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

FORM 10-Q

|    |                                                                                        
|--- | ---------------------------------------------------------------------------------------
|[X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 29, 2001

OR

|      |                                                                                         
|----- | ----------------------------------------------------------------------------------------
|[   ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(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
incorporation or organization) |  | (I.R.S. Employer
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 $.01 per share: 9,736,706 shares outstanding
as of November 1, 2001



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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    
|Exhibit Index
|EXHIBIT 4.3  



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##### Table of Contents



SPACELABS MEDICAL, INC.

FORM 10-Q

For the Quarterly Period Ended September 29, 2001

TABLE OF CONTENTS

|         |  |                                                                                                                                     |  |     
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                                                     |  | Page
|         |  |                                                                                                                                     |  |     
|        
|        
|        
|        
|PART I.  |  | Financial Information                                                                                                               |  |     
|        
|        
|        
|        
|Item 1.  |  | Financial Statements                                                                                                                |  |     
|        
|        
|        
|        
|         |  | Condensed Consolidated Balance Sheets
- September 29, 2001 (unaudited)and December 31, 2000                                         |  | 2   
|        
|        
|        
|        
|         |  | Condensed Consolidated Statements of Operations (unaudited)
- Three and Nine Months Ended September 29, 2001 and September 30, 2000 |  | 3   
|        
|        
|        
|        
|         |  | Condensed Consolidated Statements of Cash Flows (unaudited)
- Nine Months Ended September 29, 2001 and September 30, 2000           |  | 4   
|        
|        
|        
|        
|         |  | Notes to Condensed Consolidated Financial Statements                                                                                |  | 5   
|        
|        
|        
|        
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition
and Results of Operations                                               |  | 11  
|        
|        
|        
|        
|Item 3.  |  | Quantitative and Qualitative Disclosures About Market Risk                                                                          |  | 18  
|        
|        
|        
|        
|PART II. |  | Other Information                                                                                                                   |  |     
|        
|        
|        
|        
|Item 1.  |  | Legal Proceedings                                                                                                                   |  | 19  
|        
|        
|        
|        
|Item 6.  |  | Exhibits and Reports on Form 8-K                                                                                                    |  | 19  





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PART I.




Item 1. Financial Statements




SPACELABS MEDICAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

|                                     |                                                             |                            |         |               |         |              |         |         |         | 
|------------------------------------ | ----------------------------------------------------------- | -------------------------- | ------- | ------------- | ------- | ------------ | ------- | ------- | ------- | 
|                                     |                                                             |                            |         | September 29, |         | December 31,
|(in thousands)                       |                                                             | 2001                       |         | 2000         
|                                     |                                                             |                            |         |              
|                                     |                                                             |                            |         | (unaudited)   |         |              |         |        
|ASSETS                               |                                                             |                            |         |               |         |              |         |        
|Current assets                       |                                                             |                            |         |               |         |              |         |        
|                                     | Cash and cash equivalents                                   |                            | $       | 13,961        |         |              | $       | 2,583   |        
|                                     | Receivables                                                 |                            |         | 63,638        |         |              |         | 71,865  |        
|                                     | Inventories                                                 |                            |         | 63,467        |         |              |         | 74,594  |        
|                                     | Refundable income taxes                                     |                            |         |              |         |              |         | 1,766   |        
|                                     | Prepaid expenses                                            |                            |         | 1,923         |         |              |         | 2,087   |        
|                                     | Deferred income taxes                                       |                            |         | 32,015        |         |              |         | 27,986  |        
|                                     |                                                             |                            |         |               |         |              |         |        
|                                     |                                                             | Total current assets       |         |               | 175,004 |              |         |         | 180,881 | 
|Property, plant and equipment, net   |                                                             |                            | 17,145  |               |         |              | 60,425  |        
|Deferred income taxes                |                                                             |                            | 3,624   |               |         |              | 367     |        
|Other assets, net                    |                                                             |                            | 29,193  |               |         |              | 33,233  |        
|                                     |                                                             |                            |         |               |         |              |         |        
|                                     |                                                             | $                          | 224,966 |               |         | $            | 274,906 |        
|                                     |                                                             |                            |         |               |         |              |         |        
|LIABILITIES AND SHAREHOLDERS EQUITY |                                                             |                            |         |               |         |              |         |        
|Current liabilities                  |                                                             |                            |         |               |         |              |         |        
|                                     | Short-term borrowings                                       |                            | $       | 436           |         |              | $       | 366     |        
|                                     | Current portion of long-term obligations and capital leases |                            |         | 76            |         |              |         | 1,571   |        
|                                     | Current portion of deferred gain                            |                            |         | 7,186         |         |              |         |        |        
|                                     | Accounts payable and accrued expenses                       |                            |         | 37,266        |         |              |         | 37,205  |        
|                                     | Deferred revenue                                            |                            |         | 5,768         |         |              |         | 3,610   |        
|                                     | Taxes on income                                             |                            |         | 4,490         |         |              |         |        |        
|                                     |                                                             |                            |         |               |         |              |         |        
|                                     |                                                             | Total current liabilities  |         |               | 55,222  |              |         |         | 42,752  | 
|Long-term debt                       |                                                             |                            |        |               |         |              | 64,160  |        
|Deferred gain                        |                                                             |                            | 3,234   |               |         |              |        |        
|Other long-term obligations          |                                                             |                            | 2,989   |               |         |              | 2,989   |        
|Contingency (Note 12)                |                                                             |                            |        |               |         |              |        |        
|Shareholders equity                 |                                                             |                            |         |               |         |              |         |        
|                                     | Common stock and additional paid-in capital                 |                            |         | 98,476        |         |              |         | 98,834  |        
|                                     | Treasury shares, at cost                                    |                            |         | (34,597       | )       |              |         | (35,758 | )      
|                                     | Accumulated other comprehensive loss                        |                            |         | (8,637        | )       |              |         | (8,205  | )      
|                                     | Retained earnings                                           |                            |         | 108,279       |         |              |         | 110,134 |        
|                                     |                                                             |                            |         |               |         |              |         |        
|                                     |                                                             | Total shareholders equity |         |               | 163,521 |              |         |         | 165,005 | 
|                                     |                                                             |                            |         |               |         |              |         |        
|                                     |                                                             | $                          | 224,966 |               |         | $            | 274,906 |        
|                                     |                                                             |                            |         |               |         |              |         |        
|Common shares outstanding            |                                                             |                            | 9,733   |               |         |              | 9,684   |        
|                                     |                                                             |                            |         |               |         |              |         |        

See accompanying notes to condensed consolidated financial statements.

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SPACELABS MEDICAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |        |  
|-------------------------------------------- | ----------------------------------- | ---- | ------------------ | ------ | ----------------- | ---- | -------- | ------ | -------- | - | ------- | ------ | - | - | ------- | ------ | -
|                                             |                                     |      | Three Months Ended |        | Nine Months Ended
|                                             |                                     |      |                    |        |                  
|                                             |                                     |      | Sept 29,           |        | Sept 30,          |      | Sept 29, |        | Sept 30,
|(in thousands, except per share data)        |                                     | 2001 |                    | 2000   |                   | 2001 |          | 2000  
|                                             |                                     |      |                    |        |                   |      |          |       
|                                             |                                     |      | (unaudited)       
|Revenue                                      |                                     | $    | 56,974             |        |                   | $    | 65,188   |        |          | $ | 177,460 |        |   | $ | 184,679 |       
|Cost of Sales                                |                                     |      | 43,883             |        |                   |      | 36,412   |        |          |   | 113,315 |        |   |   | 105,591 |       
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|Gross margin                                 |                                     |      | 13,091             |        |                   |      | 28,776   |        |          |   | 64,145  |        |   |   | 79,088  |       
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|Operating expenses                           |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|                                             | Selling, general and administrative |      |                    | 20,940 |                   |      |          | 20,759 |          |   |         | 60,476 |   |   |         | 63,899 |  
|                                             | Research and development            |      |                    | 6,073  |                   |      |          | 6,540  |          |   |         | 18,295 |   |   |         | 20,344 |  
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|                                             |                                     |      | 27,013             |        |                   |      | 27,299   |        |          |   | 78,771  |        |   |   | 84,243  |       
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|Income (loss) from operations                |                                     |      | (13,922            | )      |                   |      | 1,477    |        |          |   | (14,626 | )      |   |   | (5,155  | )     
|Other income (expense)                       |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|                                             | Interest income                     |      |                    | 121    |                   |      |          | 194    |          |   |         | 305    |   |   |         | 616    |  
|                                             | Interest expense                    |      |                    | (946   | )                 |      |          | (1,527 | )        |   |         | (3,687 | ) |   |         | (4,205 | )
|                                             | Other income (expense) net          |      |                    | 15,769 |                   |      |          | (409   | )        |   |         | 15,443 |   |   |         | (1,203 | )
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|Income (loss) before income taxes            |                                     |      | 1,022              |        |                   |      | (265     | )      |          |   | (2,565  | )      |   |   | (9,947  | )     
|Provision (benefit) for income taxes         |                                     |      | 633                |        |                   |      | (344     | )      |          |   | (712    | )      |   |   | (3,855  | )     
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|Net income (loss)                            |                                     | $    | 389                |        |                   | $    | 79       |        |          | $ | (1,853  | )      |   | $ | (6,092  | )     
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|Basic net income (loss) per share            |                                     | $    | 0.04               |        |                   | $    | 0.01     |        |          | $ | (0.19   | )      |   | $ | (0.64   | )     
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|Diluted net income (loss) per share          |                                     | $    | 0.04               |        |                   | $    | 0.01     |        |          | $ | (0.19   | )      |   | $ | (0.64   | )     
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|Weighted average common shares outstanding - |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|                                             | Basic                               |      |                    | 9,711  |                   |      |          | 9,505  |          |   |         | 9,690  |   |   |         | 9,482  |  
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       
|                                             | Diluted                             |      |                    | 9,714  |                   |      |          | 9,506  |          |   |         | 9,690  |   |   |         | 9,482  |  
|                                             |                                     |      |                    |        |                   |      |          |        |          |   |         |        |   |   |         |       

See accompanying notes to condensed consolidated financial statements.

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SPACELABS MEDICAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                 |                                                                                       |                                                   |                                                              |         |                   |        |          |        |       |        |  
|------------------------------------------------ | ------------------------------------------------------------------------------------- | ------------------------------------------------- | ------------------------------------------------------------ | ------- | ----------------- | ------ | -------- | ------ | ----- | ------ | -
|                                                 |                                                                                       |                                                   |                                                              |         | Nine Months Ended
|                                                 |                                                                                       |                                                   |                                                              |         |                  
|                                                 |                                                                                       |                                                   |                                                              |         | Sept 29,          |        | Sept 30,
|(in thousands)                                   |                                                                                       | 2001                                              |                                                              | 2000   
|                                                 |                                                                                       |                                                   |                                                              |        
|                                                 |                                                                                       |                                                   |                                                              |         | (unaudited)      
|Operating activities                             |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|                                                 | Net loss                                                                              |                                                   | $                                                            | (1,853  | )                 |        | $        | (6,092 | )    
|                                                 | Adjustments to reconcile net loss to net cash provided (used)
by operating activities |                                                   |                                                              |         |                   |        |          |        |      
|                                                 |                                                                                       | Gain on sale of assets                            |                                                              |         | (22,393           | )      |          |        | (48   | )     
|                                                 |                                                                                       | Depreciation and amortization                     |                                                              |         | 6,584             |        |          |        | 7,159 |       
|                                                 |                                                                                       | Amortization of deferred gain on sale             |                                                              |         | (359              | )      |          |        |      |       
|                                                 |                                                                                       | Deferred income taxes                             |                                                              |         | (7,345            | )      |          |        | 208   |       
|                                                 |                                                                                       | Contribution to ISSOP 401(k) plan in common stock |                                                              |         | 535               |        |          |        | 611   |       
|                                                 |                                                                                       | Changes in operating assets and liabilities       |                                                              |         |                   |        |          |        |       |       
|                                                 |                                                                                       |                                                   | Decrease in receivables                                      |         |                   | 7,601  |          |        |       | 17,090 |  
|                                                 |                                                                                       |                                                   | Decrease (increase) in inventories                           |         |                   | 10,848 |          |        |       | (6,897 | )
|                                                 |                                                                                       |                                                   | Change in current income taxes                               |         |                   | 6,268  |          |        |       | (5,364 | )
|                                                 |                                                                                       |                                                   | Decrease in prepaid expenses                                 |         |                   | 110    |          |        |       | 1,927  |  
|                                                 |                                                                                       |                                                   | Increase (decrease) in accounts payable and accrued expenses |         |                   | 110    |          |        |       | (9,572 | )
|                                                 |                                                                                       |                                                   | Increase (decrease) in deferred revenue                      |         |                   | 2,171  |          |        |       | (523   | )
|                                                 |                                                                                       | Other                                             |                                                              |         | 2,552             |        |          |        | 288   |       
|                                                 |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|Net cash provided (used) by operating activities |                                                                                       |                                                   | 4,829                                                        |         |                   |        | (1,213   | )     
|                                                 |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|Investing activities                             |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|                                                 | Investment in property, plant and equipment                                           |                                                   |                                                              | (5,441  | )                 |        |          | (2,280 | )    
|                                                 | Proceeds on sale of assets                                                            |                                                   |                                                              | 76,961  |                   |        |          | 36     |      
|                                                 | Other                                                                                 |                                                   |                                                              | 650     |                   |        |          | (1,450 | )    
|                                                 |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|Net cash provided (used) by investing activities |                                                                                       |                                                   | 72,170                                                       |         |                   |        | (3,694   | )     
|                                                 |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|Effect of exchange rate changes on cash          |                                                                                       |                                                   | (147                                                         | )       |                   |        | 151      |       
|                                                 |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|Financing activities                             |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|                                                 | Increase in short-term borrowings                                                     |                                                   |                                                              | 80      |                   |        |          | 452    |      
|                                                 | Proceeds from (principal payments on) long-term debt, net                             |                                                   |                                                              | (65,655 | )                 |        |          | 5,032  |      
|                                                 | Exercise of stock options                                                             |                                                   |                                                              | 101     |                   |        |          | 288    |      
|                                                 |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|Net cash provided (used) by financing activities |                                                                                       |                                                   | (65,474                                                      | )       |                   |        | 5,772    |       
|                                                 |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|Increase in cash and cash equivalents            |                                                                                       |                                                   | 11,378                                                       |         |                   |        | 1,016    |       
|Cash and cash equivalents at beginning of period |                                                                                       |                                                   | 2,583                                                        |         |                   |        | 2,562    |       
|                                                 |                                                                                       |                                                   |                                                              |         |                   |        |          |       
|Cash and cash equivalents at end of period       |                                                                                       | $                                                 | 13,961                                                       |         |                   | $      | 3,578    |       
|                                                 |                                                                                       |                                                   |                                                              |         |                   |        |          |       

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.
Accordingly, certain information and disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been omitted pursuant to such rules and
regulations. 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 2000 Annual
Report to Shareholders. Certain reclassifications have been made to prior
period financial statements to conform to the current presentation.
|  
|   |  | The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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. 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.                                                                                                                                                                                                                                               
|  
|2. |  | Shipping and Handling Fees and Costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|  
|   |  | In the fourth quarter of 2000, the Company adopted the provisions of
Emerging Issues Task Force Issue 00-10, Accounting for Shipping and
Handling Fees and Costs (EITF 00-10). EITF 00-10 requires that amounts
billed to customers for shipping and handling fees be accounted for as
revenue and the associated costs in cost of goods sold. To conform with
the 2001 presentation, revenues for the three and nine month periods ended
September 30, 2000 were increased by $0.2 million and $0.6 million,
respectively, with a corresponding increase in cost of goods sold.                                                                                                                                                                                                                                                                                                                                                                         
|  
|3. |  | Inventories                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

|                                     |  |          |        |              |  |   |        | 
|------------------------------------ |  | -------- | ------ | ------------ |  | - | ------ | 
|                                     |  | Sept 29, |        | December 31,
|(in thousands)                       |  | 2001     |        | 2000        
|                                     |  |          |        |             
|Raw materials and components         |  | $        | 18,514 |              |  | $ | 25,327 | 
|Work in process                      |  |          | 10,514 |              |  |   | 7,955  | 
|Finished products                    |  |          | 19,880 |              |  |   | 20,434 | 
|Demonstration inventories            |  |          | 4,059  |              |  |   | 6,004  | 
|Customer service parts and equipment |  |          | 10,500 |              |  |   | 14,874 | 
|                                     |  |          |        |              |  |   |        | 
|                                     |  | $        | 63,467 |              |  | $ | 74,594 | 
|                                     |  |          |        |              |  |   |        | 

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|4. |  | Write-down of inventory                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | In the third quarter of 2001, the Company implemented a plan to reduce its
cost structure by reducing the space required for its corporate and
manufacturing operations. This plan includes the sale, and 18-month
leaseback, of the Companys headquarters and manufacturing facilities, the
outsourcing of certain manufacturing operations and the planned relocation
to smaller facilities. In connection with this plan, the Company evaluated
its policies and procedures with respect to the quantities of service
inventories required to adequately service its installed customer base. In
addition, the Company made adjustments to its manufacturing output and
product sales forecasts during the third quarter. As a result of these
efforts and analysis, the Company recorded a write-down of its inventory of
$7.5 million. This amount is included in cost of goods sold in the
accompanying statements of operations for the quarter and nine months ended
September 29, 2001. In order to reduce the amount of space required to
store inventory and to maximize income tax benefits, the Company implemented
a plan to physically scrap its excess inventories during the fourth quarter
of 2001.
|  
|5. |  | Sale of Property                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  
|   |  | On September 12, 2001, the Company sold approximately 13.9 acres of land
located in Redmond, Washington, including the Companys corporate
headquarters and a manufacturing facility (collectively, the Property) to
a third party for $74.0 million. The net cash proceeds from this
transaction were used to retire the Companys primary credit facility (see
note 7). The Company simultaneously entered into a lease agreement with
the new owner to lease back the Property for a period of 18 months. The
Company is responsible for the cost of insurance, taxes and maintenance of
the Property during the lease term. The Company is in the process of
seeking an alternative location for its current headquarters and
manufacturing facilities. In connection with this transaction, the
Company recognized a pre-tax gain on sale of the Property of $19.7 million,
which is included in other income (expense), and recorded a deferred gain of
$10.8 million, representing the present value of payments during the
leaseback period. The deferred gain will be recognized over the 18-month
term of the lease.                                                                                      
|  
|   |  | In July 2001, the Company sold investment property located adjacent to its
corporate headquarters facility for $6.0 million. The net proceeds from
this sale were used to reduce the Companys debt. The Company recognized a
pre-tax gain on the sale of this property of $2.7 million, which is included
in other income (expense).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  
|6. |  | Investments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|  
|   |  | The Company has made investments through the purchase of voting capital
stock of non-public companies that are engaged in businesses that are
complimentary to those of the Company. The Company periodically evaluates
whether any declines in the fair value of its investments are
other-than-temporary, through analysis of qualitative and quantitative
factors. These factors include the implied value from any recent rounds of
financing completed or proposed, the investees future prospects, operating
trends, financial condition and results of operations. Based upon an
evaluation of the facts and circumstances at September 29, 2001, the Company
determined that an other-than-temporary impairment existed for two of its
investments. An impairment loss was recorded to reflect these investments
at fair value as of September 29, 2001, and resulted in a loss in the
quarter and nine months ended September 29, 2001 of $2.2 million. This
amount is included in other income (expense).                                                                                                                                                                                                  

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|7. |  | Long-term Debt                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | In September 2001, the Company retired its primary credit facilities with
the net proceeds of the sale of its headquarters and manufacturing
properties. In connection with this transaction, the Company wrote off $0.4
million in unamortized loan fees associated with the retired credit
facility. This amount is included in other income (expense).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|  
|8. |  | Derivative Financial Instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  
|   |  | Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards No. 133 (SFAS 133), Accounting for Derivative
Instruments and Hedging Activities, which establishes accounting and
reporting standards for derivative instruments. Prior to repaying its
primary credit facility in September 2001, the Company maintained interest
rate swap agreements that converted a portion of its variable interest rate
debt into fixed rates. The Company designated these interest rate swap
agreements as cash flow hedges.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|  
|   |  | The adoption of SFAS 133 on January 1, 2001 resulted in a decrease in
shareholders equity, net of income tax effects, of approximately $0.3
million. This was attributable to decreases in the fair value of the
interest rate swaps due to declines in interest rates since the inception of
the hedging arrangement and was to be offset in future periods by offsetting
lower interest expense associated with the hedged variable rate debt.
Declines in interest rates from January 1 to September 12, 2001, resulted in
an additional decrease in the value of the interest rate swaps of
approximately $1.3 million. This was included as a component of other
comprehensive income in shareholders equity, net of related income tax
effects, through the date the Company repaid its primary credit facilities
and terminated its interest rate swap arrangements. At that time,
cumulative losses, net of income tax effects, were reclassified to results
of operations, and $1.8 million is included in other income (expense).
|  
|9. |  | 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 three and nine month periods ended September
29, 2001, unexercised stock options representing the potential rights to
2,603,471 shares and 2,598,750 shares, respectively, are excluded from the
diluted calculation as their effects would be antidilutive. For the three
and nine month periods ended September 30, 2000, unexercised, stock options
representing potential rights to 2,697,819 shares and 2,712,819 shares,
respectively, are excluded as their effects would be antidilutive. The
following schedule represents a reconciliation of the numerators and
denominators of basic and diluted net income (loss) per share calculations.                                                  

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|                                       |                                                                |             |          |               |         |           |                 |       |  |  |   |       |  
|-------------------------------------- | -------------------------------------------------------------- | ----------- | -------- | ------------- | ------- | --------- | --------------- | ----- |  |  | - | ----- | -
|                                       |                                                                |             |          |               |         |           | Weighted        |       |  |  |  
|                                       |                                                                |             | Income / |               | Average |           |                 |       | 
|                                       |                                                                |             | (loss)   |               | Shares  |           | Income / (loss)
|(In thousands, except per share data)  |                                                                | (Numerator) |          | (Denominator) |         | Per Share
|                                       |                                                                |             |          |               |         |          
|Three months ended September 29, 2001: |                                                                |             |          |               |         |           |                 |       |  |  |   |      
|                                       | Basic net income per share                                     |             | $        | 389           |         |           |                 | 9,711 |  |  | $ | 0.04  |  
|                                       | Effect of dilutive stock options and unvested
restricted stock |             |          |              |         |           |                 | 3     |  |  |   |      |  
|                                       |                                                                |             |          |               |         |           |                 |       |  |  |   |      
|                                       | Diluted net income per share                                   |             | $        | 389           |         |           |                 | 9,714 |  |  | $ | 0.04  |  
|                                       |                                                                |             |          |               |         |           |                 |       |  |  |   |      
|Three months ended September 30, 2000: |                                                                |             |          |               |         |           |                 |       |  |  |   |      
|                                       | Basic net income per share                                     |             | $        | 79            |         |           |                 | 9,505 |  |  | $ | 0.01  |  
|                                       | Effect of dilutive stock options and unvested
restricted stock |             |          |              |         |           |                 | 1     |  |  |   |      |  
|                                       |                                                                |             |          |               |         |           |                 |       |  |  |   |      
|                                       | Diluted net income per share                                   |             | $        | 79            |         |           |                 | 9,506 |  |  | $ | 0.01  |  
|                                       |                                                                |             |          |               |         |           |                 |       |  |  |   |      
|Nine months ended September 29, 2001:  |                                                                |             |          |               |         |           |                 |       |  |  |   |      
|                                       | Basic and diluted net loss per share                           |             | $        | (1,853        | )       |           |                 | 9,690 |  |  | $ | (0.19 | )
|                                       |                                                                |             |          |               |         |           |                 |       |  |  |   |      
|Nine months ended September 30, 2000:  |                                                                |             |          |               |         |           |                 |       |  |  |   |      
|                                       | Basic and diluted net loss per share                           |             | $        | (6,092        | )       |           |                 | 9,482 |  |  | $ | (0.64 | )
|                                       |                                                                |             |          |               |         |           |                 |       |  |  |   |      



|10. |  | 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. Segment profit for the three and nine months
ended September 29, 2001 excludes the charge for the write-down of
inventory and other associated costs of disposition and consolidation
of operations. The Company has no inter-segment revenue.

|                       |                            |      |                    |        |                   |      |           |        |           |  |   |         |   |  |   |         |  
|---------------------- | -------------------------- | ---- | ------------------ | ------ | ----------------- | ---- | --------- | ------ | --------- |  | - | ------- | - |  | - | ------- | -
|                       |                            |      | Three Months Ended |        | Nine Months Ended
|                       |                            |      |                    |        |                  
|                       |                            |      | Sept. 29,          |        | Sept. 30,         |      | Sept. 29, |        | Sept. 30,
|(in thousands)         |                            | 2001 |                    | 2000   |                   | 2001 |           | 2000  
|                       |                            |      |                    |        |                   |      |           |       
|Revenue:               |                            |      |                    |        |                   |      |           |        |           |  |   |         |   |  |   |        
|                       | US Monitoring              |      | $                  | 32,117 |                   |      | $         | 30,999 |           |  | $ | 94,160  |   |  | $ | 86,463  |  
|                       | US Cardiology              |      |                    | 8,051  |                   |      |           | 8,796  |           |  |   | 23,987  |   |  |   | 28,036  |  
|                       | International              |      |                    | 15,393 |                   |      |           | 22,213 |           |  |   | 53,002  |   |  |   | 60,651  |  
|                       | Consumer Health Management |      |                    | 1,413  |                   |      |           | 3,180  |           |  |   | 6,311   |   |  |   | 9,529   |  
|                       |                            |      |                    |        |                   |      |           |        |           |  |   |         |   |  |   |        
|                       | Total Revenue              |      | $                  | 56,974 |                   |      | $         | 65,188 |           |  | $ | 177,460 |   |  | $ | 184,679 |  
|                       |                            |      |                    |        |                   |      |           |        |           |  |   |         |   |  |   |        
|Segment Profit (loss): |                            |      |                    |        |                   |      |           |        |           |  |   |         |   |  |   |        
|                       | US Monitoring              |      | $                  | 5,289  |                   |      | $         | 6,870  |           |  | $ | 19,318  |   |  | $ | 13,758  |  
|                       | US Cardiology              |      |                    | (50    | )                 |      |           | (277   | )         |  |   | (375    | ) |  |   | (94     | )
|                       | International              |      |                    | (584   | )                 |      |           | 2,886  |           |  |   | 2,703   |   |  |   | 5,447   |  
|                       | Consumer Health Management |      |                    | (1,159 | )                 |      |           | (387   | )         |  |   | (2,230  | ) |  |   | (502    | )
|                       |                            |      |                    |        |                   |      |           |        |           |  |   |         |   |  |   |        
|                       | Total Segment Profit       |      | $                  | 3,496  |                   |      | $         | 9,092  |           |  | $ | 19,416  |   |  | $ | 18,609  |  

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|                                                                       |                                                 |      |                    |        |                   |      |           |        |           |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------- | ----------------------------------------------- | ---- | ------------------ | ------ | ----------------- | ---- | --------- | ------ | --------- |  | - | ------- | - |  | - | ------- | -
|                                                                       |                                                 |      | Three Months Ended |        | Nine Months Ended
|                                                                       |                                                 |      |                    |        |                  
|                                                                       |                                                 |      | Sept. 29,          |        | Sept. 30,         |      | Sept. 29, |        | Sept. 30,
|(in thousands)                                                         |                                                 | 2001 |                    | 2000   |                   | 2001 |           | 2000  
|                                                                       |                                                 |      |                    |        |                   |      |           |       
|Reconciliation of segment
profit to income (loss) before
income taxes: |                                                 |      |                    |        |                   |      |           |        |           |  |   |         |   |  |   |        
|                                                                       | Unallocated general and
administrative expenses |      | $                  | (2,620 | )                 |      | $         | (1,075 | )         |  | $ | (7,022  | ) |  | $ | (3,420  | )
|                                                                       | Unallocated cost of sales                       |      |                    | (8,725 | )                 |      |           |       |           |  |   | (8,725  | ) |  |   |        |  
|                                                                       | Research and development                        |      |                    | (6,073 | )                 |      |           | (6,540 | )         |  |   | (18,295 | ) |  |   | (20,344 | )
|                                                                       | Other income (expense)                          |      |                    | 14,944 |                   |      |           | (1,742 | )         |  |   | 12,061  |   |  |   | (4,792  | )
|                                                                       |                                                 |      |                    |        |                   |      |           |        |           |  |   |         |   |  |   |        
|                                                                       | Income (loss) before
income taxes               |      | $                  | 1,022  |                   |      | $         | (265   | )         |  | $ | (2,565  | ) |  | $ | (9,947  | )
|                                                                       |                                                 |      |                    |        |                   |      |           |        |           |  |   |         |   |  |   |        



|11. |  | Comprehensive Income (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 income (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 and nine month periods ended September 29,
2001 and September 30, 2000, are detailed below:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

|                                   |                                                                                                    |      |                    |       |                   |      |          |        |          |   |        |        |   |   |        |        |  
|---------------------------------- | -------------------------------------------------------------------------------------------------- | ---- | ------------------ | ----- | ----------------- | ---- | -------- | ------ | -------- | - | ------ | ------ | - | - | ------ | ------ | -
|                                   |                                                                                                    |      | Three Months Ended |       | Nine Months Ended
|                                   |                                                                                                    |      |                    |       |                  
|                                   |                                                                                                    |      | Sept 29,           |       | Sept 30,          |      | Sept 29, |        | Sept 30,
|(in thousands)                     |                                                                                                    | 2001 |                    | 2000  |                   | 2001 |          | 2000  
|                                   |                                                                                                    |      |                    |       |                   |      |          |       
|Net income (loss)                  |                                                                                                    | $    | 389                |       |                   | $    | 79       |        |          | $ | (1,853 | )      |   | $ | (6,092 | )     
|Other comprehensive income (loss): |                                                                                                    |      |                    |       |                   |      |          |        |          |   |        |        |   |   |        |       
|                                   | Foreign currency translation adjustments                                                           |      |                    | 766   |                   |      |          | (1,519 | )        |   |        | (432   | ) |   |        | (3,136 | )
|                                   | Change in fair value of interest rate swap agreements
including transition adjustments, net of tax |      |                    | (381  | )                 |      |          |        |          |   |        | (1,135 | ) |   |        |        |  
|                                   | Adjustment for losses reclassified to net
income (loss)                                            |      |                    | 1,135 |                   |      |          |       |          |   |        | 1,135  |   |   |        |       |  
|                                   |                                                                                                    |      |                    |       |                   |      |          |        |          |   |        |        |   |   |        |       
|Comprehensive income (loss)        |                                                                                                    | $    | 1,909              |       |                   | $    | (1,440   | )      |          | $ | (2,285 | )      |   | $ | (9,228 | )     
|                                   |                                                                                                    |      |                    |       |                   |      |          |        |          |   |        |        |   |   |        |       



|12. |  | Contingency                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | On March 21, 2001, seven named plaintiffs filed a purported class action in
Superior Court King County Washington on behalf of themselves and others
allegedly similarly situated, alleging national origin discrimination and
other claims arising out of certain alleged terms and conditions of
employment and termination of certain Hispanic employees at the Company.
After several of the claims of the named plaintiffs were dismissed in whole
or part, and after the filing of extensive opposition, including statistical
evidence, by the defendant in opposition to plaintiffs motion to certify a
class, the plaintiffs voluntarily dismissed the state court action on
September 21, 2001. The Company was also served by the same plaintiffs
attorney with a purported class action complaint venued in federal court in
the Western District of Washington by twenty-nine named plaintiffs, including
all the plaintiffs in the prior state case, and who allege national origin
discrimination and other claims arising out of certain alleged terms and
conditions of employment and termination of certain Hispanic employees at the
Company. To date the class has not been certified and the Company has
obtained dismissal of some or all of the claims of three of the named
plaintiffs. The complaint seeks class certification, judgment of no less
than $10,000,000,incidental and consequential damages, interest, and costs.
While the outcome of these

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|    |  | proceedings cannot be predicted with certainty, management does not believe
the complaint is meritorious and intends to vigorously defend the Companys
interests. No amounts, other than legal fees incurred, have been accrued for
this matter as of September 29, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|13. |  | Recent Accounting Pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|    |  | 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. 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 is required to
adopt Statement 142 on January 1, 2002. Because of the extensive effort
needed to comply with adopting Statement 142, it is not practicable to
reasonably estimate the impact of this statement on the Companys financial
statements at the date of this report, including whether any transitional
impairment losses will be required to be recognized as the cumulative effect
of a change in accounting principle.
|   
|14. |  | Supplemental Cash Flow Information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   
|    |  | The following provides additional information concerning cash flow
activities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

|                                  |  |                    |       |                   |  |          |        |          |  |   |       |  |  |   |       | 
|--------------------------------- |  | ------------------ | ----- | ----------------- |  | -------- | ------ | -------- |  | - | ----- |  |  | - | ----- | 
|                                  |  | Three Months Ended |       | Nine Months Ended
|                                  |  |                    |       |                  
|                                  |  | Sept 29,           |       | Sept 30,          |  | Sept 29, |        | Sept 30,
|(in thousands)                    |  | 2001               |       | 2000              |  | 2001     |        | 2000    
|                                  |  |                    |       |                   |  |          |        |         
|Interest paid                     |  | $                  | 1,298 |                   |  | $        | 1,403  |          |  | $ | 4,578 |  |  | $ | 3,953 | 
|                                  |  |                    |       |                   |  |          |        |          |  |   |       |  |  |   |       | 
|Income taxes paid (refunded), net |  | $                  | 268   |                   |  | $        | (1,809 | )        |  | $ | 158   |  |  | $ | 737   | 
|                                  |  |                    |       |                   |  |          |        |          |  |   |       |  |  |   |       | 

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

RESULTS OF OPERATIONS

|                                              |                    |                                     |                   |      |                    |        |                   |        |        |      |         |      |          |        |          |        |        |    |         |      |      |      |       |      |      |      |       |   |      |   |       |    |       |    | 
|--------------------------------------------- | ------------------ | ----------------------------------- | ----------------- | ---- | ------------------ | ------ | ----------------- | ------ | ------ | ---- | ------- | ---- | -------- | ------ | -------- | ------ | ------ | -- | ------- | ---- | ---- | ---- | ----- | ---- | ---- | ---- | ----- | - | ---- | - | ----- | -- | ----- | -- | 
|                                              |                    |                                     |                   |      | Three months ended |        | Nine months ended
|                                              |                    |                                     |                   |      |                    |        |                  
|                                              |                    |                                     |                   |      | Sept 29,           |        | Sept 30,          |        | Dollar |      | Percent |      | Sept 29, |        | Sept 30, |        | Dollar |    | Percent
|(dollars in millions, except per share data)  |                    | 2001                                |                   | 2000 |                    | Change |                   | Change |        | 2001 |         | 2000 |          | Change |          | Change
|                                              |                    |                                     |                   |      |                    |        |                   |        |        |      |         |      |          |        |          |       
|Revenue                                       |                    | $                                   | 57.0              |      |                    | $      | 65.2              |        |        | $    | (8.2    | )    |          |        | (12.6    | %)     |        | $  | 177.5   |      |      | $    | 184.7 |      |      | $    | (7.2  | ) |      |   | (3.9  | %)
|Gross margin                                  |                    |                                     | 13.1              |      |                    |        | 28.8              |        |        |      | (15.7   | )    |          |        | (54.5    | %)     |        |    | 64.1    |      |      |      | 79.1  |      |      |      | (14.9 | ) |      |   | (18.9 | %)
|                                              | As a % of revenue  |                                     |                   | 23.0 | %                  |        |                   | 44.1   | %      |      |         |      |          |        |          |        |        |    |         | 36.1 | %    |      |       | 42.8 | %    |      |       |   |      |   |       |    |      
|Operating expenses:                           |                    |                                     |                   |      |                    |        |                   |        |        |      |         |      |          |        |          |        |        |    |         |      |      |      |       |      |      |      |       |   |      |   |       |   
|                                              |                    | Selling, general and administrative |                   |      | 20.9               |        |                   |        | 20.8   |      |         |      | 0.2      |        |          |        | 0.9    | %  |         |      | 60.5 |      |       |      | 63.9 |      |       |   | (3.4 | ) |       |    | (5.4  | %)
|                                              |                    |                                     | As a % of revenue |      |                    | 36.8   | %                 |        |        | 31.8 | %       |      |          |        |          |        |        |    |         |      |      | 34.1 | %     |      |      | 34.6 | %     |   |      |   |       |    |       |    | 
|                                              |                    | Research and development            |                   |      | 6.1                |        |                   |        | 6.5    |      |         |      | (0.5     | )      |          |        | (7.1   | %) |         |      | 18.3 |      |       |      | 20.3 |      |       |   | (2.0 | ) |       |    | (10.1 | %)
|                                              |                    |                                     | As a % of revenue |      |                    | 10.7   | %                 |        |        | 10.0 | %       |      |          |        |          |        |        |    |         |      |      | 10.3 | %     |      |      | 11.0 | %     |   |      |   |       |    |       |    | 
|Other income (expense), net                   |                    |                                     | 14.9              |      |                    |        | (1.7              | )      |        |      | 16.7    |      |          |        | 957.9    | %      |        |    | 12.1    |      |      |      | (4.8  | )    |      |      | 16.9  |   |      |   | 351.7 | % 
|                                              | As a % of revenue  |                                     |                   | 26.2 | %                  |        |                   | (2.7   | %)     |      |         |      |          |        |          |        |        |    |         | 6.8  | %    |      |       | (2.6 | %)   |      |       |   |      |   |       |    |      
|Provision (benefit) for income taxes          |                    |                                     | 0.6               |      |                    |        | (0.3              | )      |        |      | 1.0     |      |          |        | 284.0    | %      |        |    | (0.7    | )    |      |      | (3.9  | )    |      |      | 3.1   |   |      |   | 81.5  | % 
|                                              | Effective tax rate |                                     |                   | 61.9 | %                  |        | NM                |        |        |      |         |      |          |        |          |        |        |    | 27.8    | %    |      |      | 38.8  | %    |      |      |       |   |      |   |       |   
|Net income (loss)                             |                    | $                                   | 0.4               |      |                    | $      | 0.1               |        |        | $    | 0.3     |      |          |        | 392.4    | %      |        | $  | (1.9    | )    |      | $    | (6.1  | )    |      | $    | (4.2  | ) |      |   | (69.6 | %)
|Basic and diluted net income/(loss)
per share |                    | $                                   | 0.04              |      |                    | $      | 0.01              |        |        | $    | 0.03    |      |          |        | 300.0    | %      |        | $  | (0.19   | )    |      | $    | (0.64 | )    |      | $    | (0.45 | ) |      |   | (70.3 | %)

NM  Not Meaningful

Revenue

Worldwide revenue for the third quarter of 2001 was $57.0 million as compared
to $65.2 million in the same quarter last year. On a year-to-date basis,
worldwide revenue was $177.5 million as compared to $184.7 million in the same
period a year ago.

US Monitoring Systems revenue for the third quarter of 2001 increased 3.6% to
$32.1 million as compared to $31.0 million during the same quarter a year ago.
On a year-to-date basis US Monitoring revenue increased 8.9% to $94.2 million
in 2001 versus $86.5 million for the first nine months of 2000. The
improvement for the quarter and the year is believed to be primarily a result
of an improving US healthcare provider economic environment.

Current quarter US Cardiology Systems revenue was $8.1 million compared to $8.8
million in the third quarter of 2000. For the first nine months of 2001 US
Cardiology revenue totaled $24.0 million versus $28.0 million for the same
period in 2000. The change for both periods is due primarily to issues related
to consolidation within the Companys cardiology dealer distribution channel
and their efforts to decrease inventories as well as increased competition.

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Consumer Health Management revenue decreased to $1.4 million in the third
quarter of 2001 as compared to $3.2 million for the same period in 2000.
Year-to-date Consumer Health Management revenue was $6.3 million compared to
$9.5 million in 2000. The decrease for both periods was due primarily to
decreased advertising revenue. The Company believes the decline in advertising
revenue is the result of a soft advertising market coupled with the transition
of the Companys sales efforts to include on-screen advertising as well as
traditional display advertising on the Companys health stations.

International revenue, including export sales was $15.4 million for the third
quarter of 2001 as compared to $22.2 million for the third quarter of 2000.
International revenue comprised 27.0% of total revenue in the third quarter of
2001 versus 34.1% in the same period of 2000. International revenue for the
first nine months was $53.0 million, or 29.9% of total revenue, as compared to
$60.7 million, or 32.8% of total revenue for the first nine months of 2000.
Unfavorable foreign currency exchange rate fluctuations in the first nine
months of 2001 accounted for $1.5 million in decreased revenue when compared to
exchange rates in the same period of 2000. 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. Management believes that
these uncertainties have contributed to a high degree of quarter-to-quarter
revenue volatility this year and may continue to do so into the future.

The Companys ability to produce consistent future revenue growth is, to a
certain extent, dependent on its backlog of orders that can be shipped. 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.

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Gross Margin

Gross margin was 23.0% of revenue in the third quarter of 2001 as compared to
44.1% during the corresponding quarter in 2000. Gross margin for the first
nine months of 2001 was 36.1% of revenue compared to 42.8% for the same period
a year ago. Gross margin for both the current quarter and the first nine month
period were negatively impacted by a $1.5 million charge for field corrective
actions on certain of the Companys products and an $8.7 million charge for the
write-down of inventory and other associated costs of disposition and
consolidation of operations. The inventory write-down was a result of the
Companys implementation of a plan to reduce its cost structure by reducing
the space required for its corporate and manufacturing operations. This plan
includes the sale, and 18-month leaseback, of the Companys headquarters and
manufacturing facilities, the outsourcing of certain manufacturing operations
and the planned relocation to smaller facilities. As part of the plan, the
Company evaluated its policies and procedures with respect to the quantities of
service inventories required to adequately service its installed customer base
and made adjustments to its manufacturing output and product sales forecasts
during the third quarter. The Company plans to physically scrap its excess
inventories, which have a carrying value of zero, during the fourth quarter of
2001 to reduce the amount of space required to store inventory and to maximize
tax benefits.

Excluding these charges, the Companys gross margins for the third quarter and
nine months period would have been 40.9% and 41.9%, respectively. The decline
in gross margin is primarily the result of the impact of decreased revenue
relative to the fixed-cost components of the Companys gross-margin related
expenses and competitive pricing pressures.

Operating Expenses

Selling, general and administrative expenses were $20.9 million, or 36.8% of
revenue, in the third quarter of 2001 compared to $20.8 million, or 31.8% of
revenue, in the third quarter of 2000. On a year-to-date basis, selling,
general and administrative expenses decreased $3.4 million or 5.4% to $60.5
million in the first nine months of 2001 from $63.9 million for the first nine
months of 2000. As a percentage of revenue, the first nine months 2001
selling, general and administrative expenses were 34.1% versus 34.6% in the
first nine months of 2000. This improvement was largely due to cost reduction
efforts implemented in the second half of 2000. Selling, general and
administrative expenses in the third quarter and first nine months of 2001
includes approximately $0.5 million and $1.4 million, respectively, associated
with certain strategic initiatives the Company is pursuing, and an additional
$1.0 million provision for bad debts recorded during the third quarter. The
increase in bad debt allowance is primarily related to certain international
receivables and the risk of deteriorating prospects of the economies in those
regions.

Research and development expenses were $6.1 million in the third quarter of
2001 compared to $6.5 million in the same period a year ago. On a year-to-date
basis, research and development expenses decreased $2.0 million to $18.3
million, or 10.3% of revenue, as compared to $20.3 million, or 11.0% of
revenue, for the first nine months in 2000. This decrease was also
attributable to cost reduction efforts initiated in 2000.

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 the three and nine months ended September 29,
2001 excludes the $8.7 million charge for the write-down of inventory and other
associated costs of disposition and consolidation of operations. Segment
profit

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for US Monitoring Systems was $5.3 million for the third quarter of 2001
compared to $6.9 million for the third quarter of 2000. The decline in segment
profit was due primarily to increased competitive pricing pressures and the US
portion of the charge for field corrective actions on certain products. On a
year-to-date basis, US Monitoring Systems segment profit increased 40.4% to
$19.3 million as compared to $13.8 million for the first nine months of the
prior year. The increase in segment profit was primarily attributable to an
increase in US Monitoring Systems revenue and cost reduction efforts.

During the third quarter of 2001, the US Cardiology Systems segment sustained a
loss of $0.1 million as compared to a loss of $0.3 million in the same quarter
of 2000. The decrease in segment loss was due primarily to cost reduction
efforts and to lower product discounts. For the first nine months of 2001,
Cardiology Systems segment loss was $0.4 million compared to $0.1 million for
the first nine months of 2000. The increase in segment loss was primarily
attributable to the decrease in US Cardiology Systems revenue.

Segment profit (loss) for the Companys International business unit was ($0.6)
million during the third quarter of 2001 compared to $2.9 million during the
third quarter of 2000. The decrease was primarily volume related, attributable
to a decrease in third quarter revenue. On a year-to-date basis, International
segment profit was $2.7 million in 2001 compared to $5.4 million in 2000.

Segment loss for the Consumer Health Management business unit was $1.2 million
for the third quarter of 2001 compared to $0.4 million for the same period of
2000. For the first nine months of 2001, segment loss was $2.2 million
compared to $0.5 million for the first nine months of 2000. The decrease was
due primarily to the decline in revenue.

Other Income (Expense)

During the third quarter of 2001, the Company sold its headquarters and
manufacturing facilities and investment property in Redmond, Washington and
realized an aggregate gain on the sales of $22.4 million. Also in the third
quarter, the Company incurred expenses of approximately $3.6 million in
connection with the retirement of its primary credit facilities. These
expenses include $1.8 million in recognized losses from the termination of
interest rate swaps, $0.4 million in loan fee write-offs and $1.4 million in
legal and other costs associated with sale of the properties and terminated
efforts to refinance the Companys debt with other financing sources.

Also in the third quarter of 2001, the Company recorded a loss on the
write-down of investments of $2.2 million for other-than-temporary declines in
value. The Company periodically evaluates whether any declines in fair value
of its investments are other-than-temporary, through analysis of qualitative
and quantitative factors. These factors include the implied value from any
recent rounds of financing completed or proposed, the investees future
prospects, operating trends, financial condition and results of operations.
Based upon an evaluation of the facts and circumstances at September 29, 2001,
the Company determined that an other-than-temporary impairment existed for two
of its investments.

Interest expense for the third quarter of 2001 was $1.0 million compared to
$1.5 million in the same period of 2000. The decrease was due to lower average
borrowings and lower average interest rates on the Companys long-term debt and
the retirement of the Companys primary credit facility on September 12, 2001.
On a year-to-date basis, interest expense totaled approximately $3.7 million
for 2001 and $4.2 million for 2000. Interest income was approximately $0.1
million for the third quarter of 2001 compared to $0.2 million during the third
quarter of 2000. On a year-to-date basis, interest income totaled $0.3 million
in 2001 versus $0.6 million for the first nine months of 2000.

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The Company experienced a $35,000 gain from foreign currency exchange rate
fluctuations in the third quarter of 2001 as compared to a $52,000 loss during
the same quarter a year ago. On a year-to-date basis, the Company experienced
an exchange gain of $10,000 during 2001 versus a loss of $745,000 during the
first nine months of 2000.

Taxes and Net Loss

The effective tax rate for the third quarter of 2001 was 61.9% as compared to
129.8% during the same period in 2000. On a year-to-date basis, the effective
tax rate for 2001 was 27.8% as compared to 38.8% during 2000. The effective
tax rate for the quarter and the nine months period was accrued at the rate
expected to apply for the full year based on profitability expectations in
future quarters adjusted for unusual items. 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. The tax rate in
2000 was lower than the 2001 rate due to the implementation of various tax
recovery and reduction strategies as well as taxes attributed to the gain on
sale of the corporate properties in 2001.

As a result of the above factors, the Company reported net income of $0.4
million or $0.04 per share during the third quarter of 2001 as compared to net
income of $0.1 million or $0.01 per share during the same period a year ago.
Net loss for the nine months ended September 29, 2001 was $1.9 million or $0.19
per share as compared to $6.1 million or $0.64 per share for the same period in
2000.

CAPITAL RESOURCES & LIQUIDITY

|                          |  |          |       |              |  |        |       |         |  |   |       |   |  |  |       |   
|------------------------- |  | -------- | ----- | ------------ |  | ------ | ----- | ------- |  | - | ----- | - |  |  | ----- | --
|                          |  | Sept 29, |       | December 31, |  | Dollar |       | Percent
|(dollars in millions)     |  | 2001     |       | 2000         |  | Change |       | Change 
|                          |  |          |       |              |  |        |       |        
|Cash and cash equivalents |  | $        | 14.0  |              |  | $      | 2.6   |         |  | $ | 11.4  |   |  |  | 440.5 | % 
|Working capital           |  |          | 119.8 |              |  |        | 138.1 |         |  |   | (18.3 | ) |  |  | (13.3 | %)
|Long-term obligations     |  |          | 6.2   |              |  |        | 67.1  |         |  |   | (60.9 | ) |  |  | (90.7 | %)
|Shareholders equity      |  |          | 163.5 |              |  |        | 165.0 |         |  |   | (1.5  | ) |  |  | (0.9  | %)

As of September 29, 2001, cash and cash equivalents totaled $14.0 million
compared to $2.6 million at December 31, 2000. Working capital decreased by
$18.3 million during the period to $119.8 million due primarily to a decrease
in inventories and an increase in current portion of the deferred gain recorded
on the sale and leaseback transaction.

During the first nine months of 2001, the Company generated $4.8 million in
cash from operations as compared to a use of $1.2 million during the same
period a year ago. The primary sources of operating cash in 2001 were
collection of accounts receivable and an increase in deferred revenue.

Capital expenditures in the nine months of 2001 totaled $5.4 million compared
to $2.3 million during the first nine months of 2000. Management expects
capital expenditures for the fourth quarter of 2001 to be higher than the
year-to-date rate of expenditures due primarily to planned investments in

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Lifeclinic Health Stations.

During the third quarter of 2001, the Company sold its corporate headquarters
and manufacturing facilities and an investment property for net proceeds of
$77.0 million. These proceeds were used primarily to completely retire the
Companys primary credit facility. As of September 29, 2001, the Company has
approximately $4.8 million available under several international credit lines
used to meet the operating requirements of its international subsidiaries. The
Company is currently negotiating with a bank for a $20 million revolving credit
facility to support future cash flow requirements. This facility is expected
to be finalized in the fourth quarter of 2001. The Company believes its
current cash resources coupled with the planned revolving facility will be
adequate to support its liquidity needs for at least the next twelve months.
There is no guarantee that the Company will be successful in obtaining a credit
facility or that the terms of such will be favorable to the Company.

As of September 29, 2001, approximately 848,600 shares remain authorized for
repurchase under the share repurchase programs approved by the Companys Board
of Directors in 1995 and 1997. The Company did not repurchase any shares under
these programs in 2000 or in the first nine months of 2001. Shares previously
acquired under the repurchase programs are being used to service the Companys
various employee benefit plans and may be used for other purposes the Company
deems appropriate.

The Euro Conversion

In January 1999 the European Central Bank assumed authority to direct monetary
policy for certain participating countries in the European Union. During a
transition period ending January 1, 2002, private parties may pay for goods and
services using either the euro or the participating countrys legacy currency
on a no compulsion, no prohibition basis. Beginning in 2002 the
participating countries will only use new euro-denominated bills and coins.

The euro conversion may create technical challenges to adapt information
technology and other systems to accommodate euro-denominated transactions. The
participating countries adoption of a single currency may result in greater
transparency of pricing for the Companys products, making Europe a more
competitive environment. The Company is in the process of upgrading certain of
its financial systems in its European subsidiaries to accommodate the
conversion to the euro. While management does not expect the euro conversion to
have a material impact on the Companys financial position or results of
operations, there can be no assurance that managements conversion efforts will
be successful or completed on a timely basis.

Recent Accounting Pronouncements

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. 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 is required to adopt Statement 142 on January 1, 2002. Because of
the extensive effort needed to comply with adopting Statement 142, it is not
practicable to reasonably estimate the impact of this statement on the
Companys financial statements at the date of this report, including whether
any transitional impairment losses will be required to be recognized as the
cumulative effect

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of a change in accounting principle.

Forward Looking Information

Statements that are not based on historical facts are forward-looking
statements subject to uncertainties and risks, including, but not limited to,
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, the Companys ability to obtain a new revolving credit
facility, adverse exchange rate fluctuations and political risks, the impact of
competition on pricing, adverse impact of HIPAA and other legislation and
regulatory developments, 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, 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 receivable from or payable to its foreign subsidiaries, which are
denominated in local currencies. At September 29, 2001, such net payables were
approximately $1.2 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 September 29, 2001, 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

Footnote 12 to the Financial Statements in Part I, Item 1 of this Form 10Q,
Contingency, is hereby incorporated by reference.




Item 6. Exhibits and Reports on Form 8-K

Exhibits:

| |        |  |                                                                                                                                                    
| | ------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
| | Number |  | Description                                                                                                                                        
| |        |  |                                                                                                                                                    
| | 4.3    |  | Amendment, dated November 2, 2001, to Rights Agreement between
Spacelabs Medical, Inc. and First Chicago Trust Company of New York
as Rights Agent.

During the third quarter of 2001, the Company filed with the Securities
Exchange Commission a Form 8-K, dated September 12, 2001, with respect to the
sale of its corporate facilities in Redmond, Washington.

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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: November 13, 2001 | 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
| | --------------------------------------------------------

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SPACELABS MEDICAL, INC.




Exhibit Index

Exhibits:

|       |  |                                                                                                                                                    
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|Number |  | Description                                                                                                                                        
|       |  |                                                                                                                                                    
|4.3    |  | Amendment, dated November 2, 2001, to Rights Agreement between
Spacelabs Medical, Inc. and First Chicago Trust Company of New York
as Rights Agent.

(21)