actual results to vary materially from those forecast or
projected in any such forward-looking statement. These factors include, without
limitation, those set forth below under the caption "Certain Factors That May
Affect Future Results." The Company's failure to successfully address any of
these factors could have a material adverse effect on the Company's future
results of operations.

RESULTS OF OPERATIONS

1997 Compared with 1996

Total revenues for the year ended December 31, 1997 were $57.0 million, an
increase of 14% compared with the $50.2 million recorded in 1996.

Service revenues grew to $32.0 million of the Company's total revenues for the
year ended December 31, 1997, compared to $24.2 million for the prior year.
Service revenues comprised 56% of the Company's total revenues in 1997 up from
48% in 1996. This increase in revenue reflects the continued success of the
Company's strategy to focus on subscriber growth and recurring service revenues.
As a result, there was a 26% growth in the number of subscribers the Company
monitored to approximately 196,000 at December 31, 1997 from approximately
156,000 at December 31, 1996. The increase in subscribers continues to be driven
principally by conversions of locally-monitored programs to centralized
monitoring provided by the Lifeline Response Center and growth of the Company's
existing programs. The increase in service revenues was also favorably impacted
by the Company's strategy of packaging products and services into a single
service offering, which resulted in higher per-subscriber service revenue. The
Company's ability to sustain the current level of service revenue growth depends
on its ability to expand the market for its personal response services and
convert additional locally-monitored programs to monitoring service provided
directly by Lifeline. The Company believes that the high quality of its services
and its commitment to providing caring and rapid response to the at-risk elderly
and physically challenged will be a factor in meeting this challenge.

Net product revenues totaled $23.8 million during 1997, representing a 4%
decrease over net product revenues in 1996 of $24.9 million. The decrease in
1997 was a result of the decline in the average selling price from 1996 levels
because of a change in product mix sold to lower priced products coupled with
volume discounts. In January, 1997, the Company introduced the Classic
Pendant(TM), a new personal help button designed with particular emphasis on its
fashion appeal. This new button did not have a material impact on 1997 product
revenue. The Company expects continued declining product sales in future periods
as it continues with the strategy of packaging products and services into a
single service offering.

Finance and rental income, representing income earned from the Company's
portfolio of sales-type leases, was consistent in 1997 with the $1.1 million
recorded in the previous year. While customers continue to take advantage of the
Company's leasing program, there was an unusually high number of leases expiring
during the year ended December 31, 1996 that resulted in higher rental income in
the prior year. Rental income is derived from the short-term rental of equipment
from expired leases until such time the equipment is returned to the

                                     -10-
<PAGE>
 
Company. The decline in rental income in 1997 was offset in part by an increase
in finance income from leases maintained in the Company's portfolio which led to
the consistent level achieved. The Company believes that the retention of new
leases in its own portfolio will increase finance income in future years.

Cost of services, as a percentage of service revenues, increased to 47% for the
year ended December 31, 1997 from 42% for the year ended December 31, 1996. The
Company's continued investment in personnel and systems enhancements in support
of its current service infrastructure has resulted in higher cost of services in
1997. These expenditures have enabled the Company to continue to provide a high
level of service to its increasing subscriber base. As the Company grows its
subscriber base and further develops its monitoring capabilities, it continues
to make capital expenditures on a new response center platform at its corporate
headquarters. Total expenditures for the Company's information systems
infrastructure at its primary monitoring facility are expected to be
approximately $11 million, of which approximately $7.5 million was expended
during 1997. These expenditures did not have an impact on 1997 results of
operations since the platform is expected to be placed in service in late 1998.
However, cost of services in future years is expected to be impacted by the
depreciation of these investments.

For the year ended December 31, 1997, cost of product sales as a percentage of
product sales was 28%, versus 33% in the prior year. The improvement is largely
attributable to continued utilization of new technology which reduced material
costs, improvements in manufacturing processes, and the enhanced reliability of
the Company's product which reduced the warranty costs compared to 1996 levels.

Selling, general, and administrative expenses as a percentage of total revenues
improved to 45% for the year ended December 31, 1997 from 47% for the year ended
December 31, 1996. The $2.0 million increase in actual expenses year-over-year
was primarily attributable to the Company's larger employee base in 1997. This
resulted in an increase in salaries and related fringe benefits as compared to
the year ended December 31, 1996. Also, increased spending associated with the
Company's employee recruitment efforts, higher operating costs for the Company's
corporate headquarters, enhancements related to information systems, and the
inclusion of a full year of costs associated with the July, 1996 acquisition of
CareTel, Inc. of Ontario, Canada attributed to the overall increased spending in
1997.

Research and development expenses represented 3% of revenues in 1997 versus 4%
in 1996. Research and development efforts are focused on ongoing product
improvements, and the Company expects to maintain these expenses, as a
percentage of total revenues, at a relatively consistent level.

In December, 1997, the Company announced a one-time reorganization charge of
approximately $4.3 million, or $0.43 per diluted share on an after-tax basis to
account for its approximately $11 million investment in technology for a new
call center platform, the relocation of the Company's corporate headquarters
from its current Cambridge, MA facility to a new facility in Framingham, MA, and
other initiatives to lower operating costs. As a result, the Company incurred a
$4.3 million pre-tax charge to operations for the year ended December 31, 1997.
The charge covered $304,000 of costs associated with the write down to fair
value of certain call center fixed assets, $1.2 million of costs for the write-
down to fair value of certain leasehold improvements and lease commitments on
its current facility, $150,000 of costs associated with the write down to fair
value of equipment made obsolete from prior years' acquisitions, $842,000 of
costs for employee severance and related benefits, and $1.8 million for the
write down of impaired goodwill.

                                     -11-

<PAGE>
 
The Company's effective tax rate was 41.4% for 1997, as compared to 41% in 1996.
The increase in the Company's rate was largely attributable to the
nondeductibility of the write down of the Canadian portion of goodwill and a
higher Canadian tax rate.

1996 Compared with 1995

Total revenues for the year ended December 31, 1996 were $50.2 million, an
increase of 16% compared with the $43.4 million recorded in 1995.

Service revenues represented $24.2 million of the Company's total revenues for
the year ended December 31, 1996, compared to $18.6 million for the prior year.
This 30% increase in service revenues was driven primarily by a 30% increase in
subscribers, to approximately 156,000 at December 31, 1996, from nearly 120,000
at the end of 1995. Service revenues comprised 48% of the Company's total
revenues in 1996 compared to 43% in 1995 which was consistent with the Company's
continued transition to a service-oriented business, with its focus on
developing its base of subscribers and generating recurring service revenues.
The increase in subscribers in 1996 was driven by conversions of locally-
monitored programs to centralized monitoring by the Company, growth of the
Company's existing programs, and by the Company's acquisition of CareTel, Inc.
in July, 1996 which contributed nearly 3,000 subscribers.

Net product revenues totaled $24.9 million during 1996, representing a 6%
increase over product revenues in 1995 of $23.4 million. The 1996 results
benefited from an entire year of sales of the CarePartner(TM) line, the first
models of which were introduced in September, 1995. The increase in volume
attributed to this line was partially offset by a decline in the average selling
price. The average selling price decreased because of product and service price
offerings in support of the Company's strategy to grow recurring service revenue
while maintaining product sales. The Company introduced the CarePartner
Telephone(TM) during the third quarter of 1996, which replaced the Company's
CommuniCatorPlus(TM). This version of the Company's full-function speaker
telephone incorporates digital speech technology, called VoiceAssist(TM), which
provides special features for those with visual or hearing limitations,
clarifies alarm messages, and instructs users in a friendly, reassuring manner.
This product did not have a material impact on 1996 product revenues.

Finance and rental income, representing income earned from the Company's
portfolio of sales-type leases, decreased $.2 million to $1.1 million in 1996
from $1.3 million in 1995. The decline was attributable to the overall aging of
the lease portfolio existing when the Company transitioned to an arrangement
with a third-party leasing agent, beginning in January, 1994. Although this
arrangement provided cash flow benefits during 1994 and 1995, in January, 1996
the Company terminated this arrangement and introduced a more customer-focused,
internally managed and funded leasing program.

Cost of services, as a percentage of service revenues, increased to 42% for the
year ended December 31, 1996 from 40% for the year ended December 31, 1995. The
increased cost was attributable to the Company's investment in personnel and
systems supporting its growing service infrastructure. As the Company grows its
subscriber base and develops its monitoring capabilities, it expects to continue
to invest in its service infrastructure to enhance its ability to provide caring
service for its subscribers. These investments are expected to be directed
primarily toward systems enhancements and improvements.

For the year ended December 31, 1996, cost of product sales as a percentage of
product sales was 33%, versus 36% in the prior year. This decrease was due
largely to improvements in manufacturing processes and the application of new
technology which reduced product costs.

                                     -12-

<PAGE>
 
Selling, general, and administrative expenses as a percentage of revenues
decreased slightly to 47% for the year ended December 31, 1996 from 48% for the
year ended December 31, 1995. The dollar increase in actual expenses to $23.9
million in 1996 from $21.0 million in 1995 was largely attributable to
expenditures related to enhancements to information systems, salaries, and
related fringe benefits due to the overall increase of the Company's employee
base; market development and promotional strategies aimed at the healthcare
channel and related referral networks; and the additional administrative
expenses associated with the acquisition of CareTel, Inc. in the third quarter
of 1996.

Research and development expenses represented 4% of revenues in 1996 and in
1995. Research and development efforts are focused on ongoing product
improvements.

The Company's effective tax rate was 41% for 1996, as compared to 43% in 1995.
The reduction in the Company's rate was largely due to the impact of tax-exempt
income from the Company's marketable securities portfolio and utilization of a
subsidiary with favorable tax status.

LIQUIDITY AND CAPITAL RESOURCES

During the year ended December 31, 1997, the Company's portfolio of cash, cash
equivalents, and investments decreased $5.4 million to $7.9 million at December
31, 1997 from $13.3 million at December 31, 1996. The net decrease resulted from
continued expenditures for the Company's information systems infrastructure. The
Company anticipates it will spend approximately $11.0 million as it develops a
flexible, scaleable, and fault tolerant response center platform at its primary
monitoring facility to support its growing subscriber base. While the new
platform will be placed in service after 1997, approximately $7.5 million was
expended during 1997, principally pursuant to development agreements entered
into with third party vendors. In addition, the Company used $1.6 million, net
of cash received on leases, to fund its internal leasing program, as compared to
$1.2 million in 1996, and a generation of $2.9 million of cash in 1995 from
payments received from the Company's existing portfolio of sales-type leases.
Also, during 1997 the Company invested $2.8 million in equipment purchases for
use in the development and manufacture of its products and services, as well as
for Company-owned equipment provided directly to customers under comprehensive
service agreements and to subscribers not serviced by local Lifeline programs.
Total expenditures were offset, in part, by the Company's profitable operations
in 1997.

In November, 1997, the Company entered into a ten-year lease for an 84,000
square foot facility in Framingham, MA for its corporate headquarters. The
Company intends to occupy this new facility in late 1998. Annual rental payments
under the lease approximate $775,000. The lease contains two five-year options
to renew at the end of the initial lease term. The Company is currently
evaluating possible alternatives for its existing lease. The Company expects
that it will incur capital expenditures associated with the move.

In January, 1997, the Company's Board of Directors approved the repurchase of up
to 100,000 shares of the Company's common stock from time to time in the open
market for general corporate purposes. The Company purchased 60,700 shares
directly from its Chief Executive Officer during 1997 for $1.1 million as part
of this program. These shares were purchased from the Chief Executive Officer
partly in connection with the repayment of a $250,000 note receivable and
associated tax expenses.

In November, 1995, the Company secured a $4.0 million line of credit effective
in January, 1996. During 1997, the term of the credit facility was extended
until March, 1998. This credit agreement contains a number of covenants,
including requirements that the Company maintain certain levels of financial
performance and capital structure, limitations on the Company's capital and
other expenditures, and restrictions on the 

                                      -13-
<PAGE>
 
Company's capacity to secure additional debt financing. No amounts were
outstanding as of December 31, 1997. The Company is currently in the process of
renegotiating a new line of credit.

The Company expects that funding requirements for operations and in support of
future growth are expected to be met primarily from operating cash flow and
existing cash and marketable securities. The Company expects these sources will
be sufficient to finance the cash needs of the Company through 1998 including
the continued investment in its new response center platform, the 1998 move to
new corporate headquarters, the 1998 requirements of its internally funded lease
financing program and stock repurchases, any potential acquisitions, and other
investments in support of its current business.

In June, 1997 the Financial Accounting Standards Board issued Statement No. 130
("SFAS" 130), "Reporting Comprehensive Income." SFAS 130 requires changes in
comprehensive income to be shown in a financial statement that is displayed with
the same prominence as other financial statements. While not mandating a
specific financial statement format, SFAS 130 requires that an amount
representing total comprehensive income be reported. SFAS 130 will become
effective for fiscal years beginning after December 15, 1997. Reclassification
of financial statements for earlier periods is required for comparative
purposes. The Company does not believe that the adoption of SFAS 130 will have a
material impact on results of operations.

In June, 1997, the Financial Accounting Standards Board issued Statement No. 131
("SFAS" 131), "Disclosures about Segments of an Enterprise and Related
Information." SFAS 131, which supersedes Statement No. 14, "Financial Reporting
for Segments of a Business Enterprise," changes the way public companies report
information about segments. SFAS 131, which is based on the management approach
to segment reporting, includes requirements to report segment information
quarterly and entity-wide disclosures about products and services, major
customers, and the material countries in which the entity holds assets and
reports revenues. SFAS 131 is effective for fiscal years beginning after
December 15, 1997. Restatement for earlier years is required for comparative
purposes unless impracticable. In addition, SFAS 131 need not be applied to
interim periods in the initial year; however, in subsequent years, interim
period information must be presented on a comparative basis. The Company does
not believe that the adoption of SFAS 131 will have a material impact on
financial statement disclosures.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

The following important factors, among others, could cause actual results to
differ materially from those indicated by forward-looking statements made in
this Annual Report on Form 10-K and presented elsewhere by management from time
to time.

The Company's results are partially dependent on its ability to develop services
and products that keep pace with continuing technological changes, evolving
industry standards, changing subscriber preferences and new service and product
introductions by the Company's competitors. Lifeline's future success will
depend on its ability to enhance its existing services and products (including
accessories), to introduce new service and product offerings to meet and adapt
to changing customer requirements and emerging technologies on a timely basis
and to offer such products and services at competitive prices. There can be no
assurance that Lifeline will be successful in identifying, developing,
manufacturing or marketing new services and products or enhancing its existing
services and products on a timely basis or that Lifeline will be able to offer
such services and products at competitive prices. Also, there can be no
assurance that services, products or technologies developed by others will not
render Lifeline's services or products noncompetitive or obsolete.

                                      -14-
<PAGE>
 
The Company may experience risks and uncertainties associated with the
development of new information technology. These include the risks that such
development effort may not be completed on schedule, or at all, or within
budget, or that future developments in information technology will not render
the Company's system non-competitive; the risks that the Company does not
realize the intended benefits from the new system, once completed; and the
uncertainty associated with the substantial commitment of funds to the
development effort, including the risks that the Company will have available
significantly less cash to finance its operations, other capital expenditures
and future growth, including acquisitions.

The Company's growth is dependent on its ability to increase the number of
subscribers served by its monitoring centers. The Company's ability to continue
to increase service revenue is a key factor in its long-term growth, and there
can be no assurance that the Company will be able to do so. The Company's
failure to increase service revenue could have a material adverse effect on the
Company's results of operations.

The Company may expand its operations through the acquisition of additional
businesses. There can be no assurance that the Company will be able to identify,
acquire or profitably manage additional businesses or successfully integrate any
acquired businesses into the Company without substantial expenses, delays or
other operational or financial problems. In addition, acquisitions may involve a
number of special risks, including diversion of management's attention, failure
to retain key acquired personnel, unanticipated events, contingent liabilities
and amortization of acquired intangible assets. There can be no assurance that
the acquired businesses, if any, will achieve anticipated revenues or earnings.

The Company sells a significant portion of its products to healthcare providers
which establish their own Lifeline programs. These healthcare providers
typically rent, rather than sell, the Lifeline products to subscribers and
accordingly following such time as a product is no longer used by a subscriber,
it is returned to the healthcare provider and becomes available for rent to
another subscriber. As a result of this use and reuse of the Company's products,
sales of such products are dependent on growth in the number of subscribers and
on the ability of the Company to encourage its healthcare provider customers to
replace their existing inventory by continuing to enhance its products with new
features.

The Company's monitoring operations are concentrated principally in its
corporate headquarters facility. Although the Company believes that it has
constructed safeguards to protect against system failures, the disruption of
service at its monitoring facility, whether due to telephone or electrical
failures, earthquakes, fire, the 1998 move to new corporate headquarters, or
other similar events or for any other reason, could have a material adverse
effect on the Company's results of operations.

The Company's equipment sales have continued to decline as a result of the
Company's strategy of combining service and hardware offerings to support the
transition to a service oriented business. There can be no assurance that
service revenue will increase at a rate sufficient to offset the expected
decrease in equipment sales.

                                      -15-
<PAGE>
 
IMPACT OF THE YEAR 2000 ISSUE

The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. This could result in
computer programs that have date-sensitive software recognizing a date using
"00" as the year 1900 rather than the year 2000. Such errors could cause a
system failure or miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions, send
invoices, or engage in similar normal business activities.

The Company has implemented a formal Year 2000 program to determine the extent
of its own Year 2000 problems. As part of this program, the Company is in the
process of determining whether its operating systems need modifications to be in
compliance with the Year 2000. The Company has not yet fully assessed the Year
2000 compliance expense and related potential effect on the Company's earnings.
The Company anticipates that any modifications required to be made to its
software systems to comply with the Year 2000 Issue will be completed in a
timely manner. The Company has designed its new call center platform to be in
compliance with the Year 2000.

The Company has also initiated formal communications with significant suppliers
and other key third parties to determine the extent to which the Company is
vulnerable to those third parties' failure to resolve their own Year 2000 issue.
There can be no assurance that the systems of other companies on which the
Company's systems rely will be timely converted, or that a failure to convert by
another company, or a conversion that is incompatible with the Company's
systems, would not have a material adverse effect on the Company's results of
operations.

                                      -16-
<PAGE>
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

<TABLE>
<CAPTION>
(Unaudited)                                                                         Quarter Ended                                   
(Dollars in thousands, except per share data)              Mar 31       Jun 30       Sep 30        Dec 31      Full Year 
<S>                                                       <C>          <C>           <C>          <C>          <C>                 

1997          Total revenues                              $13,556      $14,243       $14,185      $14,980       $56,964             

              Net income (loss)                               955        1,226         1,289       (1,172)        2,298             

              Net income (loss) per share, diluted        $  0.15      $  0.20       $  0.21      $ (0.20)      $  0.37            
                                                                                                                                   
1996          Total revenues                              $11,156      $13,043       $12,755      $13,269       $50,223            
              Net income                                      690        1,065         1,136        1,285         4,176            
              Net income per share, diluted               $  0.11      $  0.17       $  0.18      $  0.21       $  0.67  
</TABLE>


Report of Independent Accountants

To the Stockholders and Board of Directors of Lifeline Systems, Inc.:

We have audited the accompanying consolidated financial statements and financial
statement schedule of Lifeline Systems, Inc. ("The Company") listed in Items
14(a)(1) and 14(a)(2) of this Form 10-K. These financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
the financial statement schedule 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Lifeline Systems,
Inc. as of December 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
In addition, in our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material aspects, the information to be included
therein.


                                           /s/ Coopers & Lybrand L.L.P.
                                           ----------------------------
                                           Boston, Massachusetts
                                           February 9, 1998

                                      -17-
<PAGE>
 
                            LIFELINE SYSTEMS, INC.
                          CONSOLIDATED BALANCE SHEETS
                          DECEMBER 31, 1997 AND 1996
                            (Dollars in thousands)

<TABLE> 
<CAPTION> 
                                                                                                   1997        1996 
                                                                                                   ----        ----  
<S>                                                                                            <C>          <C>      
ASSETS                                                                                                               
Current assets:                                                                                                      
    Cash and cash equivalents                                                                  $  2,019     $  3,030 
    Short-term investments                                                                        5,850        7,140 
    Accounts receivable, net of allowance for doubtful                                                               
       accounts of $216 in 1997 and $197 in 1996                                                  7,406        6,062 
    Inventories                                                                                   1,375        1,450 
    Net investment in sales-type leases                                                           1,444        1,278 
    Prepaid expenses and other current assets                                                     1,045        1,675 
    Deferred income taxes                                                                         2,209        1,046 
       Total current assets                                                                    ---------    ---------
                                                                                                 21,348       21,681 

Long-term investments                                                                                 -        3,178 
Property and equipment, net                                                                      15,435        7,127 
Goodwill, net                                                                                       192        2,568 
Net investment in sales-type leases                                                               4,641        3,160 
Other assets                                                                                        653          195 
                                                                                               ---------    ---------
       Total assets                                                                            $ 42,269     $ 37,909 
                                                                                               =========    =========
                                                                                               
LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                 
Current liabilities:                                                                                                 
    Accounts payable                                                                           $  1,352     $  1,063 
    Accrued expenses                                                                              1,954        2,520 
    Accrued payroll and payroll taxes                                                             1,753        1,743 
    Accrued income taxes                                                                            229          854 
    Deferred revenues                                                                               714          812 
    Product warranty and other current liabilities                                                  702          686 
    Accrued restructuring charge                                                                  2,324            - 
                                                                                               ---------    ---------
       Total current liabilities                                                                  9,028        7,678 
                                                                                                                     
Deferred income taxes                                                                             2,136        1,690 
Deferred compensation                                                                               975          896 
Other non-current liabilities                                                                       413           25 
                                                                                                                     
Commitments:                                                                                                         
Stockholders' equity:                                                                                                
    Common stock, $.02 par value, 10,000,000 shares authorized,                                                      
      6,375,750 shares issued in 1997 and 6,217,192 shares issued in 1996                           128          124 
    Additional paid-in capital                                                                   16,340       15,618 
    Retained earnings                                                                            17,449       15,151 
                                                                                               ---------    ---------
                                                                                                 33,917       30,893 
    Less: treasury stock at cost, 592,548 shares in 1997 and 532,348 shares in 1996              (4,028)      (2,923) 
       Notes receivable - officers                                                                 (100)        (350)
       Cumulative translation adjustment                                                            (72)           - 
                                                                                               ---------    ---------
       Total stockholders' equity                                                                29,717       27,620 
                                                                                               ---------    ---------
       Total liabilities and stockholders' equity                                              $ 42,269     $ 37,909 
                                                                                               =========    =========
</TABLE> 

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

                                     -18-
<PAGE>
 
                            LIFELINE SYSTEMS, INC.
                       CONSOLIDATED STATEMENTS OF INCOME
             FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                   (In thousands except for per share data)

<TABLE> 
<CAPTION> 
                                                  1997       1996       1995
                                                  ----       ----       ----
<S>                                           <C>        <C>        <C> 
Revenues
  Services                                    $  32,031  $  24,220  $  18,602
  Net product sales                              23,776     24,864     23,440
  Finance and rental income                       1,157      1,139      1,337
                                              ---------  ---------  ---------

     Total revenues                              56,964     50,223     43,379
                                              ---------  ---------  ---------

Costs and expenses
  Cost of services                               15,133     10,064      7,454
  Cost of sales                                   6,582      8,238      8,500
  Selling, general, and administrative           25,903     23,855     20,959
  Research and development                        1,709      1,771      1,701
  Restructuring charge                            4,310          -          -
                                              ---------  ---------  ---------

     Total costs and expenses                    53,637     43,928     38,614
                                              ---------  ---------  ---------

Income from operations                            3,327      6,295      4,765
                                              ---------  ---------  ---------

Other income (expense)
  Interest income                                   614        790        748
  Interest expense                                  (20)        (7)        (8)
                                              ---------  ---------  ---------

     Total other income, net                        594        783        740
                                              ---------  ---------  ---------

Income before income taxes                        3,921      7,078      5,505
Provision for income taxes                        1,623      2,902      2,357
                                              ---------  ---------  ---------

Net income                                    $   2,298  $   4,176  $   3,148
                                              =========  =========  =========

Net income per weighted average share:
  Basic                                       $    0.40  $    0.74  $    0.56
  Diluted                                     $    0.37  $    0.67  $    0.51

Weighted average shares
  Basic                                           5,736      5,678      5,643
  Diluted                                         6,232      6,197      6,115
</TABLE> 

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

                                     -19-





<PAGE>
 
                            LIFELINE SYSTEMS, INC.
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
             FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                            (Dollars in thousands)
 
<TABLE> 
<CAPTION> 
                                                        Additional                               Notes    Cumulative           Total
                                      Common Stock         Paid-In    Retained   Treasury   Receivable   Translation   Stockholders'
                                  ---------------------
                                  Shares         Amount    Capital    Earnings     Stock     Officers     Adjustment       Equity
                                  --------------------------------------------------------------------------------------------------
<S>                               <C>            <C>      <C>         <C>        <C>        <C>          <C>           <C>
BALANCE, DECEMBER 31, 1994          5,494,915       $118     $14,533    $ 8,366     ($1,559)     ($250)                  $21,208
 
Exercise of stock options             177,202          5         423                                                         428
Issuance of stock under employee 
 stock purchase plan                   16,053                     88                                                          88
Purchase of treasury stock            (10,000)                                         (122)                                (122)
Sale of stock to officer                8,939                     69                     31       (100)
Issuance of treasury stock              8,500                     48                     30                                   78
Purchase of common stock warrant                                           (539)                                            (539)
Net income                                                                3,148                                            3,148
                                  --------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1995          5,695,609        123      15,161     10,975      (1,620)      (350)                   24,289
 
Exercise of stock options              69,650          1         230                                                         231
Issuance of stock under employee 
 stock purchase plan                   15,085                    163                                                         163
Purchase of treasury stock           (103,000)                                       (1,337)                              (1,337)
Issuance of treasury stock              7,500                     64                     34                                   98
Net income                                                                4,176                                            4,176
                                  --------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996          5,684,844        124      15,618     15,151      (2,923)      (350)                   27,620
 
Exercise of stock options             143,546          4         490                                                         494
Issuance of stock under employee 
 stock purchase plan                   15,012                    220                                                         220
Income tax benefit from stock 
 options exercised                                                 6                                                           6
Purchase of treasury stock            (60,700)                                       (1,107)                              (1,107)
Issuance of treasury stock                500                      6                      2                                    8
Payment of note receivable by CEO                                                                  250                       250
Cumulative translation adjustment                                                                           ($72)            (72)
Net income                                                                2,298                                            2,298
                                  --------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997          5,783,202       $128     $16,340    $17,449     ($4,028)     ($100)     ($72)        $29,717
                                  ==================================================================================================
</TABLE> 
 
The accompanying notes are an integral part of these consolidated financial
 statements.

                      

                                      -20-

<PAGE>
 
                            LIFELINE SYSTEMS, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
             FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
                            (Dollars in thousands)

<TABLE> 
<CAPTION> 
                                                                     1997      1996      1995 
                                                                     ----      ----      ---- 
<S>                                                              <C>        <C>        <C>    
Cash flows from operating activities:                                                         
  Net income                                                     $  2,298   $  4,176   $ 3,148
  Adjustments to reconcile net income to net cash provided
     by operating activities:                                                                 
     Restructuring charge                                           4,310          -         -
     Depreciation and amortization                                  3,919      3,216     2,231
     Provision for bad debts                                           85        120         -
     Deferred income tax provision (benefit)                         (717)       589      (869)
     Deferred compensation                                             79        446       384
  Changes in operating assets and liabilities:                                                
     Accounts receivable                                           (1,440)      (182)     (961)
     Inventories                                                       75        (56)      117
     Net investment in sales-type leases                           (1,647)    (1,238)    2,963
     Prepaid expenses, other current assets and other assets          171     (1,049)     (331)      
     Accounts payable, accrued expenses and other liabilities         112      1,099       509
     Income taxes payable/receivable                                 (625)       529       319
     Accrued restructuring charge                                       -          -      (200)
                                                                 --------   --------   -------
        Net cash provided by operating activities                   6,620      7,650     7,310   
                                                                 --------   --------   -------
Cash flows from investing activities:                                                         
  Purchases of investments                                         (7,500)   (20,664)   (9,323)
  Sales and maturities of investments                              11,968     19,669         -
  Additions to property and equipment                             (11,886)    (5,033)   (2,709)
  Payment for business acquisition                                      -     (1,146)   (1,000)
                                                                 --------   --------   -------
        Net cash used in investing activities                      (7,418)    (7,174)  (13,032)
                                                                 --------   --------   -------
Cash flows from financing activities:                                                         
  Principal payments under long-term obligations                      (59)       (91)     (276)      
  Proceeds from stock options exercised and                                                   
   employee stock purchase plan                                       720        394       516
  Purchase of common stock warrant                                      -          -      (539)
  Repayment of loan from officer                                      250          -         -
  Purchase of treasury stock                                       (1,107)    (1,337)     (122)
  Issuance of treasury stock                                            8         98        78
                                                                 --------   --------   -------
        Net cash used in financing activities                        (188)      (936)     (343)
                                                                 --------   --------   -------
Net decrease in cash and cash equivalents                            (986)      (460)   (6,065)
                                                                 --------   --------   -------
Effect of foreign exchange on cash                                    (25)         -         -
                                                                 --------   --------   -------
Cash and cash equivalents at beginning of year                      3,030      3,490     9,555  
                                                                 --------   --------   -------
Cash and cash equivalents at end of year                         $  2,019   $  3,030   $ 3,490
                                                                 ========   ========   ======= 
</TABLE> 

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

                                      21




<PAGE>
 
     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     A.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Principles of Consolidation 
     The consolidated financial statements include the accounts of Lifeline
     Systems, Inc. and its wholly owned subsidiaries (the "Company"). All
     significant intercompany balances and transactions have been eliminated.

     Use of Estimates in the Preparation of Financial Statements 
     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 periods. Actual results could differ from those
     estimates.

     Cash, Cash Equivalents, and Investments 
     The Company considers all securities purchased with a maturity of three
     months or less at the date of acquisition to be cash equivalents. The
     Company's investments are deemed to be available for sale. Short-term
     investments consist primarily of obligations of the US Government and its
     agencies, tax-exempt securities, commercial paper, and bank time deposits
     with maturities at date of acquisition beyond three months and less than
     one year. Long-term investments consist primarily of obligations of the US
     Government and its agencies, tax-exempt securities, and commercial paper
     with maturities at date of acquisition beyond one year and less than three
     years. Investments are carried at fair market value, which approximates
     cost.

     The fair market value of securities, which approximates cost, consists of
     the following at December 31, 1997 and 1996:

<TABLE>
<CAPTION>
(Dollars in thousands)                                        Maturity
                                   -------------------------------------------------------------
                                             Less than                          More than
Type of Security                             one year                           one year                        Total
----------------------------------------------------------------------------------------------------------------------------------
                                         1997            1996           1997           1996           1997             1996
                                         ----            ----           ----           ----           ----             ----       
<S>                                     <C>             <C>            <C>            <C>            <C>              <C> 
US Government and Agency
   securities                           $  649          $2,917          $   -         $  500         $  649            $ 3,417     
Tax-exempt securities                    2,724           4,223              -          2,678          2,724              6,901     
Corporate bonds and securities           2,477               -              -              -          2,477                  -     
                                   -----------------------------------------------------------------------------------------------
                                        $5,850          $7,140          $   -         $3,178         $5,850            $10,318
----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents                                                                             2,019              3,030
----------------------------------------------------------------------------------------------------------------------------------
                                                                                                     $7,869            $13,348
==================================================================================================================================
</TABLE>

                                      -22-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

A.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Inventories
Inventories are stated at the lower of cost or market, as determined by the
first-in, first-out method.

Property and Equipment
Property and equipment are carried at cost. Depreciation and amortization are
computed principally by the straight-line method over the useful lives of the
assets, typically three to five years, or, in the case of leasehold
improvements, over the lesser of the useful life or the lease term.

When assets are sold or retired, the related cost and accumulated depreciation
are removed from the accounts and any resulting gain or loss is credited or
charged to income. Expenditures for maintenance and repairs are charged to
expense as incurred; betterments are capitalized.

Goodwill
Goodwill is recorded at cost and amortized on a straight-line basis over an
estimated useful life not to exceed seven years. Amortization expense was
$542,000, $472,000, and $361,000 in 1997, 1996 and 1995, respectively.
Accumulated amortization amounted to $0 and $1,244,000 as of December 31, 1997
and 1996, respectively.

Impairment of long-lived assets
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 121,
"Accounting for the Impairment of Long-lived Assets and for Long-Lived Assets to
be Disposed Of," the Company evaluates the possible impairment of long-lived
assets, including goodwill, whenever events or circumstances indicate that the
carrying value of the assets may not be recoverable. In December, 1997, the
Company initiated a reorganization plan to account for its approximately $11
million investment in technology for a new call center platform, the relocation
of the Company's corporate headquarters from its current Cambridge, MA facility
to a new facility in Framingham, MA, and other initiatives to lower operating
costs. In accordance with this plan, the Company analyzed the acquisitions of
the Communicall(R) brand of value-added supportive home monitoring services to
the elderly, Tele-Response and Support Services, Inc. who was a distributor of
the Company's personal response products and services, and the ProtectAlert(TM)
trade name. Based on an estimate of future discounted net cash flows, the
Company recorded a charge of $1.8 million to write down the carrying amounts of
these businesses to their estimated fair values. The charge is included in the
Company's results of operations for the year ended December 31, 1997 as part of
the restructuring charge.

As a result of the Company's reorganization plan, the Company also recorded a
non-cash accounting charge of $897,000 related to a write down of property,
plant and equipment associated with the Company's current call center, leasehold
improvements on its current facility, and certain assets related to the
aforementioned acquisitions. The charge is included in the Company's results of
operations for the year ended December 31, 1997 as part of the restructuring
charge.

                                      -23-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

A.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Product Warranty
The Company's products are generally under warranty against defects in material
and workmanship. The Company provides an accrual for estimated warranty costs at
the time of sale of the related products.

Revenue Recognition
Service revenues are associated primarily with providing monitoring and
maintenance of personal response products and are recognized ratably over the
contractual period. Revenues from the sale of personal response products are
recognized upon shipment. Finance income attributable to sales-type lease
contracts is initially recorded as unearned income and subsequently recognized
under the interest method over the term of the leases.

Income Taxes
The Company accounts for income taxes under a liability approach. Under this
approach, deferred tax assets and liabilities are recognized based on temporary
differences between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
temporary differences are expected to reverse.

Net Income Per Common Share
Net income per basic common share is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for the period. Net income per diluted common shares is computed based on the
weighted average number of common and dilutive common equivalent shares
outstanding during each period. Common equivalent shares consist of stock
options and warrants calculated in accordance with SFAS No. 128, "Earnings per
Share."

Industry Segments
The Company operates in one industry segment. Its operations consist of
providing personal response services associated with the monitoring of those
products it designs, manufactures, and markets. Foreign revenues, from Canada,
comprise less than 10% of the Company's total revenues, and the Company has no
significant tangible assets in foreign countries.

Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentration of
credit risk include cash, cash equivalents, investments, and trade receivables.
The Company sells its products primarily to hospitals and other healthcare
institutions. The Company performs ongoing credit evaluations of its customers
and, in the case of sales-type leases, the leased equipment serves as collateral
in the transactions. The Company has established guidelines relative to credit
ratings, diversification and maturities that maintain safety and liquidity. The
Company has not experienced any significant losses on these financial
instruments.

Reclassification
Certain prior year balances have been reclassified to conform to the current
year presentation. 

                                      -24-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
B.   INVENTORIES

Inventories consist of the following:

<TABLE>
<CAPTION>
                                                                             December 31,
                                                               ------------------------------------
(Dollars in thousands)                                               1997                  1996
---------------------------------------------------------------------------------------------------
<S>                                                            <C>                       <C>
Purchased parts and  assemblies                                    $  827                $  797
Work in progress                                                      391                   392
Finished goods                                                        157                   261
---------------------------------------------------------------------------------------------------
                                                                   $1,375                $1,450
===================================================================================================
</TABLE> 

C.   PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

<TABLE> 
<CAPTION> 
                                                                             December 31,
                                                               ------------------------------------
(Dollars in thousands)                                               1997                  1996
---------------------------------------------------------------------------------------------------
<S>                                                            <C>                         <C>
Equipment                                                           $ 10,410               $  9,099       
Furniture and fixtures                                                   659                    574       
Equipment leased to others                                             7,195                  5,218       
Equipment under capital leases                                         1,035                  1,035       
Leasehold improvements                                                   751                    692       
Capital in progress                                                    8,319                    687        
                                                               ------------------------------------
                                                                      28,369                 17,305       
Less: accumulated depreciation and amortization                      (12,934)               (10,178)       
---------------------------------------------------------------------------------------------------
                                                                    $ 15,435               $  7,127
===================================================================================================
</TABLE>


Accumulated depreciation and amortization amounted to $3,708,000 and $2,256,000
on equipment leased to others and $1,014,000 and $1,006,000 on equipment under
capital leases at December 31, 1997 and 1996, respectively.  In total,
depreciation expense amounted to $3,377,000, $2,750,000 and $1,774,000 for the
years ended December 31, 1997, 1996, and 1995, respectively.

D.  LEASING ARRANGEMENTS

As Lessor
The Company maintains an internally-financed and operated leasing program and
leases its personal response products to customers principally under sales-type
leases.

                                      -25-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

D.   LEASING ARRANGEMENTS (continued)

As sales-type leases, the lease payments to be received over the term of the
leases are recorded as a receivable at the inception of the new lease. Finance
income attributable to the lease contracts is initially recorded as unearned
income and subsequently recognized as income under the interest method over the
term of the leases. The lease contracts are generally for five-year terms, and
the residual value of the leased equipment is considered to be nominal at the
end of the lease period.

The components of the net investment in sales-type leases are
as follows:

<TABLE> 
<CAPTION> 
                                                                               December 31,
                                                                ------------------------------------
(Dollars in thousands)                                                1997                  1996
----------------------------------------------------------------------------------------------------
<S>                                                             <C>                         <C>
Minimum lease payments receivable                                     $8,580                $6,193
Less:    Unearned interest                                             2,305                 1,579
         Allowance for doubtful accounts                                 190                   176
----------------------------------------------------------------------------------------------------
                                                                       6,085                 4,438
Less:    Current portion                                               1,444                 1,278
----------------------------------------------------------------------------------------------------
Net investment in sales-type leases                                   $4,641                $3,160
====================================================================================================
</TABLE> 

Future minimum lease payments due under non-cancellable sales-type leases at
December 31, 1997 are as follows:

<TABLE> 
<CAPTION>  
(Dollars in thousands)
<S>                                                                                         <C> 
1998                                                                                        $2,357
1999                                                                                         1,995  
2000                                                                                         1,953  
2001                                                                                         1,615  
2002                                                                                           653  
Thereafter                                                                                       7   
----------------------------------------------------------------------------------------------------
                                                                                            $8,580
====================================================================================================
</TABLE>
                                                                                
As Lessee
The Company conducts its primary operations in a leased facility under a ten-
year operating lease which commenced in the second quarter of 1994. The lease
includes scheduled base rent increases over the term of the lease. The total
amount of base rent payments is being charged to expense on the straight-line
method over the term of the lease. The Company recorded a deferred credit to
reflect the excess of rent expense over cash payments upon the commencement of
the lease. In addition, the Company pays a monthly allocation of the building's
operating expenses and real estate taxes. The lease contains two five-year
renewal options.

                                      -26-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

D. LEASING ARRANGEMENTS (continued)

In conjunction with the leased facility, the Company also entered into operating
lease arrangements for certain furniture, computer equipment, and leasehold
improvements totaling approximately $1.5 million.  These leases contain renewal
options and expire through 2001.

In November, 1997, the Company entered into a ten-year lease for an 84,000
square foot facility in Framingham, MA for its corporate headquarters. The
Company intends to occupy this new facility in late 1998.  Annual rental
payments under the lease approximate $775,000.  The lease contains two five-year
options to renew at the end of the initial lease term. The Company is currently
evaluating possible alternatives for its existing lease.

As a result of the Company's reorganization plan, the Company recorded a charge
of $731,000 for the rental commitment on its current facility.

The Company also has several operating lease arrangements for sales offices and
office equipment that expire through 2000 and leases certain equipment under
capital leases which expire through 2000.  Capital lease obligations are
collateralized by the related equipment.


Future minimum lease payments under capital and operating leases with initial or
remaining terms of one year or more are:

<TABLE>
<CAPTION>
(Dollars in thousands)                                    Capital Leases      Operating Leases                  
                                                         --------------------------------------
<S>                                                      <C>                  <C>                             
1998                                                                 $13               $ 1,540                   
1999                                                                  13                 1,941                   
2000                                                                   6                 1,986                   
2001                                                                   -                 1,876                   
2002                                                                   -                 1,842                   
Thereafter                                                             -                 6,132                   
-----------------------------------------------------------------------------------------------                  
Total minimum lease payments                                          32               $15,317                   
                                                                                       ========                   
Less amount representing interest                                      7
--------------------------------------------------------------------------
Present value of net minimum lease payments                           25
Less current portion                                                   9
--------------------------------------------------------------------------
Long-term obligation under capital leases                            $16
==========================================================================
</TABLE>
                                                                                
Total rent expense under all operating leases was $1,485,000, $1,466,000, and
$1,451,000, for the years ended December 31, 1997, 1996, and 1995,
respectively.

                                      -27-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

E.   STOCKHOLDERS' EQUITY

Net Income Per Common Share

The Company has adopted SFAS No. 128, "Earnings per Share" for the fiscal year
ended December 31, 1997.  This Statement replaces the presentation of primary
and fully diluted earnings per share ("EPS") with a presentation of  basic and
diluted EPS.  Basic EPS excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period.  Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that then shared in the earnings of the entity.  A reconciliation of the
basic EPS to diluted EPS and dual presentation on the face of the statement of
income are also required.

Calculation of per share earnings is as follows:

<TABLE>
<CAPTION>
(In thousands except per share figures)
                                                               1997              1996          1995
                                                               ----              ----          ----
<S>                                                           <C>               <C>            <C>
Basic:                                                                                     
------                                                                                     
Net income                                                    $2,298            $4,176         $3,148
Weighted average common shares outstanding                     5,736             5,678          5,643
                                                            
Net income per share, basic                                   $ 0.40            $ 0.74         $ 0.56
                                                              ======            ======         ======
 
Diluted:
--------
Net income for calculating diluted earnings per share         $2,298            $4,176         $3,148
 
Weighted average common shares outstanding                     5,736             5,678          5,643
Common stock equivalents                                         496               519            472
                                                              ------            ------         ------
Total weighted average shares                                  6,232             6,197          6,115
 
Net income per share, diluted                                 $ 0.37            $ 0.67         $ 0.51
                                                              ======            ======         ======
</TABLE>
                                                                                

Stock-Based Compensation Plans

The Company has adopted the disclosure requirements of SFAS No. 123 "Accounting
for Stock-Based Compensation."  The Company continues to recognize compensation
costs using the intrinsic value based method described in Accounting Principles
Board Opinion No. 25 "Accounting for Stock Issued to Employees."

In May, 1994 the stockholders approved the 1994 Stock Option Plan (the "1994
Plan").  The 1994 Plan provides that officers and key employees may be granted
either nonqualified or incentive stock options for the purchase of the Company's
common stock at the fair market value

                                      -28-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

E.   STOCKHOLDERS' EQUITY (continued)

on the date of grant. The employee options granted generally become exercisable
at a rate of 20% per year and expire ten years from the date of grant. Certain
options, as originally granted, became exercisable only to the extent the
Company achieved specific financial goals. During 1995 these options were
amended to provide for vesting on the earlier of the six year anniversary of the
date of grant or the original vesting schedule upon the achievement of the
aforementioned financial goals. As a result of this change, the Company incurred
additional compensation expense totaling $1.6 million, which is being amortized
based on a vesting schedule which approximates the expected date of meeting the
specific financial goals. Compensation expense of $79,000, $446,000, and
$384,000 was recorded in 1997, 1996, and 1995 and accumulated deferred
compensation was $975,000 and $896,000 at December 31, 1997 and 1996,
respectively.

The 1991 Stock Option Plan also remains in effect, providing for similar grants
to officers and employees.  Additionally, the 1991 Plan provides for an
automatic annual grant to non-employee directors.  The non-employee director
options become exercisable in three equal installments with the first
installment exercisable on the date of grant and the second and third
installments becoming exercisable on the second and third anniversaries of such
date.

Prior to the adoption of the 1994 Plan, several other stock option plans were in
effect and options which remain outstanding under those plans are included
below.

In May, 1996 the Company, upon approval by the Board of Directors and
stockholders, increased the total number of shares approved for future grant
under plans currently in effect by 300,000 for the 1994 Stock Option Plan and
25,000 for the 1991 Stock Option Plan.  At December 31, 1997 shares available
for future grants under all option plans were 309,150.

Net income and net income per share as reported in these financial statements
and on a pro forma basis for the years ended December 31, 1997, 1996 and 1995,
as if the fair value based method described in SFAS No. 123 had been adopted are
as follows (in thousands, except per share data):


<TABLE> 
<CAPTION> 
                                                    Year Ended December 31,
                                                   ------------------------ 
                                                   1997     1996       1995
                                                   ----     ----       ---- 
<S>                             <C>               <C>       <C>       <C>  
Net income                      As Reported       $2,298    $4,176    $3,148 
                                Pro Forma         $1,973    $3,990    $3,069 
                                                  
Basic net income per share      As Reported        $0.40     $0.74     $0.56    
                                Pro Forma          $0.34     $0.70     $0.54
                                                                            
Diluted net income per share    As Reported        $0.37     $0.67     $0.51
                                Pro Forma          $0.32     $0.66     $0.53 
</TABLE> 

                                      -29-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

E.   STOCKHOLDERS' EQUITY (continued)

The effect of applying SFAS No. 123 for the purpose of providing pro forma
disclosure may not be indicative of the effects on reported net income and net
income per share for future years. The pro forma disclosures include the effects
of all awards granted after January 1, 1995 and additional awards in future
years are anticipated.

For the purpose of providing pro forma disclosures, the fair values of stock
options granted were estimated using the Black-Scholes option-pricing model with
the following weighted-average assumptions used for grants in 1997, 1996 and
1995, respectively: a risk-free interest rate of 6.3%, 6.3% and 6.7%; an
expected life of 6 years in all years; expected volatility of 37%, 40% and 50%;
and no expected dividends.

<TABLE> 
<CAPTION> 
                                        1997                  1996                  1995           
                                   -------------------   -------------------  ------------------   
                                            Wgtd. Avg.            Wgtd. Avg.          Wgtd. Avg.   
                                   Shares   Exer.Price   Shares   Exer.Price  Shares  Exer.Price   
                                   ------   ----------   ------   ----------  ------  ----------   
<S>                                <C>      <C>          <C>      <C>         <C>     <C>           
Outstanding             
at beginning of year               875,657     $ 6.24    871,673     $ 5.40   866,226     $ 4.22
          Granted                  128,450      17.03    100,500      12.51   207,450       7.83
          Exercised               (143,546)      3.43    (69,650)      3.31  (177,202)      2.41
          Cancelled or lapsed      (29,151)      7.00    (26,866)      9.95   (24,801)      6.18
                                  ---------             ---------            ---------
Outstanding at end of year         831,410       8.37    875,657       6.24   871,673       5.40
                                  =========             =========            =========
Option exercisable
at year end                        380,709     $ 7.01    400,726     $ 5.58   363,880     $ 5.30

Weighted average fair value
of options granted
during the year                                $ 8.12                $ 6.19               $ 4.45  
</TABLE> 

                                     -30-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

E.   STOCKHOLDERS' EQUITY (continued)

The following table summarizes information about stock options outstanding at   
December 31, 1997.

<TABLE> 
<CAPTION> 
                       Options Outstanding                          Options Exercisable
            ------------------------------------               ----------------------------------

                      Number     Weighted Average                         Number
   Range of        Outstanding      Remaining      Weighted Average    Exercisable   Weighted Average
Exercise Prices    at 12/31/97  Contractual Life   Exercise Price     at 12/31/97    Exercise Price
---------------    -----------  ----------------   ----------------   -----------    ----------------
<S>                <C>          <C>                <C>                <C>            <C> 
$ 3.00-$ 5.00        363,410          5.0              $  3.56            212,039        $  3.65            
  5.50-  7.25        120,110          6.4                 6.34             41,120           6.11            
 10.00- 11.94        102,500          6.7                11.12             59,300          10.93            
 12.13- 14.81        110,190          6.5                13.20             56,750          13.95            
 16.19- 18.50        135,200          8.9                17.05             11,500          17.84            
                     -------                                              -------                           
$ 3.00-$18.50        831,410          6.3              $  8.37            380,709        $  7.01             
                     =======                                              =======                         
</TABLE> 

In May, 1995 the stockholders approved the Lifeline Employee Stock Purchase Plan
(ESPP) whereby eligible employees may invest up to 10% of their base salary in
shares of the Company's common stock.  The purchase price of the shares is 90%
of the fair market value of the stock on either the commencement date or the
date of purchase, whichever is lower.  Under the Plan, 200,000 shares of common
stock are available for purchase over ten offering periods through April, 2000,
of which approximately 162,116 shares remain available.  Shares purchased under
the ESPP totaled 15,012, 15,085, and 7,787 in 1997, 1996 and 1995, respectively.
The weighted-average grant-date fair value of shares purchased under the ESPP
was $17.79, $15.62 and $9.39 in 1997, 1996, and 1995, respectively.

For the purpose of providing pro forma disclosures, the fair values of shares
purchased were estimated using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for purchases in 1997, 1996 and 1995
respectively:  a risk free interest rate of 5.94%, 5.41% and 5.37%; an expected
life of 6 months in each year; expected volatility of 30% in 1997 and 40% in
1996 and 1995; and no expected dividends.

Common Stock

In September, 1995 the Company issued 8,939 shares of its common stock to the
Vice President, Customer Care in exchange for a collateralized promissory note
in the amount of $100,000. The note, which bears interest at a rate of 6.3% per
annum, payable annually in arrears, is due September, 2002. In September, 1992
the Company issued 83,333 shares of its common stock to the Chief Executive
Officer in exchange for a collateralized promissory note in the amount of
$250,000. The note, which bears interest at a rate of 5.98% per annum, payable
annually in

                                      -31-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

E. STOCKHOLDERS' EQUITY (continued)

arrears, was due September 1, 1999. On February 24, 1997, the Company's Chief 
Executive Officer repaid the note in full, in part by exercising stock options 
and selling 10,700 shares of Common Stock back to the Company at their fair 
market value of $17.00 on such date, the proceeds of which were used to repay 
the note.

In connection with the 1993 acquisition of the assets of CarePartners, Inc., the
Company issued a warrant to purchase 100,000 shares of the Company's common 
stock at $4.78 per share, expiring in March, 1996. In September, 1995 the 
Company paid $539,000 to repurchase the warrant.

In January, 1997, the Board of Directors authorized the repurchase of an 
additional 100,000 shares of common stock for general corporate purposes. The 
Company has purchased 60,700 shares directly from the Company's Chief Executive 
Officer through December 31, 1997 for $1.1 million as part of this program, 
including the 10,700 shares repurchased on February 24, 1997. These shares were 
purchased from the Chief Executive Officer partly in connection with the 
repayment of the $250,000 note and associated tax expenses.

F. INCOME TAXES

The provision (benefit) for income taxes was computed as follows:

<TABLE> 
<CAPTION> 
                                               For the years ended December 31,
                                             -----------------------------------
(Dollars in thousands)                           1997       1996      1995
--------------------------------------------------------------------------------
<S>                                          <C>            <C>       <C> 
Federal income taxes:
  Current                                        $1,720     $1,834    $2,563
  Deferred                                         (586)       404      (722)
--------------------------------------------------------------------------------
                                                  1,134      2,238     1,841
--------------------------------------------------------------------------------
State income taxes:
  Current                                           504        567       663
  Deferred                                         (131)        97      (147)
--------------------------------------------------------------------------------
                                                    373        664       516
--------------------------------------------------------------------------------
Foreign income taxes:
  Foreign income taxes                              116          -         -
--------------------------------------------------------------------------------

--------------------------------------------------------------------------------
Provision for income taxes                       $1,623     $2,902    $2,357
================================================================================
</TABLE> 

                                     -32-

<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

F.   INCOME TAXES (continued)

Total deferred tax assets (liabilities) are as follows at December 31:

<TABLE>
<CAPTION> 
(Dollars in thousands)                                                                         1997               1996
----------------------------------------------------------------------------------------------------------------------
<S>                                                                                         <C>                <C>
Total deferred tax assets                                                                   $ 3,588            $ 1,913
Total deferred tax liabilities                                                               (3,515)            (2,557)
----------------------------------------------------------------------------------------------------------------------
Net deferred tax asset (liability)                                                          $    73              ($644)
----------------------------------------------------------------------------------------------------------------------
 
Deferred tax assets (liabilities) are comprised of the following
significant items at December 31:
                                                                                               1997               1996
                                                                                               ----               ----
Current deferred tax assets:
     Inventory and warranty reserves                                                        $   653            $   793
     Restructuring reserve                                                                      586                  -
     Deferred compensation                                                                      393                  -
     Deferred revenue                                                                           255                  -
     Accounts receivable reserves                                                               126                105
     Accrued vacation and other reserves                                                        196                148
----------------------------------------------------------------------------------------------------------------------
Net current deferred tax asset                                                                2,209              1,046
----------------------------------------------------------------------------------------------------------------------
Noncurrent deferred tax assets (liabilities):
     Sales type leases                                                                       (3,447)            (2,489)
     Restructuring reserve                                                                      425                  -
     Depreciation                                                                               117                485
     Foreign net operating losses                                                                 -                126
     Amortization                                                                               769                188
----------------------------------------------------------------------------------------------------------------------
Net noncurrent deferred tax liability                                                        (2,136)            (1,690)
----------------------------------------------------------------------------------------------------------------------
Net deferred tax asset (liability)                                                          $    73              ($644)
----------------------------------------------------------------------------------------------------------------------
</TABLE>

The differences between the statutory U.S. federal income tax rate and the
Company's effective tax rate are as follows:

<TABLE>
<CAPTION>
                                                                   For the  years ended December 31,
                                                                 -------------------------------------
(Dollars in thousands)                                              1997           1996           1995
------------------------------------------------------------------------------------------------------
<S>                                                       <C>                    <C>            <C>
Provision at statutory rate                                       $1,336         $2,406         $1,872
State income tax, net of federal tax effect                          246            472            338
Tax exempt income                                                    (68)           (60)             -
Canadian goodwill                                                    112              -              -
Foreign rate differences                                              65              -              -
Other, net                                                           (68)            84            147
------------------------------------------------------------------------------------------------------
Provision for income taxes                                        $1,623         $2,902         $2,357
------------------------------------------------------------------------------------------------------
</TABLE>

The Company has no foreign operating loss carry forwards at December 31, 1997.

                                      -33-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

G.  EMPLOYEE BENEFIT PLAN

The Company has a 401(k) defined contribution savings plan covering
substantially all of its employees. The Company's contributions, which are
included in selling, general and administrative expenses, were $354,000,
$184,000, and $152,000 for the years ended December 31, 1997, 1996 and 1995,
respectively.

H.  SUPPLEMENTAL CASH FLOW INFORMATION

The Company did not incur capital lease obligations in 1997 or 1996.  However,
the Company did incur a capital lease obligation to obtain certain equipment in
the amount of $41,000 in 1995.

Cash paid for income taxes amounted to $2,313,000, $2,679,000, and $2,908,000
during 1997, 1996, and 1995, respectively.  Interest paid was $20,000, $7,000,
and $8,000 during 1997, 1996, and 1995, respectively.

I.  REVOLVING CREDIT AGREEMENT

The Company secured a $4.0 million line of credit effective in January, 1996.
During 1997, the term of the credit facility was extended until March, 1998.
This credit agreement contains a number of covenants, including requirements
that the Company maintain certain levels of financial performance and capital
structure, limitations on the Company's capital and other expenditures, and
restrictions on the Company's capacity to secure additional debt financing. No
amounts were outstanding at December 31, 1997 and 1996. The Company is currently
in the process of renegotiating a new line of credit.

J. ACQUISITION

In July, 1996 the Company acquired all of the outstanding stock of CareTel, Inc.
of Toronto, Ontario, Canada through its subsidiary, Lifeline Systems (Canada),
Inc.  CareTel provided monitoring services similar to those offered by the
Company, directly to consumers under the brand name ProtectAlert.  The purchase
price was approximately $1.1 million in cash, all of which was paid in 1996.
The acquisition was accounted for as a purchase transaction, and, as a result,
the Company recorded goodwill of approximately $1,000,000.  The results of the
acquired business have been included in the Company's consolidated financial
statements from the date of acquisition.  See Note K.

K. RESTRUCTURING

In December, 1997, the Company initiated a plan of reorganization and
restructuring designed to account for an approximate $11 million investment in
technology for a new call center platform, the relocation of the Company's
corporate headquarters from its current Cambridge, MA facility to a new facility
in Framingham, MA, and other initiatives to lower operating costs.

                                      -34-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

K.  RESTRUCTURING (continued)

As a result, in the fourth quarter of 1997, the Company recorded a $4.3 million
pre-tax charge to operations.  The Company took a charge for a minor workforce
reduction in such areas as sales and marketing, research and development and
administration.  This resulted in a pre-tax charge of $842,000 for employee
severance and related benefits, and none of these amounts were paid as of
December 31, 1997.  Also in connection with the restructuring plan, the Company
will take steps to decommission the current call center system.  Therefore, the
restructuring charge also included $304,000 of costs associated with the write
down to fair value of certain call center fixed assets.  Also in association
with the Company's relocation from its current Cambridge, MA facility to a new
facility in Framingham, MA, the restructuring charge included $1.2 million of
costs for the write down to fair value of certain leasehold improvements and
lease commitments on its current facility. The remaining restructuring charge
primarily related to $150,000 of costs associated with the write down to fair
value of equipment made obsolete from prior years' acquisitions, and $1.8
million for the write down of impaired goodwill.

Accrued restructuring charges in 1997 of $2.3 million represent the expected
future cash payments remaining at December 31, 1997. A summary of the
restructuring activity is presented below:

<TABLE>
<CAPTION>
(In thousands)
<S>                                                             <C>          
Balance at December 31, 1996                                             $     -
Non-cash write-downs of property
    and equipment                                                            827
Rent commitment                                                              655
Reduction of workforce and other cash flows                                  842
                                                                         -------
Balance at December 31, 1997                                             $ 2,324
                                                                         =======
</TABLE>


L.  NEWLY ISSUED ACCOUNTING STANDARDS

In June, 1997 the Financial Accounting Standards Board issued Statement No. 130
("SFAS" 130), "Reporting Comprehensive Income."  SFAS 130 requires changes in
comprehensive income to be shown in a financial statement that is displayed with
the same prominence as other financial statements. While not mandating a
specific financial statement format, SFAS 130 requires that an amount
representing total comprehensive income be reported. SFAS 130 will become
effective for fiscal years beginning after December 15, 1997. Reclassification
of financial statements for earlier periods is required for comparative
purposes. The Company does not believe that the adoption of SFAS 130 will have a
material impact on results of operations.

                                      -35-
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

L.  NEWLY ISSUED ACCOUNTING STANDARDS (continued)

In June, 1997, the Financial Accounting Standards Board issued Statement No. 131
("SFAS" 131), "Disclosures about Segments of an Enterprise and Related
Information."  SFAS 131, which supersedes Statement No. 14, "Financial Reporting
for Segments of a Business Enterprise," changes the way public companies report
information about segments. SFAS 131, which is based on the management approach
to segment reporting, includes requirements to report segment information
quarterly and entity-wide disclosures about products and services, major
customers, and the material countries in which the entity holds assets and
reports revenues. SFAS 131 is effective for fiscal years beginning after
December 15, 1997. Restatement for earlier years is required for comparative
purposes unless impracticable. In addition, SFAS 131 need not be applied to
interim periods in the initial year; however, in subsequent years, interim
period information must be presented on a comparative basis. The Company does
not believe that the adoption of SFAS 131 will have a material impact on
financial statement disclosures.


ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

  None.

                                      -36-
<PAGE>
 
                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

  The information under the heading "Election of Directors" in the Company's
definitive proxy material for its annual meeting of stockholders to be held on
May 20, 1998, is incorporated herein by reference. Information concerning
officers of the Company appears in Part I of this Annual Report on Form 10-K.

ITEM 11.  EXECUTIVE COMPENSATION

  The information under the heading "Executive Compensation," excluding the
"Compensation Committee Report on Executive Compensation" and the Stock Price
Performance Graph in the Company's definitive proxy material for its annual
meeting of stockholders to be held on May 20, 1998, is incorporated herein by
reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     (a)  Security ownership of certain beneficial owners:  The information
          under the heading "Beneficial Ownership of Common Stock" in the
          Company's definitive proxy material for its annual meeting of
          stockholders to be held on May 20, 1998, is incorporated herein by
          reference.

     (b)  Security ownership of management:  The information under the heading
          "Beneficial Ownership of Common Stock" in the Company's definitive
          proxy material for its annual meeting of stockholders to be held on
          May 20, 1998, is incorporated herein by reference.

     (c)  Changes in control:  None known.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     None.

                                      -37-
<PAGE>
 
                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(A)(1) FINANCIAL STATEMENTS

       The following consolidated financial statements of LIFELINE SYSTEMS, INC.
and the report of independent accountants relating thereto, are set forth in
Item 8 of this Annual Report on Form 10-K on the pages indicated.

<TABLE>
<CAPTION>
                                                                Pages
                                                                -----
<S>                                                             <C>
Report of Independent Accountants                                  17
 
Consolidated Balance Sheets as of December 31, 1997 and 1996       18
 
Consolidated Statements of Income for the years
  ended December 31, 1997, 1996, and 1995                          19
 
Consolidated Statements of Stockholders' Equity
  for the years ended December 31, 1997, 1996, and 1995            20
 
Consolidated Statements of Cash Flows for the years
  ended December 31, 1997, 1996, and 1995                          21
 
Notes to Consolidated Financial Statements                      22-36
</TABLE>

(A)(2) FINANCIAL STATEMENT SCHEDULE

       The following financial statement schedule of LIFELINE SYSTEMS, INC. is
filed herewith and included in ITEM 14 (a)(2) on the pages indicated below.

                                                                Pages
                                                                -----

Schedule II - Valuation and Qualifying Accounts for
 the years ended December 31, 1997, 1996 and 1995                  45


       All other schedules are omitted because they are not applicable, not
required, or because the required information is included in the financial
statements or notes thereto.

(B)    REPORTS ON FORM 8-K

       The Company filed no reports on Form 8-K with the Securities and Exchange
Commission during the quarter ended December 31, 1997.

(C)    EXHIBITS

       The Exhibits which are filed with this Report or which are incorporated
herein by reference are set forth in the Exhibit Index which appears on pages 40
through 44 hereof.

                                      -38-
<PAGE>
 
                                  SIGNATURES


     Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                             LIFELINE SYSTEMS, INC.



March 16, 1998                               By: /s/ Ronald Feinstein
--------------                                  --------------------------------
Date                                                 Ronald Feinstein
                                                     Chief Executive Officer


     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
Signature                 Capacity                                 Date
---------                 --------                                 ----     
<S>                       <C>                                 <C>
/s/ L. Dennis Shapiro     Chairman of the Board               March 16, 1998
------------------------                                      --------------
L. Dennis Shapiro
 
/s/ Ronald Feinstein      Chief Executive Officer,            March 16, 1998
------------------------                                      --------------
Ronald Feinstein          President and Director (Principal
                          Executive Officer)
 
/s/ Dennis M. Hurley      Vice President of Finance           March 16, 1998
------------------------                                      --------------
Dennis M. Hurley          (Principal Financial and
                          Accounting Officer)
 
/s/ Everett N. Baldwin    Director                            March 16, 1998
------------------------                                      --------------
Everett N. Baldwin
 
/s/ Joseph E. Kasputys    Director                            March 16, 1998
------------------------                                      --------------
Joseph E. Kasputys
 
/s/ Carolyn C. Roberts    Director                            March 16, 1998
------------------------                                      --------------
Carolyn C. Roberts
 
/s/ Steven M. Tritman     Director                            March 16, 1998
------------------------                                      --------------
Steven M. Tritman
 
/s/ Gordon C. Vineyard    Director                            March 16, 1998
------------------------                                      --------------
Gordon C. Vineyard
</TABLE>

                                      -39-
<PAGE>
 
                                 EXHIBIT INDEX

     The following designated exhibits are, as indicated below, either filed
herewith or have heretofore been filed with the Securities and Exchange
Commission under the Securities Act of 1933 or the Securities and Exchange Act
of 1934 and are referred to and incorporated herein by reference to such
filings.

<TABLE>
<CAPTION>
EXHIBIT NO.    EXHIBIT                                              SEC DOCUMENT REFERENCE
-----------    -------                                              ------------------------
<S>            <C>                                                  <C>
EXHIBIT 3.     ARTICLES OF INCORPORATION AND BY-LAWS
 
     3.1       Articles of Organization of Lifeline Systems, Inc.,       2-84060 Exhibit 3.1
                 as amended.
 
     3.2       Articles of Amendment of Lifeline Systems, Inc.          1987 10K Exhibit 3.4
 
     3.3       Restated By-Laws of Lifeline Systems, Inc.               1990 10K Exhibit 3.4
 
EXHIBIT 4.     INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS
 
     4.1       Specimen Stock Certificate.                               2-84060 Exhibit 4.1
 
EXHIBIT 10.    MATERIAL CONTRACTS
 
   10.01       Registrant's 1982 Incentive Stock Option Plan           2-84060 Exhibit 10.19
                 and form of Option Agreement.
 
   10.02       Registrant's 1982-A Incentive Stock Option Plan and     2-84060 Exhibit 10.20
                 form of Option Agreement.
           
   10.03       Medical Expense Reimbursement Plan.                     2-84060 Exhibit 10.21
           
   10.04       Registrant's 1986 Incentive Stock                      33-12030 Exhibit 10.26
                 Option Plan and form of Option Agreement
           
   10.05       Amendments to Registrant's 1986 Incentive              1987 10K Exhibit 10.13
                 Stock Option Plan.
           
   10.06       Registrant's 1982 Incentive Stock Option Plan,         1988 10K Exhibit 10.14
                 as amended.
           
   10.07       Registrant's 1982-A Incentive Stock Option Plan,       1988 10K Exhibit 10.15
                 as amended.
           
   10.08       Amendment to Registrant's 1986 Incentive                Proxy Statement filed
                 Stock Option Plan.                                  April 13, 1989 (0-13617)
           
   10.09       Registrant's 1991 Stock Option Plan.                   1990 10K Exhibit 10.37
</TABLE>

                                      -40-
<PAGE>
 
<TABLE> 
   <S>         <C>                                                       <C> 
   10.10       Form of Non-statutory Stock Option Agreement              1992 10K Exhibit 10.32
                 for Registrant's 1991 Stock Option Plan.

   10.11       Form of Special Non-statutory Stock Option Agreement      1992 10K Exhibit 10.33
                 for Registrant's 1991 Stock Option Plan.
           
   10.12       Lease Agreement between the Registrant and                1992 10K Exhibit 10.34
                 the Massachusetts Institute of Technology,
                 dated April 3, 1992.
           
   10.13       First Amendment to Lease Agreement dated April 3, 1992    1992 10K Exhibit 10.35
                 between the Registrant and the Massachusetts
                 Institute of Technology, dated August 25, 1992.
           
   10.14       Amended Employment and Noncompetition Agreement           1992 10K Exhibit 10.36
                 between Ronald Feinstein and the Registrant,
                 dated August 27, 1992.
           
   10.15       Secured Promissory Note between Ronald Feinstein and      1992 10K Exhibit 10.37
                 the Registrant, dated September 1, 1992.
           
   10.16       Security and Pledge Agreement between                     1992 10K Exhibit 10.38
                 Ronald Feinstein and the Registrant,
                 dated September 1, 1992.
           
   10.17       Non-statutory Stock Option Agreement, as amended,         1992 10K Exhibit 10.39
                 between Ronald Feinstein and the Registrant,
                 dated August 27, 1992.
           
   10.18       Special Non-statutory Stock Option Agreement, as          1992 10K Exhibit 10.40
                 amended, between Ronald Feinstein and the Registrant,
                 dated August 27, 1992.
           
   10.19       Second Amendment to Lease Agreement dated April 3, 1992      10Q for the Quarter
                 between the Registrant and                                 ended June 30, 1993
                 the Massachusetts Institute of Technology,                       Exhibit 10.42
                 dated May 18, 1993.
           
   10.20       Amended and Restated Asset Purchase Agreement                10Q for the Quarter
                 dated September 9, 1993 between the Registrant and     ended September 30,1993
                 CarePartners, Inc.                                               Exhibit 10.43
           
   10.21       Second Amendment to Lease Agreement                       1993 10K Exhibit 10.44
                 dated August 31, 1989 and Consent to
                 Assignment of Lease between the Registrant
                 and Tierrasanta 234 dated September 9, 1993.
           
   10.22       Letter Agreement between Ronald Feinstein                 1993 10K Exhibit 10.45
                 and the Registrant dated March 4, 1994.
</TABLE>

                                      -41-
<PAGE>
 
<TABLE>
   <S>         <C>                                                     <C>
   10.23       Nonstatutory Stock Option Agreement between             1993 10K Exhibit 10.46
                 Ronald Feinstein and the Registrant dated
                 February 11, 1994.
           
   10.24       Third Amendment to Lease Agreement dated April 3, 1992     10Q for the Quarter
                 between the Registrant and the Massachusetts            ended March 31, 1993
                 Institute of Technology                                        Exhibit 10.47
           
   10.25       Registrant's 1994 Stock Option Plan.                    1994 10K Exhibit 10.48
           
   10.26       Form of Non-statutory Stock Option Agreement            1994 10K Exhibit 10.49
                 for Registrant's 1994 Stock Option Plan.
           
   10.27       Form of Special Non-statutory Stock Option Agreement    1994 10K Exhibit 10.50
                 for Registrant's 1994 Stock Option Plan.
           
   10.28       Master Lease Agreement between Registrant and           1994 10K Exhibit 10.51
                 Bell Atlantic-TriCon Leasing Corporation
           
   10.29       Master Lease Agreement between Registrant and           1994 10K Exhibit 10.52
                 U.S. Leasing Corporation
           
   10.30       Secured Promissory Note between Thomas E. Loper
                 and the Registrant, dated September 11, 1995.         1995 10K Exhibit 10.30
           
   10.31       Security and Pledge Agreement between
                 Thomas E. Loper and the Registrant,
                 dated September 11, 1995.                             1995 10K Exhibit 10.31
           
   10.32       Asset Purchase Agreement dated May 17, 1995
                 between the Registrant and Martha's Vineyard
                 Hospital Foundation.                                  1995 10K Exhibit 10.32
           
   10.33       Form of the Non-statutory Stock Option
                 Agreement to Registrant's 1991 Stock
                 Option Plan                                           1995 10K Exhibit 10.33
           
   10.34       Form of the Non-statutory Stock Option
                 Agreement to Registrant's 1994 Stock
                 Option Plan                                           1995 10K Exhibit 10.34
           
   10.35       1995 Employee Stock Purchase Plan                       1995 10K Exhibit 10.35
           
   10.36       Revolving Credit Agreement between
                 the First National Bank of Boston
                 and the Registrant, dated November 30, 1995           1995 10K Exhibit 10.36 
</TABLE> 

                                      -42-
<PAGE>
 
<TABLE> 
   <S>          <C>                                             <C>       
   10.37        Amended Employment Agreement between
                  Ronald Feinstein and the Registrant,                  10Q for the quarter ended
                  dated June 14, 1996                                June 30, 1996, Exhibit 10.60
  
   10.38        Employment Agreement between Len Wechsler
                  and Lifeline Systems (Canada), Inc.                   10Q for the quarter ended
                  dated July 3, 1996                            September 30, 1996, Exhibit 10.60
 
   10.39        Stock purchase agreement between
                  Lifeline Systems (Canada), Inc. and
                  Len Wechsler dated July 3, 1996                       10Q for the quarter ended
                                                               September 30, 1996, Exhibit 10.61
   10.40        Stock purchase agreement between
                  Lifeline Systems (Canada), Inc., and
                  CareTel, Inc. and the stockholders of                 10Q for the quarter ended
                  CareTel, ,Inc., dated July 3, 1996            September 30, 1996, Exhibit 10.62
 
   10.41        Amendment to Registrant's 1991
                  Stock Option Plan                                         1996 10K Exhibit10.41
 
   10.42        Amendment to Registrant's 1994                             1996 10K Exhibit 10.42
                  Stock Option Plan
 
   10.43        First Amendment to Revolving  Credit Agreement
                  between the First National Bank of Boston
                  and the Registrant dated November 29, 1996               1996 10K Exhibit 10.43
Filed herewith:

   10.44        Lease Agreement between the Registrant and
                  Bishop/Clark Associates Limited Partnership
                  dated November 11, 1997

   10.45        Second Amendment to Revolving  Credit Agreement
                  between the First National Bank of Boston
                  and the Registrant dated December 31, 1997

   10.46        Offer to Lease between CareTel, Inc. and Graduate Holdings
                  Limited and Samuel Sarick Limited dated September 1, 1994

   10.47        Form of Lease Agreement between Lifeline Systems, Canada and
                  Samuel Sarick Limited and Graduate Holdings Limited
                  dated January 29, 1998

   10.48        Master Agreement for Professional Services between
                  Cambridge Technology Partners and the
</TABLE> 

                                      -43-
<PAGE>
 
<TABLE> 
   <S>          <C> 
                  Registrant dated June 16, 1997

   10.49        Form of Change in Control Agreement for
                  the following Named Executives:
                  Mr. Richard Reich, Mr. Thomas Loper
                  Mr. Dennis Hurley, Mr. John Gugliotta
 
EXHIBIT 21.     SUBSIDIARIES. 

Filed herewith:
   21.1         Subsidiaries of Lifeline Systems, Inc.

EXHIBIT 23.     CONSENTS OF EXPERTS AND COUNSEL.

Filed herewith:
   23.1         Consent of Coopers and Lybrand L.L.P.
</TABLE> 

                                      -44-
<PAGE>
 
                            LIFELINE SYSTEMS, INC.

                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                                        
             FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995

                            (Dollars in thousands)

 <TABLE>
<CAPTION>
                                                        Additions
                                        Balance at      Charged to                     Balance at
                                        Beginning       Costs &                          End of
Description                              of Year        Expenses       Deductions/(1)/    Year   
-----------                              -------        --------       ---------------    -----    
<S>                                     <C>             <C>            <C>              <C>   
1997
----                            
Allowance for doubtful
receivables:
 Trade accounts receivable                  $197            $ 71            $ 52             $216   
 Lease receivables                           176              14               -              190     
                                            ----            ----            ----             ----     
  Total                                     $373            $ 85            $ 52             $406     

1996                                                                                                  
----                                                                        
Allowance for doubtful                                                                                
 receivables:                                                                                         
 Trade accounts receivable                  $156            $120            $ 79             $197     
 Lease receivables                           217               -              41              176     
                                            ----            ----            ----             ----     
  Total                                     $373            $120            $120             $373     

1995                                                                                                  
----                                                                        
Allowance for doubtful                                                                                
 receivables:                                                                                         
 Trade accounts receivable                  $221            $  -            $ 65             $156     
 Lease receivables                           304               -              87              217     
                                            ----                            ----             ----     
  Total                                     $525                            $152             $373      
</TABLE>                                  

/(1)/  Uncollectible accounts and adjustments.

                                      -45-