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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

For the quarterly period ended  September 30, 2002        

or

For the transition period from ____________________ to ____________________

Commission file number   0-16752

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.

The number of shares of the Common Stock of the registrant outstanding as of November 11, 2002 was 3,758,220.

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MEDSTONE INTERNATIONAL, INC.

INDEX TO FORM 10-Q

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MEDSTONE INTERNATIONAL, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying notes.

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MEDSTONE INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

See accompanying notes.

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MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

See accompanying notes.

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MEDSTONE INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine months ended September 30, 2002 and 2001
(Unaudited)

See accompanying notes.

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MEDSTONE INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

September 30, 2002

A.     Basis of presentation

         The accompanying condensed consolidated financial statements include the accounts of Medstone International, Inc. and its subsidiaries (the Company).  All significant intercompany transactions and accounts have been eliminated.

         In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements include all adjustments (which consist only of normal recurring adjustments) necessary for a fair presentation of its consolidated financial position at September 30, 2002 and consolidated results of operations and cash flows for the periods presented.  Although the Company believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These financial statements should be read in conjunction with the Company’s audited financial statements included in the Company’s 2002 Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2002.  Results of operations for the three and nine months ended September 30, 2002 are not necessarily indicative of results to be expected for the full year.

         The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from these estimates.

B.     Accumulated Other Comprehensive Loss

         The components of other comprehensive loss are as follows:

         The functional currency of the investment in foreign subsidiary is considered to be the United States dollar.

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         The earnings associated with the Company’s investment in its foreign subsidiary are considered to be permanently invested and no provision for U.S. federal and state income taxes on those earnings or translation adjustments has been provided.      

         For the three months ended September 30, 2002 and 2001, total comprehensive income was $201,779 and $321,068, respectively, For the nine months ended September 30, 2002 and 2001, total comprehensive income was $404,872 and $887,820, respectively.

C.     Business Segments

         The Company operates in two business segments, equipment sales and fees for procedures, maintenance and management.

D.     Per share information

         The following table sets forth the computation of earnings per share:

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               Common equivalent shares result from the assumed exercise of outstanding dilutive securities when applying the treasury stock method.  Fully diluted per share information is not presented for periods in which the effect is antidilutive.

E.     Inventories

               At September 30, 2002 and December 31, 2001, inventories consisted of the following:

F.     Contingencies

               From time to time, the Company is subject to legal actions and claims for personal injuries or property damage related to patients who use its products.  The Company has obtained a liability insurance policy providing coverage for product liability and other claims.  Management does not believe that the resolution of any current proceedings will have a material financial impact on the Company or the consolidated financial statements.

G.     Stock Repurchase Plan

               In the third quarter of 2002 the Company purchased a total of 161,800 shares at an aggregate cost of $732,808, completing the Company’s latest Stock Repurchase Plan.  Under all the Company’s stock repurchase plans a total of 1,984,450 shares have been repurchased at a total cost of $12,765,709. The Company currently has no further plans to repurchase common stock.

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               The following discussion and analysis should be read in conjunction with the Company’s audited financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2001 Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2002.

               In the ordinary course of business, the company has made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of its financial statements in conformity with accounting principles generally accepted in the United States of America.  Actual results could differ significantly from those estimates under different assumptions and conditions.  The Company believes that the following discussion addresses the Company’s most critical accounting policies, which are those that are most important to the portrayal of the Company’s financial condition and results.  The Company constantly re-evaluates these significant factors and makes adjustments where facts and circumstances dictate.  Historically, actual results have not significantly deviated from those determined using the necessary estimates inherent in the preparation of financial statements.  Estimates and assumptions include, but are not limited to, customer receivables, inventories, equity investments, fixed asset lives, contingencies and litigation.  The Company has also chosen certain accounting policies when options were available, including:

               These accounting policies are applied consistently for all years presented.  Our operating results would be affected if other alternatives were used.  Information about the impact on our operating results is included in the footnotes to our consolidated financial statements.

Results of Consolidated Operations

General

               Medstone manufactures, markets and maintains lithotripters, and continues to expand its Fee-for-Service Program to supply lithotripsy equipment to providers on a per procedure basis.  The lithotripters manufactured by Medstone are approved to treat both kidney stones and gallstones.  The Company is also marketing a urology imaging and treatment table, used for various urological functions, mobile urology and pain management tables to serve the mobile treatment market and various radiology room equipment, capitalizing on the relationships that the

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Company has with radiology equipment manufacturers. To date, the Company’s consolidated revenues have come primarily from Medstone’s lithotripsy business.

               As a manufacturer of medical devices, the Company has been vertically integrating by offering its medical devices directly to providers.  It currently offers lithotripsy procedures using 15 mobile systems,  two fixed sites and 23 transmobile lithotripters located throughout the United States on a per procedure basis.  With the ability to offer quality equipment at reasonable prices, Medstone intends to continue the growth of this manufacturer direct business.

Results of Operations

Three Months ended September 30, 2002 Compared to Three Months Ended September 30, 2001

               The Company recognized total revenue of $5.96 million in the third quarter of 2002 compared to $5.99 million in the third quarter of 2001, less than a 1% decrease. Revenues from procedures, maintenance and management fees decreased from $4.82 million in the three months ended September 30, 2001 to $4.60 million in the three months ended September 30, 2002 due to lower average per patient charges on the Company’s fee-for-service equipment along with a slightly lower patient count.  Also decreasing were the revenues for procedure fees as pricing pressures continue to cause declines in the per-patient fees when compared to the prior year.  Partially offsetting these decreases were increased maintenance fees as both the number of units shipped and the number of units under maintenance contracts increased when compared to the same period of the prior year.  Equipment revenues increased to $1.27 million in the quarter ending September 30, 2002 from $ 1.07 million in the comparable quarter of the prior year, or a 19% increase.  The Company shipped two lithotripsy systems and one UroPro urology system in the three months ended September 30, 2002 compared to one lithotripsy system shipped in the same period of 2001.  The number of various patient handling tables shipped in the third quarter of each year remained constant.

               Interest income decreased by 19% in the third quarter of 2002 when compared to the same period of the prior year due to a continued low investment yields and a decrease of approximately $ .80 million in the average invested balance.

               Recurring revenue cost of sales decreased to 57% of sales in the quarter ended September 30, 2002 compared to 61% in the same quarter of the prior year.  This is due to the continued shift from mostly mobile van routes to a larger number of fixed site fee-for-service units and the resulting lower depreciation and equipment rental expenses. Operating costs for the remaining mobile vans continue to decline as van movements are less frequent and fixed costs have substantially declined. 

               Cost of sales on equipment sales increased to 66% of sales in the three months ended September 30, 2002 compared to 64% of sales in the same period of 2001.  This increase is due to a higher cost of sales of UroPro urology tables when compared to the historical costs of lithotripsy equipment.  Lithotripsy equipment cost of sales increased slightly as average sales

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prices decreased slightly.   Overall cost of sales, as a percentage of revenue (excluding interest), decreased to 59% in the third quarter of 2002 compared to 61% in the third quarter of 2001.

               Research and development costs increased to $360,000 in the third quarter of 2002 compared to $320,000 in the third quarter of 2001 or an increase of 13% due to development spending on new equipment projects and consulting expenses for enhancements of our existing equipment.

               Selling costs increased to $702,000 in the third quarter of 2002 compared to $681,000 in the same period of the prior year, a change of $21,000 or 3% due to higher payroll expenses for radiological sales staff and the related travel expenses.

               General and administrative expenses increased by $118,000 or 20% in the three months ended September 30, 2002 compared to the same period in the prior year due to higher consulting and outsides services related to the Company’s gallstone lithotripsy study.

               There was no Gain on sale of investments in the three months ended September 30, 2002 compared to approximately $200,000 in the quarter ending September 30, 2001.  The Company had sold the final 86,000 shares of its Cardiac Science, Inc. common stock in the prior year with no corresponding activity in the current year.

               Total minority interest expense decreased to $192,000 in the three months ended September 30, 2002 compared to $416,000 in the same period of the prior year.  This decrease was due to the prior years’ write down of the k.Biotech investment with only slightly lower profits in the Northern Nevada and Southern Idaho operations in the current year.

               Provision for income taxes for the third quarter of 2002 increased by $97,000 compared to the same period of 2001 as a result of higher domestic taxable income in the current year.

Nine Months Ended September 30, 2002 Compared to Nine Months Ended September 30, 2001

               The Company recorded total revenue of $18.30 million in the first nine months of 2002 or a 10% increase compared to $16.57 million in the corresponding period of 2001.  Revenues from procedures, maintenance and management fees decreased by $799,000, or 6%, due to lower average reimbursement per patient and total patient count.  Partially offsetting this decrease was an increase in maintenance revenue in the current year compared to the same period in the prior year due to higher unit shipments and a greater number of units covered under maintenance contracts.  Offsetting the lower recurring revenue, equipment revenue increased by $2,643,000, or 124%, as lithotripter shipments increased from 2 in the nine months ended September 30, 2001 to 8 in the same period of 2002.  Also increasing was revenue related to the UroPro urology table which had no corresponding activity in 2001.  Activity in the various patient handling tables in the first nine months of 2002 was approximately even with the same period in 2001. Interest income decreased by 32% for the first nine months of 2002 when compared to the same period of the prior year as significantly lower interest yields were in effect for the first nine months of 2002 and the average invested balance was lower.

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               Procedure, maintenance and management fee cost of sales decreased to 58% in the nine months ended September 30, 2002 compared to 60% in the same period of the prior year as costs decreased in the fee-for-service program due to a shift in equipment placements and the related lower depreciation and equipment rental costs.

               Cost of sales on equipment sales decreased to 73% of revenue in the first nine months of 2002 compared to 79% of revenue in the first nine months of 2002 due to higher lithotripsy equipment shipments and the corresponding higher profit margin.   Overall cost of sales, as a percentage of revenue (excluding interest), decreased slightly to 62% in the first nine months of 2002 compared to 63% in the first nine months of 2001.

               Research and development costs increased by $55,000, or 6% in the first nine months of 2002 when compared to the same period of 2001 as the Company developed the UroPro table in 2001 and is increasing spending on new project applications in 2002 and consulting expenses to develop enhancements on our existing equipment.

               Selling costs increased by 20%, or $384,000, in the first nine months of 2002 compared to the same period of 2001 due to higher payroll, travel and commissions relating higher staffing levels to achieve higher equipment sales.

               General and administrative expenses increased by 24%, or $456,000, in the nine months ended September 30, 2002 compared to the first nine months of 2001 due to higher consulting and advisory service expense for the gallstone study being conducted by the Company as a condition of the approval of the gallstone lithotripsy application. 

               There was no Gain on sale of investments in the nine months ended September 30,2002 compared to  $628,000 in the nine months ended September 30, 2001.  In 2001, the Company sold a total of 187,000 shares of Cardiac Science common stock whereas there were no shares sold in 2002.

               Minority interest decreased by 23% in the nine months ended September 30, 2002 when compared to the same period of the prior year due to a slight decrease in profits in the partnership operations and recognition of a write down of the k.Biotech investment in 2001 with no corresponding expense in 2002.

               Provision for income taxes decreased to $497,000 in the first nine months of 2002 compared to $640,000 for the same period of 2001 as a result of lower taxable income in the current year.

Liquidity and Capital Resources

               At  September 30, 2001, the Company had cash and short-term investments of approximately $6.0 million.  These funds were generated from continuing operating activities.

               The Company’s long-term capital expenditure requirements will depend on numerous

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factors, including the progress of the Company’s research and development programs, the time required to obtain regulatory approvals, the resources that the Company devotes to the development of self-funded products, proprietary manufacturing methods and advanced technologies, the costs of acquisitions and/or new revenue opportunities, the ability of the Company to obtain additional licensing arrangements and to manufacture products under those arrangements, and the demand for its products if and when approved and possible acquisitions of products, technologies and companies.

               The Company believes that its existing working capital and funds anticipated to be generated from operations will be sufficient to meet the cash needs for continuation of its present operations during 2002.

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

               Forward-looking statements in this report, including without limitation, statements relating to the Company’s plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Investors are cautioned that such forward-looking statements involve risks and uncertainties including without limitation the following:  (i) the Company’s plans, strategies, objections, expectations and intentions are subject to change at any time at the discretion of the Company, (ii) the Company’s plans and results of operations will be affected by the Company’s ability to manage its growth; (iii) the Company’s businesses are highly competitive and the entrance of new competitors into or the expansion of the operations by existing competitors in the Company’s markets and other changes could adversely affect the Company’s plans and results of operations; and (iv) other risks and uncertainties indicated from time to time in the Company’s filings with the Securities and Exchange Commission.

Item 3.      Quantitative and Qualitative Disclosures About Market Risk

               The Company has no financial instruments which are subject to market risk.  Although the Company’s earnings and cash flows are subject to fluctuations due to changes in the interest rates on its investments, a hypothetical 10% adverse decrease in the interest rates would not have a material adverse effect on the results of operations because the majority of the Company’s investments are short-term treasury bills.  A 10% reduction in interest rates would reduce interest income by approximately $50,000 annually.  Due to the short period to maturity, the Company believes that the impact of a 10% reduction in interest rates would not have a material effect on the carrying value of its securities.

               The Company’s earnings and cash flows at Medstone International, Ltd., a Scottish subsidiary, are subject to fluctuations due to changes in foreign currency rates. The Company believes that changes in the foreign currency exchange rate would not have a material adverse effect on its results of operations as the majority of its foreign transactions are delineated in Medstone International, Ltd.’s functional currency, the British Pound.

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Item 4.      Controls and Procedures

               Within the 90  day period prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule I 5d-1 4 (c). ] Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in a timely manner to alert them to material information relating to the Company which is required to be included in the Company’s periodic Securities and Exchange Commission filings.  There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the evaluation date.

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MEDSTONE INTERNATIONAL, INC.

PART II.  OTHER INFORMATION