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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

|    |  |                                                                                       
|--- |  | --------------------------------------------------------------------------------------
|[X] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 30, 2002

OR

|    |  |                                                                                        
|--- |  | ---------------------------------------------------------------------------------------
|[ ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From  to  .

Commission File Number 0-20083

SPACELABS MEDICAL, INC.


(Exact name of registrant as specified in its charter)


|                                |  |                    
|------------------------------- |  | -------------------
|Delaware                        |  | 91-1558809         
|                               
|                               
|                               
|                               
|(State or other jurisdiction of |  | (I.R.S. Employer   
|                               
|                               
|                               
|                               
|incorporation or organization)  |  | Identification No.)

15220 N.E. 40th Street, P.O. Box 97013, Redmond, Washington 98073

|                                         |  |           
|---------------------------------------- |  | ----------
|(Address of principal executive offices) |  | (Zip Code)

Registrants telephone number, including area code: (425) 882-3700

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes  [X]    No  [ ]

Common stock, par value $0.01 per share: 9,768,787 shares outstanding
as of May 1, 2002



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##### Table of Contents



SPACELABS MEDICAL, INC.

FORM 10-Q

For the Quarterly Period Ended March 30, 2002

TABLE OF CONTENTS

|        |  |                                                                                       |  |     
|------- |  | ------------------------------------------------------------------------------------- |  | ----
|        |  |                                                                                       |  | Page
|        |  |                                                                                       |  |     
|PART I  |  | Financial Information                                                                 |  |     
|       
|       
|       
|       
|Item 1. |  | Financial Statements                                                                  |  |     
|       
|       
|       
|       
|        |  | Condensed Consolidated Balance Sheets                                                 |  |     
|       
|       
|       
|       
|        |  | - March 30, 2002 (unaudited)and December 31, 2001                                     |  | 2   
|       
|       
|       
|       
|        |  | Condensed Consolidated Statements of Operations (unaudited)                           |  |     
|       
|       
|       
|       
|        |  | - Three Months Ended March 30, 2002 and March 31, 2001                                |  | 3   
|       
|       
|       
|       
|        |  | Condensed Consolidated Statements of Cash Flows (unaudited)                           |  |     
|       
|       
|       
|       
|        |  | - Three Months Ended March 30, 2002 and March 31, 2001                                |  | 4   
|       
|       
|       
|       
|        |  | Notes to Condensed Consolidated Financial Statements                                  |  | 5   
|       
|       
|       
|       
|Item 2. |  | Managements Discussion and Analysis of Financial Condition
and Results of Operations |  | 10  
|       
|       
|       
|       
|Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 17  
|       
|       
|       
|       
|PART II |  | Other Information                                                                     |  |     
|       
|       
|       
|       
|Item 1. |  | Legal Proceedings                                                                     |  | 18  
|       
|       
|       
|       
|Item 6. |  | Exhibits and Reports on Form 8-K                                                      |  | 18  



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TABLE OF CONTENTS



|          |                                                                                               |  |  |  |  |  |  | 
|--------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I.  
|          | Item 1. Financial Statements                                                                 
|          | CONDENSED CONSOLIDATED BALANCE SHEETS                                                        
|          | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                                              
|          | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                                              
|          | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                         
|          | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|          | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|PART II. 
|          | Item 1. Legal Proceedings                                                                    
|          | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURE



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##### Table of Contents






PART I.




Item 1. Financial Statements

SPACELABS MEDICAL, INC.




CONDENSED CONSOLIDATED BALANCE SHEETS

|                                   |                                             |                            |                      |                                      |         |             |         |              |         |         |        | 
|---------------------------------- | ------------------------------------------- | -------------------------- | -------------------- | ------------------------------------ | ------- | ----------- | ------- | ------------ | ------- | ------- | ------ | 
|                                   |                                             |                            |                      |                                      |         | March 30,   |         | December 31,
|                                   |                                             |                            |                      |                                      |         | 2002        |         | 2001        
|                                   |                                             |                            |                      |                                      |         |             |         |             
|                                   |                                             |                            |                      |                                      |         | (unaudited) |         |              |         |        
|(in
thousands)                     |                                             |                            |                      |                                      |         |             |         |             
|                                  
|                                  
|                                  
|                                  
|                                   |                                             |                            |                      | ASSETS                               |         |             |         |              |         |         |        | 
|                                  
|                                  
|                                  
|                                  
|Current assets                     |                                            
|                                   | Cash and cash equivalents                   |                            | $                    | 20,382                               |         |             | $       | 19,904       |        
|                                  
|                                  
|                                  
|                                  
|                                   | Receivables                                 |                            |                      | 62,617                               |         |             |         | 61,601       |        
|                                  
|                                  
|                                  
|                                  
|                                   | Inventories                                 |                            |                      | 55,916                               |         |             |         | 61,340       |        
|                                  
|                                  
|                                  
|                                  
|                                   | Refundable income taxes                     |                            |                      | 6,340                                |         |             |         | 2,298        |        
|                                  
|                                  
|                                  
|                                  
|                                   | Prepaid expenses                            |                            |                      | 2,107                                |         |             |         | 2,411        |        
|                                  
|                                  
|                                  
|                                  
|                                   | Deferred income taxes                       |                            |                      | 21,614                               |         |             |         | 22,928       |        
|                                   |                                             |                            |                      |                                      |         |             |         |             
|                                   |                                             |                            | Total current assets |                                      |         | 168,976     |         |              |         | 170,482 |       
|                                  
|                                  
|                                  
|                                  
|Property, plant and equipment, net |                                             |                            | 18,468               |                                      |         |             | 18,455  |             
|                                  
|                                  
|                                  
|                                  
|Deferred income taxes              |                                             |                            | 2,582                |                                      |         |             | 5,574   |             
|                                  
|                                  
|                                  
|                                  
|Goodwill, net                      |                                             |                            | 18,558               |                                      |         |             | 18,558  |             
|                                  
|                                  
|                                  
|                                  
|Other assets, net                  |                                             |                            | 10,117               |                                      |         |             | 10,391  |             
|                                   |                                             |                            |                      |                                      |         |             |         |             
|                                   |                                             | $                          | 218,701              |                                      |         | $           | 223,460 |             
|                                   |                                             |                            |                      |                                      |         |             |         |             
|                                   |                                             |                            |                      | LIABILITIES
AND SHAREHOLDERS EQUITY |         |             |         |              |         |         |        | 
|                                  
|                                  
|                                  
|                                  
|Current liabilities                |                                             |                            |                      |                                      |         |             |         |             
|                                  
|                                  
|                                  
|                                  
|                                   | Short-term borrowings                       |                            | $                    |                                     |         |             | $       | 30           |        
|                                  
|                                  
|                                  
|                                  
|                                   | Current portion of capital leases           |                            |                      | 84                                   |         |             |         | 78           |        
|                                  
|                                  
|                                  
|                                  
|                                   | Current portion of deferred gain            |                            |                      | 6,827                                |         |             |         | 7,186        |        
|                                  
|                                  
|                                  
|                                  
|                                   | Accounts payable and accrued expenses       |                            |                      | 40,294                               |         |             |         | 43,064       |        
|                                  
|                                  
|                                  
|                                  
|                                   | Deferred revenue                            |                            |                      | 6,170                                |         |             |         | 5,193        |        
|                                   |                                             |                            |                      |                                      |         |             |         |             
|                                   |                                             |                            |                      | Total current liabilities            |         |             | 53,375  |              |         |         | 55,551 | 
|                                  
|                                  
|                                  
|                                  
|Long-term capital leases           |                                             |                            | 89                   |                                      |         |             | 139     |             
|                                  
|                                  
|                                  
|                                  
|Deferred gain                      |                                             |                            |                     |                                      |         |             | 1,437   |             
|                                  
|                                  
|                                  
|                                  
|Other long-term obligations        |                                             |                            | 2,869                |                                      |         |             | 2,843   |             
|                                  
|                                  
|                                  
|                                  
|Contingency                        |                                             |                            |                     |                                      |         |             |        |             
|                                  
|                                  
|                                  
|                                  
|Shareholders equity               |                                             |                            |                      |                                      |         |             |         |             
|                                  
|                                  
|                                  
|                                  
|                                   | Common stock and additional paid-in capital |                            |                      | 98,044                               |         |             |         | 98,209       |        
|                                  
|                                  
|                                  
|                                  
|                                   | Treasury shares at cost                     |                            |                      | (33,867                              | )       |             |         | (34,235      | )      
|                                  
|                                  
|                                  
|                                  
|                                   | Accumulated other comprehensive loss        |                            |                      | (8,899                               | )       |             |         | (8,520       | )      
|                                  
|                                  
|                                  
|                                  
|                                   | Retained earnings                           |                            |                      | 107,090                              |         |             |         | 108,036      |        
|                                   |                                             |                            |                      |                                      |         |             |         |             
|                                   |                                             | Total shareholders equity |                      |                                      | 162,368 |             |         |              | 163,490 |        
|                                   |                                             |                            |                      |                                      |         |             |         |             
|                                   |                                             | $                          | 218,701              |                                      |         | $           | 223,460 |             
|                                   |                                             |                            |                      |                                      |         |             |         |             
|Common shares outstanding          |                                             |                            | 9,764                |                                      |         |             | 9,753   |             
|                                   |                                             |                            |                      |                                      |         |             |         |             

See accompanying notes to condensed consolidated financial statements.

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SPACELABS MEDICAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

|                                             |                                     |   |                    |        |                |   |        |        |  
|-------------------------------------------- | ----------------------------------- | - | ------------------ | ------ | -------------- | - | ------ | ------ | -
|                                             |                                     |   | Three Months Ended
|                                             |                                     |   |                   
|(in
thousands, except per share data)        |                                     |   | March 30, 2002     |        | March 31, 2001
|                                             |                                     |   |                    |        |               
|                                             |                                     |   | (unaudited)       
|                                             |                                     |   |                    |        |                |   |       
|Revenue                                      |                                     | $ | 61,954             |        |                | $ | 59,154 |       
|                                            
|                                            
|                                            
|                                            
|Cost of sales                                |                                     |   | 36,053             |        |                |   | 34,525 |       
|                                             |                                     |   |                    |        |                |   |        |       
|Gross margin                                 |                                     |   | 25,901             |        |                |   | 24,629 |       
|                                             |                                     |   |                    |        |                |   |        |       
|Operating expenses                           |                                    
|                                             | Selling, general and administrative |   |                    | 20,718 |                |   |        | 19,744 |  
|                                            
|                                            
|                                            
|                                            
|                                             | Research and development            |   |                    | 6,389  |                |   |        | 6,130  |  
|                                             |                                     |   |                    |        |                |   |        |       
|                                             |                                     |   | 27,107             |        |                |   | 25,874 |       
|                                             |                                     |   |                    |        |                |   |        |       
|Loss from operations                         |                                     |   | (1,206             | )      |                |   | (1,245 | )     
|                                            
|                                            
|                                            
|                                            
|Other income (expense)                       |                                     |  
|                                            
|                                            
|                                            
|                                            
|                                             | Interest income                     |   |                    | 155    |                |   |        | 64     |  
|                                            
|                                            
|                                            
|                                            
|                                             | Interest expense                    |   |                    | (73    | )              |   |        | (1,502 | )
|                                            
|                                            
|                                            
|                                            
|                                             | Other expense, net                  |   |                    | (402   | )              |   |        | (130   | )
|                                             |                                     |   |                    |        |                |   |        |       
|Loss before income taxes                     |                                     |   | (1,526             | )      |                |   | (2,813 | )     
|                                            
|                                            
|                                            
|                                            
|Income tax benefit                           |                                     |   | (580               | )      |                |   | (1,055 | )     
|                                             |                                     |   |                    |        |                |   |        |       
|Net loss                                     |                                     | $ | (946               | )      |                | $ | (1,758 | )     
|                                             |                                     |   |                    |        |                |   |        |       
|Basic net loss per share                     |                                     | $ | (0.10              | )      |                | $ | (0.18  | )     
|                                             |                                     |   |                    |        |                |   |        |       
|Diluted net loss per share                   |                                     | $ | (0.10              | )      |                | $ | (0.18  | )     
|                                             |                                     |   |                    |        |                |   |        |       
|Weighted average common shares outstanding - |                                     |   |                    |        |                |   |        |       
|                                            
|                                            
|                                            
|                                            
|                                             | Basic                               |   |                    | 9,745  |                |   |        | 9,665  |  
|                                             |                                     |   |                    |        |                |   |        |       
|                                             | Diluted                             |   |                    | 9,745  |                |   |        | 9,665  |  
|                                             |                                     |   |                    |        |                |   |        |       

See accompanying notes to condensed consolidated financial statements.

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SPACELABS MEDICAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                 |                                                                                |                                                     |                                                              |        |                    |        |           |        |       |        |  
|------------------------------------------------ | ------------------------------------------------------------------------------ | --------------------------------------------------- | ------------------------------------------------------------ | ------ | ------------------ | ------ | --------- | ------ | ----- | ------ | -
|                                                 |                                                                                |                                                     |                                                              |        | Three Months Ended
|                                                 |                                                                                |                                                     |                                                              |        |                   
|                                                 |                                                                                |                                                     |                                                              |        | March 30,          |        | March 31,
|(in
thousands)                                   |                                                                                | 2002                                                |                                                              | 2001  
|                                                 |                                                                                |                                                     |                                                              |       
|                                                 |                                                                                |                                                     |                                                              |        | (unaudited)       
|Operating activities                            
|                                                
|                                                
|                                                
|                                                
|                                                 | Net loss                                                                       |                                                     | $                                                            | (946   | )                  |        | $         | (1,758 | )    
|                                                
|                                                
|                                                
|                                                
|                                                 | Adjustments to reconcile net loss to net cash provided by operating
activities
|                                                 |                                                                                | Depreciation and amortization                       |                                                              |        | 1,909              |        |           |        | 2,128 |       
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                | Amortization of deferred gain on sale of facilities |                                                              |        | (1,796             | )      |           |        |      |       
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                | Deferred income taxes                               |                                                              |        | 4,282              |        |           |        | 39    |       
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                | Contribution to ISSOP 401(k) plan in common stock   |                                                              |        | 180                |        |           |        | 188   |       
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                | Changes in operating assets and liabilities        
|                                                 |                                                                                |                                                     | (Increase) decrease in receivables                           |        |                    | (1,268 | )         |        |       | 11,400 |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                |                                                     | Decrease in inventories                                      |        |                    | 5,156  |           |        |       | 481    |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                |                                                     | Increase in refundable income taxes                          |        |                    | (4,048 | )         |        |       | (965   | )
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                |                                                     | Decrease in prepaid expenses                                 |        |                    | 294    |           |        |       | 272    |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                |                                                     | Increase (decrease) in accounts payable and accrued expenses |        |                    | (2,680 | )         |        |       | 954    |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                |                                                     | Increase in deferred revenue                                 |        |                    | 985    |           |        |       | 246    |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                | Other                                               |                                                              |        | (10                | )      |           |        | 2     |       
|                                                 |                                                                                |                                                     |                                                              |        |                    |        |           |       
|Net cash provided by operating activities        |                                                                                |                                                     | 2,058                                                        |        |                    |        | 12,987    |       
|                                                 |                                                                                |                                                     |                                                              |        |                    |        |           |       
|Investing activities                            
|                                                 | Investment in property, plant and equipment                                    |                                                     |                                                              | (1,614 | )                  |        |           | (1,446 | )    
|                                                
|                                                
|                                                
|                                                
|                                                 | Other                                                                          |                                                     |                                                              | (26    | )                  |        |           | 21     |      
|                                                 |                                                                                |                                                     |                                                              |        |                    |        |           |       
|Net cash used by investing activities            |                                                                                |                                                     | (1,640                                                       | )      |                    |        | (1,425    | )     
|                                                 |                                                                                |                                                     |                                                              |        |                    |        |           |       
|Financing activities                            
|                                                 | Decrease in short-term borrowings                                              |                                                     |                                                              | (30    | )                  |        |           | (297   | )    
|                                                
|                                                
|                                                
|                                                
|                                                 | Proceeds from (principal payments on) long-term obligations, net               |                                                     |                                                              | 5      |                    |        |           | (8,608 | )    
|                                                
|                                                
|                                                
|                                                
|                                                 | Exercise of stock options                                                      |                                                     |                                                              | 23     |                    |        |           | 101    |      
|                                                 |                                                                                |                                                     |                                                              |        |                    |        |           |       
|Net cash used by financing activities            |                                                                                |                                                     | (2                                                           | )      |                    |        | (8,804    | )     
|                                                 |                                                                                |                                                     |                                                              |        |                    |        |           |       
|Effect of exchange rate changes on cash          |                                                                                |                                                     | 62                                                           |        |                    |        | 20        |       
|                                                 |                                                                                |                                                     |                                                              |        |                    |        |           |       
|Increase in cash and cash equivalents            |                                                                                |                                                     | 478                                                          |        |                    |        | 2,778     |       
|                                                
|                                                
|                                                
|                                                
|Cash and cash equivalents at beginning of period |                                                                                |                                                     | 19,904                                                       |        |                    |        | 2,583     |       
|                                                 |                                                                                |                                                     |                                                              |        |                    |        |           |       
|Cash and cash equivalents at end of period       |                                                                                | $                                                   | 20,382                                                       |        |                    | $      | 5,361     |       
|                                                 |                                                                                |                                                     |                                                              |        |                    |        |           |       

See accompanying notes to condensed consolidated financial statements.

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SPACELABS MEDICAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.      Basis of Presentation



| |  | The accompanying condensed consolidated financial statements include the
accounts of Spacelabs Medical, Inc. and its subsidiaries, collectively
referred to as the Company. The unaudited interim condensed consolidated
financial statements and related notes have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission (SEC).
Accordingly, certain information and footnote disclosures normally included
in financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been omitted
pursuant to such rules and regulations. The information furnished reflects,
in the opinion of management, all adjustments, consisting of normally
recurring items, necessary for a fair presentation of the results for the
interim periods presented. Interim results are not necessarily indicative
of results for a full year. Certain reclassifications have been made to
prior period financial statements to conform to the current presentation.
The accompanying condensed consolidated financial statements and related
notes should be read in conjunction with the consolidated financial
statements and notes thereto included in the Companys Annual Report on Form
10-K for the year ended December 31, 2001.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

2.      Merger Agreement



| |  | On March 22, 2002, the Company announced the signing of a definitive
merger agreement (the Merger Agreement) with Instrumentarium
Corporation (Instrumentarium) whereby Spacelabs will become a
subsidiary of Instrumentarium and each share of Spacelabs stock will be
converted into a right to receive $14.25 in cash (subject to possible
adjustment as set forth in the Merger Agreement). Since that
announcement, the Company has filed preliminary proxy materials with
the SEC and submitted filings to the appropriate antitrust regulatory
agencies. The Company expects to complete the merger as promptly as
practicable after obtaining the necessary regulatory and shareholder
approvals and after all of the other conditions to the merger have been
satisfied or waived, currently anticipated to be in or before July
2002. The Merger Agreement may be terminated and the merger may be
abandoned at any time prior to the effective time of the merger under
certain circumstances. Generally, the expenses incurred in connection
with the Merger Agreement and the merger will be paid by the party
incurring those expenses. However, in the event of the termination of
the Merger Agreement, under certain circumstances, the Company will be
required to reimburse Instrumentariums expenses and/or pay a
termination fee of $5.6 million.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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3.      Inventories

|                                     |  |           |        |              |  |   |        | 
|------------------------------------ |  | --------- | ------ | ------------ |  | - | ------ | 
|                                     |  | March 30, |        | December 31,
|(in thousands)                       |  | 2002      |        | 2001        
|                                    
|                                    
|                                    
|                                    
|                                    
|Raw materials and components         |  | $         | 12,383 |              |  | $ | 16,481 | 
|                                    
|                                    
|                                    
|                                    
|Work in process                      |  |           | 7,474  |              |  |   | 9,665  | 
|                                    
|                                    
|                                    
|                                    
|Finished products                    |  |           | 20,579 |              |  |   | 18,941 | 
|                                    
|                                    
|                                    
|                                    
|Demonstration inventories            |  |           | 4,106  |              |  |   | 4,332  | 
|                                    
|                                    
|                                    
|                                    
|Customer service parts and equipment |  |           | 11,374 |              |  |   | 11,921 | 
|                                     |  |           |        |              |  |   |        | 
|                                     |  | $         | 55,916 |              |  | $ | 61,340 | 
|                                     |  |           |        |              |  |   |        | 

4.      Goodwill and Intangible Assets



| |  | In July 2001, the Financial Accounting Standards Board issued Statement No.
141 Business Combinations and Statement No. 142 Goodwill and Other
Intangible Assets. Statement No. 141 requires business combinations
initiated after June 30, 2001 to be accounted for using the purchase method
of accounting, and specifies criteria for recognizing intangible assets
acquired in a business combination. No business combinations have been
initiated since July 1, 2001. Statement No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually. Intangible assets with
definite useful lives will continue to be amortized over their respective
estimated useful lives.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The Company adopted the provisions of Statement 142 on January 1, 2002.
Accordingly, the Company did not record any amortization of goodwill during
the first quarter of 2002. Statement 142 prescribes a two-phase process for
impairment testing of goodwill and the timing of transitional impairment
steps. The first phase, required to be completed by June 30, 2002, identifies
indications of impairment; while the second phase (if necessary), required to
be completed by December 31, 2002, measures the impairment. The Company has
not yet completed step one of the transition impairment test, including the
determination of whether any transitional impairment losses will be required
to be recognized as the cumulative effect of a change in accounting principle
as of January 1, 2002. Factors the Company is considering in this analysis
include the extent the book value of the Company exceeds its market
capitalization at January 1, 2002, the identification of reporting units and
the determination of the fair values and carrying values, including goodwill,
of reporting units. During the first quarter of 2002, the Company completed
its required analysis of other intangible assets and concluded that all such
assets have determinable lives and that the original useful lives of 4 to 40
years remain appropriate.

(6)



---



##### Table of Contents





| |  | In accordance with Statement 142, the effect of this accounting change is
reflected prospectively. Supplemental comparative disclosure as if the
change had been retroactively applied to the prior year period is as follows:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                      |                                      |                                               |   |                    |       |           |   |        |        |  
|------------------------------------- | ------------------------------------ | --------------------------------------------- | - | ------------------ | ----- | --------- | - | ------ | ------ | -
|                                      |                                      |                                               |   | Three Months Ended
|                                      |                                      |                                               |   |                   
|                                      |                                      |                                               |   | March 30,          |       | March 31,
|(in
thousands, except per share data) |                                      | 2002                                          |   | 2001              
|                                      |                                      |                                               |   |                   
|                                      | Reported net loss                    |                                               | $ | (946               | )     |           | $ | (1,758 | )     
|                                     
|                                     
|                                     
|                                     
|                                      | Add back goodwill amortization       |                                               |   |                   |       |           |   | 292    |       
|                                      |                                      |                                               |   |                    |       |           |   |       
|                                      |                                      | Adjusted net loss                             |   | $                  | (946  | )         |   | $      | (1,466 | )
|                                      |                                      |                                               |   |                    |       |           |   |       
|                                      | Basic and diluted net loss per share |                                               | $ | (0.10              | )     |           | $ | (0.18  | )     
|                                     
|                                     
|                                     
|                                     
|                                      | Add back goodwill amortization       |                                               |   |                   |       |           |   | 0.03   |       
|                                      |                                      |                                               |   |                    |       |           |   |       
|                                      |                                      | Adjusted basic and diluted net loss per share |   | $                  | (0.10 | )         |   | $      | (0.15  | )
|                                      |                                      |                                               |   |                    |       |           |   |       

Goodwill and other intangible assets were as follows at March 30, 2002 and December 31, 2001:

|                  |  |                |                   |              |  |              |         |                |  |              |        |              |  |   |        |  |  |   |         |   |  |   |        | 
|----------------- |  | -------------- | ----------------- | ------------ |  | ------------ | ------- | -------------- |  | ------------ | ------ | ------------ |  | - | ------ |  |  | - | ------- | - |  | - | ------ | 
|                  |  | March 30, 2002 | December 31, 2001
|                  |  |                |                  
|                  |  | Gross          |                   |              |  |              |         |                |  |              |        |              |  |   |        |  |  |   |         |   |  |  
|                  |  | Carrying       |                   | Accumulated  |  | Net Carrying |         | Gross Carrying |  | Accumulated  |        | Net Carrying
|(in thousands)    |  | Amount         |                   | Amortization |  | Amount       |         | Amount         |  | Amortization |        | Amount      
|                  |  |                |                   |              |  |              |         |                |  |              |        |             
|Goodwill          |  | $              | 28,957            |              |  | $            | (10,399 | )              |  | $            | 18,558 |              |  | $ | 28,957 |  |  | $ | (10,399 | ) |  | $ | 18,558 | 
|                 
|                 
|                 
|                 
|Trademark         |  |                | 4,804             |              |  |              | (520    | )              |  |              | 4,284  |              |  |   | 4,804  |  |  |   | (520    | ) |  |   | 4,284  | 
|                 
|                 
|                 
|                 
|Customer List     |  |                | 1,894             |              |  |              | (434    | )              |  |              | 1,460  |              |  |   | 1,894  |  |  |   | (410    | ) |  |   | 1,484  | 
|                 
|                 
|                 
|                 
|Patents and other |  |                | 332               |              |  |              | (86     | )              |  |              | 246    |              |  |   | 332    |  |  |   | (82     | ) |  |   | 250    | 
|                  |  |                |                   |              |  |              |         |                |  |              |        |              |  |   |        |  |  |   |         |   |  |   |        | 
|                  |  | $              | 35,987            |              |  | $            | (11,439 | )              |  | $            | 24,548 |              |  | $ | 35,987 |  |  | $ | (11,411 | ) |  | $ | 24,576 | 
|                  |  |                |                   |              |  |              |         |                |  |              |        |              |  |   |        |  |  |   |         |   |  |   |        | 

5.      Bank Line of Credit



| |  | In January 2002, the Company entered into a three-year, $20 million
revolving credit agreement with a bank to support future cash flow
requirements. Outstanding borrowings under the revolving credit line will
bear interest at a margin over LIBOR or the prime rate. Borrowings will be
collateralized by substantially all the assets of the Company. The credit
agreement contains certain, customary restrictive covenants, including
minimum net worth and restrictions on capital expenditures and additional
indebtedness. The Company did not borrow any funds under this line during
the first quarter of 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

6.      Net Income (Loss) per Share



| |  | Basic net income (loss) per share is based on the weighted-average number of
common shares outstanding for the period. Diluted net income (loss) per
share includes the effect of dilutive potential common shares outstanding,
consisting of stock options and unvested restricted shares, using the
treasury stock method. For the first quarter of 2002, unexercised stock
options representing the potential rights to 2,558,775 shares are excluded
from the diluted calculation as their effects would be antidilutive. For
the first quarter of 2001, unexercised stock options representing the
potential rights to 2,616,700 shares are excluded from the diluted
calculation as their effects would be antidilutive. The following schedule
represents a reconciliation of the numerators and denominators of basic and
diluted net loss per share calculations.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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##### Table of Contents



|                                   |                                       |                                      |             |          |               |        |           |          |       |  |  |   |       |  
|---------------------------------- | ------------------------------------- | ------------------------------------ | ----------- | -------- | ------------- | ------ | --------- | -------- | ----- |  |  | - | ----- | -
|                                   |                                       |                                      |             |          |               |        |           | Weighted |       |  |  |  
|                                   |                                       |                                      |             |          |               |        |           | Average  |       |  |  |  
|                                   |                                       |                                      |             | Net Loss |               | Shares |           | Net Loss
|                                   | (In
thousands, except per share data) |                                      | (Numerator) |          | (Denominator) |        | Per Share
|                                   |                                       |                                      |             |          |               |        |          
|                                  
|                                  
|                                  
|                                  
|                                   | Three months ended March 30, 2002:    |                                      |             |          |               |        |           |          |       |  |  |   |      
|                                  
|                                  
|                                  
|                                  
|                                   |                                       | Basic and diluted net loss per share |             | $        | (946          | )      |           | $        | 9,745 |  |  |   | (0.10 | )
|                                   |                                       |                                      |             |          |               |        |           |          |       |  |  |  
|Three months ended March 31, 2001: |                                       |                                      |             |          |               |        |           |          |       |  |  |  
|                                  
|                                  
|                                  
|                                  
|                                   |                                       | Basic and diluted net loss per share |             | $        | (1,758        | )      |           |          | 9,665 |  |  | $ | (0.18 | )
|                                   |                                       |                                      |             |          |               |        |           |          |       |  |  |  

7.      Business Segments



| |  | The Company identifies its business segments based on management
responsibility using a combination of product and geographic factors.
The Company has four reporting segments: US Monitoring Systems, US
Cardiology Systems, International and Consumer Health Management.
Segment profit is measured as operating income (loss) before research
and development, and certain unallocated corporate general and
administrative expenses. The Company has no inter-segment revenue.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                              |                            |                                                 |      |                    |        |           |   |        |        |  
|------------------------------------------------------------- | -------------------------- | ----------------------------------------------- | ---- | ------------------ | ------ | --------- | - | ------ | ------ | -
|                                                              |                            |                                                 |      | Three Months Ended
|                                                              |                            |                                                 |      |                   
|                                                              |                            |                                                 |      | March 30,          |        | March 31,
|(in
thousands)                                                |                            |                                                 | 2002 |                    | 2001  
|                                                              |                            |                                                 |      |                   
|Revenue:                                                      |                            |                                                 |      |                    |        |           |   |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | US Monitoring Systems      |                                                 | $    | 34,266             |        |           | $ | 32,836 |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | US Cardiology Systems      |                                                 |      | 8,037              |        |           |   | 7,828  |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | International              |                                                 |      | 17,984             |        |           |   | 15,697 |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Consumer Health Management |                                                 |      | 1,667              |        |           |   | 2,793  |       
|                                                              |                            |                                                 |      |                    |        |           |   |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Total revenue              |                                                 | $    | 61,954             |        |           | $ | 59,154 |       
|                                                              |                            |                                                 |      |                    |        |           |   |       
|Segment Profit (loss):                                        |                            |                                                 |      |                    |        |           |   |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | US Monitoring Systems      |                                                 | $    | 8,038              |        |           | $ | 6,879  |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | US Cardiology Systems      |                                                 |      | 481                |        |           |   | (175   | )     
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | International              |                                                 |      | 727                |        |           |   | 484    |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Consumer Health Management |                                                 |      | (1,119             | )      |           |   | (126   | )     
|                                                              |                            |                                                 |      |                    |        |           |   |       
|                                                              | Total segment profit       |                                                 | $    | 8,127              |        |           | $ | 7,062  |       
|                                                             
|                                                             
|                                                             
|                                                             
|Reconciliation of segment profit to loss before
income taxes: |                            |                                                 |      |                    |        |           |   |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                            | Unallocated general and administrative expenses |      | $                  | (2,944 | )         |   | $      | (2,177 | )
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                            | Research and development                        |      |                    | (6,389 | )         |   |        | (6,130 | )
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                            | Other expense                                   |      |                    | (320   | )         |   |        | (1,568 | )
|                                                              |                            |                                                 |      |                    |        |           |   |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              |                            | Loss before income taxes                        |      | $                  | (1,526 | )         |   | $      | (2,813 | )
|                                                              |                            |                                                 |      |                    |        |           |   |       

(8)



---



##### Table of Contents



8.      Comprehensive Loss



| |  | Comprehensive income (loss) refers to the total change in equity during a
period except those changes that result from investments by owners and
distributions to owners. Comprehensive income (loss) includes net income
(loss) as well as a component comprised of certain revenues, expenses, gains
and losses that under generally accepted accounting principles are reflected
in shareholders equity but excluded from the determination of net income
(loss). The Company has segregated the total accumulated other
comprehensive loss (specifically, accumulated foreign currency translation
adjustments and change in fair value of interest rate swap agreements) from
the other components of shareholders equity in the accompanying Condensed
Consolidated Balance Sheets.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Comprehensive loss for the three month periods ended March 30, 2002 and
March 31, 2001, are detailed below:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

|               |                           |                                                                                                    |   |                    |      |           |   |        |      |  
|-------------- | ------------------------- | -------------------------------------------------------------------------------------------------- | - | ------------------ | ---- | --------- | - | ------ | ---- | -
|               |                           |                                                                                                    |   | Three Months Ended
|               |                           |                                                                                                    |   |                   
|               |                           |                                                                                                    |   | March 30,          |      | March 31,
|(in
thousands) |                           | 2002                                                                                               |   | 2001              
|              
|              
|              
|              
|              
|               | Net loss                  |                                                                                                    | $ | (946               | )    |           | $ | (1,758 | )   
|              
|              
|              
|              
|               | Other comprehensive loss: |                                                                                                    |   |                    |      |           |   |        |     
|              
|              
|              
|              
|               |                           | Foreign currency translation adjustments                                                           |   |                    | (379 | )         |   |        | (755 | )
|              
|              
|              
|              
|               |                           | Change in fair value of interest rate swap agreements including
transition adjustments, net of tax |   |                    |     |           |   |        | (701 | )
|               |                           |                                                                                                    |   |                    |      |           |   |       
|               | Comprehensive loss        |                                                                                                    | $ | (1,325             | )    |           | $ | (3,214 | )   
|               |                           |                                                                                                    |   |                    |      |           |   |       

9.      Supplemental Cash Flow Information



| |  | The following provides additional information concerning cash flow
activities:
| |  | ------------------------------------------------------------------------------

|                                  |  |                    |      |           |  |   |       |  
|--------------------------------- |  | ------------------ | ---- | --------- |  | - | ----- | -
|                                  |  | Three Months Ended
|                                  |  |                   
|                                  |  | March 30,          |      | March 31,
|(in thousands)                    |  | 2002               |      | 2001     
|                                 
|                                 
|                                 
|                                 
|                                 
|Interest paid                     |  | $                  | 73   |           |  | $ | 1,568 |  
|                                  |  |                    |      |           |  |   |       |  
|Income taxes paid (refunded), net |  | $                  | (856 | )         |  | $ | (146  | )
|                                  |  |                    |      |           |  |   |       |  

(9)



---



##### Table of Contents






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

RESULTS OF OPERATIONS

|                                             |                    |                                     |       |      |      |           |       |           |      |                    |  |         |  |    |      |   |     |  |       |    |     |   |  | 
|-------------------------------------------- | ------------------ | ----------------------------------- | ----- | ---- | ---- | --------- | ----- | --------- | ---- | ------------------ |  | ------- |  | -- | ---- | - | --- |  | ----- | -- | --- | - |  | 
|                                             |                    |                                     |       |      |      |           |       |           |      | Three months ended |  |         |  |   
|                                             |                    |                                     |       |      |      |           |       |           |      |                    |  |         |  |   
|                                             |                    |                                     |       |      |      | March 30, |       | March 31, |      | Dollar             |  | Percent
|(dollars
in millions, except per share data) |                    | 2002                                |       | 2001 |      | Change    |       | Change   
|                                            
|                                             |                    |                                     |       |      |      |           |       |           |      |                    |  |         |  |    |      |   |     |  |      
|                                            
|                                            
|                                            
|                                            
|Revenue                                      |                    | $                                   | 62.0  |      |      | $         | 59.2  |           |      |                    |  |         |  | $  | 2.8  |   |     |  | 4.7   | % 
|                                            
|                                            
|                                            
|                                            
|Gross margin                                 |                    |                                     | 25.9  |      |      |           | 24.6  |           |      |                    |  |         |  |    | 1.3  |   |     |  | 5.2   | % 
|                                            
|                                            
|                                            
|                                            
|                                             | As a % of revenue  |                                     |       | 41.8 | %    |           |       | 41.6      | %    |                    |  |         |  |    |      |   |     |  |       |    |    
|                                            
|                                            
|                                            
|                                            
|Operating expenses:                          |                    |                                     |       |      |      |           |       |           |      |                    |  |         |  |    |      |   |     |  |       |   
|                                            
|                                            
|                                            
|                                            
|                                             |                    | Selling, general and administrative |       |      | 20.7 |           |       |           | 19.7 |                    |  |         |  |    |      |   | 1.0 |  |       |    | 4.9 | %
|                                            
|                                            
|                                            
|                                            
|                                             |                    | As
a % of revenue                   |       |      | 33.4 | %         |       |           | 33.4 | %                  |  |         |  |    |      |   |     |  |       |    |     |  
|                                            
|                                            
|                                            
|                                            
|                                             |                    | Research
and development            |       |      | 6.4  |           |       |           | 6.1  |                    |  |         |  |    |      |   | 0.3 |  |       |    | 4.2 | %
|                                            
|                                            
|                                            
|                                            
|                                             |                    | As
a % of revenue                   |       |      | 10.3 | %         |       |           | 10.4 | %                  |  |         |  |    |      |   |     |  |       |    |     |  
|                                            
|                                            
|                                            
|                                            
|Other expense, net                           |                    |                                     | 0.3   |      |      |           | 1.6   |           |      |                    |  |         |  |    | (1.2 | ) |     |  | (79.6 | %)
|                                            
|                                            
|                                            
|                                            
|                                             | As a % of revenue  |                                     |       | 0.5  | %    |           |       | 2.7       | %    |                    |  |         |  |    |      |   |     |  |       |    |    
|                                            
|                                            
|                                            
|                                            
|Benefit for income taxes                     |                    |                                     | (0.6  | )    |      |           | (1.1  | )         |      |                    |  |         |  |    | (0.5 | ) |     |  | (45.0 | %)
|                                            
|                                            
|                                            
|                                            
|                                             | Effective tax rate |                                     |       | 38.0 | %    |           |       | 37.5      | %    |                    |  |         |  |    |      |   |     |  |       |    |    
|                                            
|                                            
|                                            
|                                            
|Net loss                                     |                    | $                                   | (0.9  | )    |      | $         | (1.8  | )         |      |                    |  |         |  | ($ | 0.8  | ) |     |  | (46.2 | %)
|                                            
|                                            
|                                            
|                                            
|Basic and diluted net loss per share         |                    | $                                   | (0.10 | )    |      | $         | (0.18 | )         |      |                    |  |         |  | ($ | .08  | ) |     |  | (45.9 | %)

Critical Accounting Policies

The Companys critical accounting policies and estimates are substantially the
same as those discussed in its 2001 Annual Report of Form 10-K, as amended.
They include revenue recognition; estimating the allowances for doubtful
accounts and sales returns; valuation of inventories; valuation of deferred tax
assets; valuation of goodwill and intangible assets; valuation of investments;
and estimating product warranties.

Revenue

Worldwide revenue for the first quarter of 2002 increased 4.7% to $62.0 million
compared to $59.2 million in the same quarter last year.

US Monitoring Systems revenue for the first quarter of 2002 increased 4.4% to
$34.3 million as compared to $32.8 million during the same quarter a year ago.
The increase for the quarter is believed to be primarily the result of
improvements in the US healthcare provider economic environment and the
Companys ability to compete effectively within the market.

Current quarter US Cardiology Systems revenue increased 2.7% to $8.0 million
compared to $7.8 million in the first quarter of 2001. The improvement is
believed to be primarily attributable to the managed decrease in distributor
inventories during 2001, which resulted in greater sales opportunities in 2002
for the Companys physicians office distribution channel.

(10)



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##### Table of Contents



Consumer Health Management revenue was $1.7 million in the first quarter of
2002 compared to $2.8 million for the same period in 2001, primarily due to
decreased advertising revenue. The Company believes the decline in advertising
revenue is due to a weak advertising market.

International revenue, including export sales, increased 14.6% to $18.0
million, or 29.0% of total revenue, in the first quarter of 2002 as compared to
$15.7 million, or 26.5% of total revenue, in the first quarter of 2001. Foreign
currency exchange rate fluctuations negatively impacted current quarter revenue
by approximately $0.2 million when compared to the first quarter of 2001. The
increase in International revenue was due to improvements in parts of Europe
and Asia. International revenue has historically been subject to a higher
degree of uncertainty than US revenue due to the need for foreign government
approvals, more complex financing arrangements, greater variability in the
financial stability of the customers, and instability of currencies in parts of
the world.

The Companys ability to produce consistent future revenue growth is, to a
certain extent, dependent on its backlog of shippable orders. In addition to
the variability in international revenue, backlog is subject to seasonal
variations and there is no guarantee that the Company will have sufficient
backlog in any given quarter to meet its revenue objectives.

Gross Margin

Gross margin was 41.8% of revenue in the first quarter of 2002 as compared to
41.6% during the corresponding quarter in 2001. The increase in gross margin
is a result of the impact of increased revenue relative to the fixed-cost
components of the Companys gross margin-related expenses, partly offset by
changes in product mix and continued competitive pricing pressures. The
Company believes that pressure on gross margin from aggressive worldwide
competitive pricing will continue.

Operating Expenses

Selling, general and administrative expenses increased by $1.0 million, or
4.9%, in the first quarter of 2002 to $20.7 million compared to $19.7 million
in the first quarter of 2001. This increase is primarily due to approximately
$1.0 million associated with merger related activities, a $0.5 million charge
for severance expenses for an officer of the Company, as well as increased
commission expenses associated with increased revenues. These increases have
been partially offset by continued efforts to reduce fixed expenses. Selling,
general and administrative expenses represented 33.4% of current period
revenue, the same as the first quarter of 2001.

Research and development expenses were $6.4 million, or 10.3% of revenue, in
the first quarter of 2002 compared to $6.1 million, or 10.4% of revenue, in the
same period a year ago.

Segment Profit

The Company measures segment profit as operating income before research and
development, and certain unallocated corporate general and administrative
expenses. Segment profit for US Monitoring Systems improved by $1.2 million or
16.8% to $8.0 million during the first quarter of 2002 from $6.9 million during
the first quarter of 2001. The increase in segment profit was primarily
attributable to an increase in US Monitoring Systems revenue and reductions in
fixed expenses.

During the first quarter of 2002, the segment profit of the US Cardiology
Systems increased by $0.7 million to $0.5 million as compared to a loss of $0.2
million during the first quarter of 2001. The increase in segment profit was
primarily attributable to the increase in revenues in the physicians

(11)



---



##### Table of Contents



office market and reduced product discounts.

Consumer Health Management segment loss was ($1.1) million during the first
quarter of 2002 compared to ($0.1) million during the first quarter of 2001,
due primarily to lower advertising revenue.

Segment profit for the Companys International business unit increased to $0.7
million during the first quarter of 2002 compared to $0.5 million during the
first quarter of 2001. This improvement was primarily volume related,
attributable to an increase in first quarter segment revenue and offset in part
by unfavorable foreign currency exchange rate fluctuations.

Other Income (Expense)

Interest expense for the first quarter of 2002 was approximately $73,000, a 95%
decrease from the same period of 2001. The decrease was due primarily to the
retirement of the Companys primary credit facilities in September of 2001.
Interest income was approximately $155,000 for the first quarter of 2002
compared to $64,000 during the first quarter of 2001 due to an increase in cash
and cash equivalents. The Company experienced a $73,000 loss from foreign
currency exchange rate fluctuations in the first quarter of 2002 as compared to
a $30,000 gain during the same quarter a year ago.

Taxes and Net Loss

The effective tax rate for the first quarter of 2002 was 38.0% as compared to
37.5% during the same period of 2001. The effective tax rate for the quarter
was accrued at the rate expected to apply for the full year based on
profitability expectations in future quarters. Failure to meet such
profitability expectations could result in changes to the effective tax rate
and potential increases to the valuation allowance for deferred tax assets.

As a result of the above factors, the Company reported a net loss of $0.9
million or $0.10 per share during the first quarter of 2002 as compared to net
loss of $1.8 million or $0.18 per share during the same period a year ago.

(12)



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##### Table of Contents



CAPITAL RESOURCES & LIQUIDITY

|                          |  |           |       |              |  |        |       |         |  |   |      |   |  |  |       |   
|------------------------- |  | --------- | ----- | ------------ |  | ------ | ----- | ------- |  | - | ---- | - |  |  | ----- | --
|                          |  | March 30, |       | December 31, |  | Dollar |       | Percent
|(dollars
in millions)     |  | 2002      |       | 2001         |  | Change |       | Change 
|                          |  |           |       |              |  |        |       |        
|                         
|                         
|                         
|                         
|Cash and cash equivalents |  | $         | 20.4  |              |  | $      | 19.9  |         |  | $ | 0.5  |   |  |  | 2.4   | % 
|                         
|                         
|                         
|                         
|Working capital           |  |           | 115.6 |              |  |        | 114.9 |         |  |   | 0.7  |   |  |  | 0.6   | % 
|                         
|                         
|                         
|                         
|Long-term obligations     |  |           | 3.0   |              |  |        | 4.4   |         |  |   | (1.5 | ) |  |  | (33.1 | %)
|                         
|                         
|                         
|                         
|Shareholders equity      |  |           | 162.4 |              |  |        | 163.5 |         |  |   | (1.1 | ) |  |  | (0.7  | %)

As of March 30, 2002, cash and cash equivalents totaled $20.4 million compared
to $19.9 million at December 31, 2001. Working capital increased by $0.7
million during the period to $115.6 million due primarily to increases in
accounts receivable and cash and decreases in accounts payable and accrued
expenses, offset in part by a decrease in inventories.

During the first quarter of 2002, the Company generated $2.1 million in cash
from operations. The primary source of operating cash was a $5.1 million
reduction in inventory, due primarily to outsourcing of the production of the
Companys printed circuit board assemblies.

Capital expenditures in the first quarter of 2002 totaled $1.6 million compared
to $1.4 million during the first quarter of 2001. Management expects capital
expenditures for the full year 2002 to be higher than 2001 levels due to
planned investments in Lifeclinic Health Stations.

In January 2002, the Company entered into a three-year, $20 million revolving
credit agreement with a bank to support future cash flow requirements.
Outstanding borrowings under the revolving credit line will bear interest at a
margin over LIBOR or Prime. The loan is collateralized by substantially all
the assets of the Company and contains certain customary restrictive covenants.
As of March 30, 2002, the Company had approximately $20.0 million available
under the revolving credit agreement and $4.4 million available under several
international credit lines to meet the operating requirements of its
international subsidiaries. The Company believes its current cash resources
coupled with the new revolving facility will be adequate to support its
liquidity needs for at least the next twelve months.

The Companys financial commitments as of March 30, 2002 are substantially
similar to those disclosed in its 2001 Annual Report on Form 10-K.

Merger Agreement

On March 22, 2002, the Company announced the signing of a definitive merger
agreement (the Merger Agreement) with Instrumentarium Corporation
(Instrumentarium) whereby Spacelabs will become a subsidiary of
Instrumentarium and each share of Spacelabs stock will be converted into a
right to receive $14.25 in cash (subject to possible adjustment as set forth in
the Merger Agreement). Since that announcement, the Company has filed
preliminary proxy materials with the SEC and submitted filings to the
appropriate antitrust regulatory agencies. Before the merger can be
completed, a number of conditions must be satisfied or waived by the applicable
party. The most important of these include:

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| |  | approval and adoption of the Merger Agreement and the merger by holders of a majority of the outstanding shares of
Spacelabs common stock;                                                                                                                                                                                                                                                                                   
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | all regulatory approvals (required or mutually deemed necessary) having been received by the parties, all notice and
waiting periods required having passed (including the expiration or early termination of applicable waiting periods under
United States federal antitrust laws) and all conditions contained in any such approvals required to be satisfied prior to
the completion of the merger having been satisfied;
| 
| |  | absence of any legal prohibitions or restraints against the merger;                                                                                                                                                                                                                                                                                                                                                          
| 
| |  | each partys material compliance with its obligations under the merger agreement; and                                                                                                                                                                                                                                                                                                                                        
| 
| |  | accuracy, as qualified by materiality, of each partys representations and warranties under the merger agreement.                                                                                                                                                                                                                                                                                                            

On May 7, 2002, the Company announced that the Federal Trade Commission has
completed its review of the acquisition under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976 and has allowed the waiting period to
expire without further action. The Company expects to complete the merger
as promptly as practicable after all of the conditions to the merger have
been satisfied or waived. The current expectation is that this will
occur in or before July 2002.

The Merger Agreement may be terminated and the merger may be abandoned at any
time prior to the effective time of the merger under certain
circumstances. Whether or not the merger is consummated, the expenses
incurred in connection with the merger agreement and the merger will be
paid by the party incurring those expenses. However, in the event of the
termination of the Merger Agreement, under certain circumstances, the
Company will be required to reimburse Instrumentariums expenses and/or
pay a termination fee under the circumstances summarized below:



| |  | If Instrumentarium or the Company terminates the Merger Agreement
because the Companys stockholders do not approve the Merger
Agreement, or if the special meeting held to vote on the merger is
adjourned until a date after August 31, 2002, in each case
irrespective of the presence of a competing takeover proposal, the
Company will reimburse Instrumentariums expenses.                                                                                                                                                                                                                                                                                          
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | If Instrumentarium or the Company terminates the Merger Agreement
because the Companys stockholders do not approve the Merger Agreement
and (a) prior to the failure of approval of the stockholders, a
competing takeover proposal has been publicly announced relating to
the Company, and (b) the Company either consummates a transaction with
such competing bidder within 12 months of the date of termination or
enters into an agreement with respect to such competing bidder within
such 12 month period (which is eventually consummated within 18 months
from the termination date), then the Company will pay Instrumentarium
a termination fee of $5,600,000.
| 
| |  | The Company will pay Instrumentarium the termination fee of $5,600,000
and will reimburse Instrumentariums expenses, if Instrumentarium
terminates the Merger Agreement for one of the reasons listed below:                                                                                                                                                                                                                                                                                                                                                                                                                                                               



| |  |  | the Companys board of directors withdraws, modifies or changes
its recommendation of the merger or resolves to do so;                                           
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the board of directors recommends a competing takeover proposal
or resolves to do so or enters into a letter of intent to accept any
competing takeover proposal;

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| |  |  | the Company does not include the board of directors
recommendation in favor of the merger in the proxy statement;                                                                               
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the board of directors does not reaffirm its recommendation for
the Merger Agreement within five days of a request made by
Instrumentarium;                                                      
|
| |  |  | the Companys stockholders meeting for the purpose of
considering the merger proposal is not called by June 30, 2002;                                                                           
|
| |  |  | the Company has intentionally breached its no-shop
obligation; or                                                                                                                              
|
| |  |  | a tender or exchange offer for
25% or more of the the Companys
outstanding capital stock is commenced and the board of directors
fails to recommend against the acceptance of such tender offer.

The foregoing description of the Merger Agreement and merger is qualified in
its entirety by reference to the Preliminary Proxy Statement filed by the
Company on April 19, 2002 and to the terms of such Merger Agreement.

Adoption of Accounting Standards

In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards Nos. 141 Business Combinations
and 142 Goodwill and Other Intangible Assets. Statement 141 requires business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method of accounting, and specifies criteria for recognizing
intangible assets acquired in a business combination. Statement 142 requires
that goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually. Intangible
assets with definite useful lives will continue to be amortized over their
respective estimated useful lives. Statement 141 was effective July 1, 2001 and
the Company adopted Statement 142 on January 1, 2002. As a result of the
adoption of Statement 142, the Company recognized no goodwill amortization
expense during the first quarter of 2002 compared with $292,000 during the same
period of the prior year.

Upon adoption of Statement 142, the Company was required to reassess the useful
lives and residual values of all intangible assets acquired, and make any
necessary amortization period adjustments by the end of the first quarter of
2002. During the first quarter of 2002, the Company completed this analysis and
determined that all of its intangible assets, consisting primarily of
trademarks, have determinable lives and that the original useful lives of 4 to
40 years remain appropriate.

In connection with Statement 142s transitional goodwill impairment evaluation,
the Statement requires the Company to perform an assessment of whether there is
an indication that goodwill is impaired as of the date of adoption. To
accomplish this, the Company must identify its reporting units and determine
the carrying value of each reporting unit by assigning the assets and
liabilities, including the existing goodwill and intangible assets, to those
reporting units as of January 1, 2002. The Company has not yet completed this
process but must do so before June 30, 2002. Factors being considered by the
Company include the extent that its book value exceeds its market
capitalization at January 1, 2002, the identification of its reporting units
and the determination of the fair value and carrying value of reporting units,
including goodwill.

To the extent a reporting units carrying amount exceeds its fair value, an
indication exists that the reporting units goodwill may be impaired and the
Company must perform the second step of the transitional impairment test. In
the second step, the Company must compare the implied fair value of the
goodwill of each of the reporting units, determined by allocating the reporting
units fair value to all its assets (recognized and unrecognized) and
liabilities in a manner similar to a purchase price

(15)



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allocation in accordance with Statement 141, to its carrying amount, both of
which would be measured as of January 1, 2002. This second step is required to
be completed as soon as possible, but no later than the end of 2002. Any
transitional impairment loss will be recognized as the cumulative effect of a
change in accounting principle in the Companys statement of operations.

In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,
which is effective for fiscal years beginning after December 15, 2001.
Statement 144 supersedes certain provisions of APB Opinion No. 30 Reporting
the Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions (APB 30) and supersedes Statement No. 121 Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
Although Statement 144 supersedes Statement 121 and the provisions of APB 30
regarding the accounting and reporting of the disposal of a segment of a
business, it retains many of the fundamental provisions of Statement 121 and
the requirements in APB 30 to report separately discontinued operations.
Statement 144 also extends the reporting of discontinued operations to a
component of an entity that either has been disposed of (by sale, abandonment,
or in a distribution to owners) or is classified as held for sale. The adoption
of Statement 144 did not have a material effect on its consolidated financial
position, results of operations, or cash flows.

Forward Looking Information

This document contains certain forward-looking statements about the proposed
merger of Spacelabs and Instrumentarium Corporation and other matters. These
statements include statements regarding the anticipated closing date of the
transaction and the expectation that no adjustment to the purchase price will
be required. There is no assurance that any transaction will close or that no
adjustment to the purchase price will be required. Forward-looking statements
can be identified by the fact that they do not relate strictly to historical or
current facts. They often include words like believe, expect, anticipate,
estimate, and intend or future or conditional verbs such as will,
would, should, could or may. Certain factors that could cause actual
results to differ materially from expected include, but are not limited to,
delays in completing the merger, adjustments to the purchase price, changes in
product and service demand and acceptance, adverse economic conditions, risk
that the Company may not raise additional capital to fully fund Lifeclinic on
favorable terms, adverse exchange rate fluctuations and political risks, the
impact of competition on pricing, adverse impact of HIPAA and other legislation
and regulatory changes that adversely affect the business in which Spacelabs
and Instrumentarium Corporation are engaged, capacity and supply constraints or
difficulties, the failure to achieve product development objectives, the risk
of potential business interruption associated with the move from the
headquarters facility, the risk that a suitable facility may not be identified
on a timely basis, the risk that the amount of reimbursement for ambulatory
blood pressure monitoring will be inadequate or delayed, changes in the
interest rate environment, changes in the securities markets and other risks
detailed in this document and other of the Companys Securities and Exchange
Commission filings.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency

Substantially all of the revenue and operating expenses of the Companys
foreign subsidiaries are denominated in local currencies and translated into US
dollars at rates of exchange approximating those existing at the date of the
transactions. Foreign currency translation impacts primarily revenue and
operating expenses as a result of foreign exchange rate fluctuations. Because
the Companys products are primarily manufactured in the United States, foreign
currency fluctuations generally do not affect its cost of goods sold. The
Companys foreign currency transaction risk is primarily limited to current
amounts payable to its foreign subsidiaries, which are denominated in local
currencies. At March 30, 2002, such net payables were approximately $0.1
million. To minimize foreign currency transaction risk, the Company ensures
that its foreign subsidiaries remit amounts to the US parent in a timely
manner. Foreign country short-term borrowing facilities are utilized where
necessary to ensure prompt payments. The Company does not currently utilize
foreign currency hedging contracts.

Interest Rate Risk

The Company invests its excess cash primarily in money market funds and other
financial instruments with maturities of three months or less. Therefore, if
market interest rates were to increase immediately and uniformly by 10% from
levels at March 30, 2002, the fair values of cash and cash equivalents would
not change by a material amount.

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PART II.




Item 1. Legal Proceedings

A purported class action lawsuit was filed on March 29,2002 in the Superior
Court of the State of Washington, King County, against Spacelabs, Spacelabs
chief executive officer and its directors. The complaint alleges, among other
things, that the merger, as announced on March 22,2002, is unfair to Spacelabs
shareholders, that the consideration to be paid in the merger is inadequate and
unfair to Spacelabs shareholders and that the directors of Spacelabs breached
their fiduciary duties owed to Spacelabs shareholders. The lawsuit seeks,
among other things: an injunction enjoining the merger; in the event that the
merger is consummated, rescission of the merger; and an imposition of a
constructive trust in favor of the plaintiff, upon any benefits received by the
defendants as a result of their conduct. The plaintiff also seeks costs and
disbursements of the action, including reasonable attorneys fees and expenses.
Spacelabs believes that the allegations contained in the complaint are without
merit and intends to defend them vigorously.




Item 6. Exhibits and Reports on Form 8-K

There were no reports on Form 8-K filed during the three months ended March 30,
2002.

(18)



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SIGNATURE

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

|                   |  |     |  |                           | 
|------------------ |  | --- |  | ------------------------- | 
|                   |  |     |  | SPACELABS MEDICAL, INC.  
|                  
|                  
|                  
|                  
|                   |  |     |  | (Registrant)             
|                  
|                  
|                  
|                  
|                   |  |     |  |                          
|                   |  |     |  |                          
|DATE: May 14, 2002 |  | BY: |  | /s/ Carl A. Lombardi     
|                   |  |     |  |                          
|                   |  |     |  | Carl A. Lombardi         
|                  
|                  
|                  
|                  
|                   |  |     |  | Chairman of the Board and
|                  
|                  
|                  
|                  
|                   |  |     |  | Chief Executive Officer  
|                  
|                  
|                  
|                  
|                   |  |     |  |                          
|                   |  |     |  |                          
|                   |  | BY: |  | /s/ James A. Richman     
|                   |  |     |  |                          
|                   |  |     |  | James A. Richman         
|                  
|                  
|                  
|                  
|                   |  |     |  | Vice President and       
|                  
|                  
|                  
|                  
|                   |  |     |  | Corporate Controller     

(19)