<PAGE>   1
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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

                                    Form 10-K

(MARK ONE)

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

                   For the fiscal year ended December 31, 1998

                                       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 0-27212 
                                 ENDOCARE, INC.
             (Exact name of registrant as specified in its charter)

            Delaware                                        33-0618093
 (State or other jurisdiction of                         (I.R.S. Employer
  incorporation or organization)                        Identification No.)

    7 Studebaker, Irvine, California                          92618
 (Address of principal executive offices)                   (Zip code)

       Registrant's telephone number, including area code: (949) 595-4770

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

           Securities registered pursuant to Section 12(g) of the Act:

                          Common Stock, $.001 par value
                                (Title of Class)

   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 [ ]

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

   The number of shares of the registrant's common stock outstanding as of March
18, 1999 was 10,477,290.

   The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant was $28,187,058 (computed using the average
bid and asked prices quoted on the NASDAQ Small Cap Market on March 18, 1999).

   The information required to be included in Part III of this Form 10-K is
incorporated by reference to the definitive proxy statement for the registrant's
annual meeting of stockholders to be filed by the registrant no later than 120
days after December 31, 1998, the close of its fiscal year.

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                                 ENDOCARE, INC.
                       INDEX TO ANNUAL REPORT ON FORM 10-K
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

                             ITEM NUMBER AND CAPTION

<TABLE>
<CAPTION>
                                                                                                       PAGE
  PART I                                                                                              NUMBER
  ------                                                                                              ------
  <S>          <C>                                                                                    <C>
    Item 1.    Business..........................................................................         3
    Item 2.    Properties........................................................................        14
    Item 3.    Legal Proceedings.................................................................        14
    Item 4.    Submission of Matters to a Vote of Security Holders...............................        14

    PART II

    Item 5.    Market for Registrant's Common Equity and Related Shareholder Matters.............        15
    Item 6.    Selected Financial Data...........................................................        16
    Item 7.    Management's Discussion and Analysis of Financial Condition and Results of
               Operations........................................................................        16
    Item 7A.   Quantitative and Qualitative Disclosures about Market Risk........................        20
    Item 8.    Financial Statements and Supplementary Data.......................................        20
    Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial
               Disclosure........................................................................        20

    PART III

    Item 10.   Directors and Executive Officers of the Registrant................................        20
    Item 11.   Executive Compensation............................................................        20
    Item 12.   Security Ownership of Certain Beneficial Owners and Management....................        20
    Item 13.   Certain Relationships and Related Transactions....................................        20

    PART IV

    Item 14.   Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................        20
</TABLE>







                                       2


<PAGE>   3

                                     PART I


ITEM 1.  BUSINESS

GENERAL

   Endocare, Inc., a Delaware corporation ("Endocare" or the "Company"),
develops, manufactures and markets minimally invasive medical devices to treat a
variety of urological conditions. In 1998, the Company focused its efforts on
the clinical development of surgical devices for the treatment of the two most
common diseases of the prostate: Benign Prostate Hyperplasia ("BPH") and
prostate cancer. The Company has received marketing clearance by the Food and
Drug Administration ("FDA") for several of its products, recently received
notice of the Health Care Financing Administration's ("HCFA") decision to
implement national Medicare reimbursement for its cryosurgical procedure for
prostate cancer, and is researching and developing other novel urological
devices.

   Endocare has developed and recently introduced an innovative, second
generation cryosurgical system for the treatment of prostate cancer. The
CRYOcare System(TM) offers the advantage of controlled, targeted freezing of the
tumor with the benefit of faster patient recovery and minimal complications. In
February 1999, the HCFA announced the decision to implement national Medicare
coverage for cryosurgical procedures as a primary treatment alternative for
localized prostate cancer. The recommendation was made by HCFA following its
review of scientific evidence on the medical effectiveness of cryosurgery for
prostate cancer.

   Endocare has also developed new therapies for the improved treatment of BPH.
The Company's initial product development efforts for BPH involve the use of
stent technology to provide both immediate and long-term relief to BPH patients.
Endocare has implemented a two-part strategy for the commercialization of its
stent-based BPH therapies. The first stage is the development of the Company's
Horizon Stent. This nitinol-based stent has shape memory characteristics for
easy placement via a catheter following surgical intervention of the prostate
and convenient atraumatic removal of the stent following the healing process.
The Company believes that its Horizon Stent will address one of the major issues
of BPH therapy, the immediate relief of patients following thermotherapy and
surgical resection. In early 1999, Endocare completed phase two of the Horizon
Stent FDA study and is awaiting approval to expand the trial to the pivotal
study. The Company expects to complete the FDA study in early 2000.

   The second stage in developing the Company's stent technology will combine a
nitinol stent with a catheter system to deliver thermotherapy. The Company
believes that this ThermaStent(TM) will provide immediate and long-term therapy
in a one-step process. Both stent applications are being designed to be
performed on an outpatient basis. The Company believes that its ability to
perform BPH therapy in this manner could result in an increase in the number of
BPH sufferers who will seek curative surgical procedures.

   Since its formation in 1990, Endocare operated first as a research and
development department, then later as a division of Medstone International, Inc.
("Medstone"). Effective January 1, 1996, Endocare became a totally independent,
publicly-owned corporation upon being spun-out to existing Medstone
shareholders.


MARKET BACKGROUND

PROSTATE CANCER

   The incidence of prostate cancer has risen steadily since 1980 to become the
second most common cause of cancer-related deaths among men. The dramatic
increase in prostate cancer cases has led to heightened awareness of the
disease, which has led to increased rates of testing and improved diagnostic
methods.

   Therapeutic alternatives for patients with prostate cancer have been both
limited and unattractive. Current treatment options include radical surgery,
radiation therapy, hormone therapy, cryotherapy and "watchful waiting." These
options are evaluated using a number of criteria, including the patient's age,
physical condition and stage of the disease. However, due to the slow
progression of the disease, the decision for treatment typically is based upon
the severity of the condition and the resulting quality of life.

   Radical prostatectomy is most often the therapy of choice due to the high
degree of confidence in surgically removing the cancerous tissue, particularly
for patients having more advanced stages of the disease and those who fail to
respond to less invasive


                                       3


<PAGE>   4

alternatives. The procedure is dependent on the skill of the surgeon and is
highly morbid, often associated with high rates of impotence, incontinence and
operative mortality.

   Cryosurgery, freezing tissue to destroy tumor cells, was first developed in
the 1960's. During this period, the use of "cold probes," or cryoprobes, was
explored as a method to kill prostate tissue without having to use radical
surgery. Although effective in killing cancer cells, the lack of control as to
the amount of tissue frozen prevented broad use and development of cryotherapy
for prostate cancer.

   In the late 1980's, progress in ultrasound imaging allowed for a revival in
the use of cryosurgery. Using ultrasound, the cryoprobe may be guided to the
targeted tissue from outside the body through a small incision. The physician
activates the cryoprobe and uses ultrasound to monitor the growth of ice in the
prostate as it is occurring. When the ice encompasses the entire prostate, the
probe is turned off. This feedback mechanism of watching the therapy as it is
administered allows the physician precise control during application. Recent
published studies suggest that cryosurgery may be able to deliver disease free
rates comparable to radical surgery, but with the benefit of being performed in
an outpatient setting and with lower rates of incontinence and mortality.

BENIGN PROSTATE HYPERPLASIA

   BPH, which affects a large number of adult men, is a non-cancerous
enlargement of the innermost part of the prostate. BPH frequently results in a
gradual squeezing of the part of the urethra which runs through the prostate.
This causes patients to experience a frequent urge to urinate because of the
incomplete emptying of the bladder and a burning sensation or similar discomfort
during urination. The obstruction of urinary flow can also lead to a general
lack of control over urination, including difficulty initiating urination when
desired as well as difficulty preventing urinary flow because of the residual
volume of urine in the bladder (a condition known as urinary incontinence). BPH
symptoms may disturb sleep by causing the BPH sufferer to awaken frequently to
urinate. Although symptoms occasionally stabilize or diminish without
intervention, they generally become more severe over the course of the disease.
Left untreated, the obstruction caused by BPH can lead to acute urinary
retention (complete inability to urinate), serious urinary tract infections and
permanent bladder and kidney damage.

   Most males will eventually suffer from BPH. The incidence of BPH for men in
their fifties is approximately 50% and rises to approximately 80% by the age of
80. The general aging of the United States population, as well as increasing
life expectancies, is anticipated to contribute to the continued growth in the
number of BPH sufferers.

   Patients diagnosed with BPH generally have four options for treatment: (i)
"watchful waiting," (ii) drug therapy; (iii) surgical intervention, including
transurethral resection of the prostate ("TURP") and laser assisted
prostatectomy; and (iv) new, less invasive thermal therapies. Currently the
number of patients who are actually treated by surgical approaches is
approximately 2% to 3% of patients with BPH. Treatment is generally reserved for
patients with intolerable symptoms or those with significant potential symptoms
if treatment were withheld. A large number delay discussing their symptoms or
elect "watchful waiting" to see if the condition remains tolerable. The Company
believes the development of less invasive procedures for treatment of BPH could
result in a substantial increase in the number of BPH patients who elect to
receive interventional therapy.

   Drug Therapies: Some drugs are designed to shrink the prostate by inhibiting
or slowing the growth of prostate cells. Other drugs are designed to relax the
muscles in the prostate and bladder neck to relieve urethral obstruction.
Current drug therapy generally requires daily administration for the duration of
the patient's life.

   Surgical Interventions: The most common surgical procedure, transurethral
resection of the prostate ("TURP"), involves the removal of the prostate's
innermost core in order to reduce pressure on the urethra. TURP is performed by
introducing an electrosurgical cutting loop through a cystoscope into the
urethra and "chipping out" both the prostatic urethra and surrounding prostate
tissue up to the surgical capsule, thereby completely clearing the obstruction.
The average TURP procedure costs approximately $8,000 and requires a hospital
stay of approximately four days.

   Modified Electrosurgical Electrodes: These devices have made it possible to
surgically remove prostate tissue in a "near bloodless" procedure using an
electrode which cauterizes as it removes tissue. Introduced in 1995, this new
technology has rapidly gained acceptance in the urology community as a means of
ablating prostate tissue in a well controlled and near-bloodless fashion.
However, like a conventional TURP, this procedure must be performed in a
hospital under general or spinal anesthesia, results in destruction of the
prostatic urethra and requires insertion of a urinary catheter post-surgery.



                                       4



<PAGE>   5

   Laser Ablation of the Prostate: Laser assisted prostatectomy includes two
similar procedures, visual laser ablation of the prostate (V-LAP ) and contact
laser ablation of the prostate ( C-LAP ), in which a laser fiber catheter is
guided through a cystoscope and used to ablate and coagulate the prostatic
urethra and prostatic tissue. Typically, the procedure is performed in the
hospital under either general or spinal anesthesia, and an overnight hospital
stay is required. In V-LAP, the burnt prostatic tissue then necroses, or dies,
and over four to twelve weeks is sloughed off during urination. In C-LAP, the
prostatic and urethral tissue is burned on contact and vaporized.

   Less Invasive Thermal Therapies: Other technologies under development are
non-surgical, catheter based therapies that use thermal energy to preferentially
heat diseased areas of the prostate to a temperature sufficient to cause cell
death. Thermal energy forms being utilized include microwave, radio frequency
("RF") and ultrasound energy. The procedures are typically performed in an
outpatient setting under local anesthesia. Both microwave and RF therapy systems
are currently being marketed worldwide, including the United States, where the
first FDA clearances were obtained in May and October 1996, for microwave and
RF, respectively.

ENDOCARE PRODUCTS

   Endocare has developed the following products:


<TABLE>
<CAPTION>
  PRODUCT NAME                TARGETED INDICATION        STATUS         LAUNCH DATE
<S>                           <C>                        <C>            <C>
  Vaporbar                    BPH                        Marketing      November 1995
  Uroloop                     BPH                        Marketing      November 1995
  CRYOcare-4 Probe System     General Surgery            Marketing      May 1996
  CRYOcare-8 Probe System     Prostate Cancer            Marketing      May 1996
  Horizon Stent               Acute Urinary Retention    FDA Trials       ------
  ThermaStent                 BPH                        Pre-Clinical     ------
                                                         Studies
</TABLE>

CRYOCARE SYSTEM

   Endocare has developed the CRYOcare System, a second generation cryosurgery
system designed to overcome the limitations of existing systems and to allow the
urologist to treat prostate cancer in a minimally invasive manner in an
outpatient setting. The CRYOcare System has been designed to freeze tissue much
faster and with more control than existing systems. This product is marketed by
Endocare.

   The Company believes the CRYOcare System is significantly more efficient than
current competitive cryosurgical technology in creating the lethal temperatures
in the cryoprobe necessary to kill cancer cells. Current cryosurgical technology
employs a tank of liquid nitrogen, which is at -186 degrees celcius (C), and
pumps it through a tube to the cryoprobe. The challenge for current liquid
nitrogen technology is to not "leak" the cold prior to delivering it to the
tumor site. Liquid nitrogen technology starts out coldest at the storage tank
and can only get warmer and less effective by the time it reaches the tumor site
and attempts to freeze the tissue.

   Endocare's CRYOcare System utilizes a system that converts argon gas to a
liquid form at the tip of the probe. The gas itself is at room temperature until
reaching the tip, making it easier to handle and eliminating the need to store
liquid nitrogen. In addition, a temperature of -150 degrees C is achieved at the
tip of the cryoprobe, considerably colder than the -90 degrees C achieved using
liquid nitrogen systems, which results in substantially faster tissue freezing
rates using the CRYOcare System.

   The CRYOcare System incorporates enhanced control mechanisms to minimize the
risk of unintended damage to tissue surrounding the prostate. Most
significantly, the CRYOcare probes stop freezing instantly, whereas probes using
liquid nitrogen take up to one minute to stop freezing tissue. Use of four to
six temperature probes selectively placed in the prostate near the rectal
tissue, sphincter muscles (which control continence) and neurovascular bundles
(which control potency) enables the physician to monitor temperatures of tissue
adjacent to the prostate. Combining these control features allows the physician
to treat prostate cancer with a high degree of control and precision that was
not previously possible. The CRYOcare System is approximately one quarter of the
size of currently available systems and one tenth of the weight.

   The CRYOcare System has been cleared for marketing by the FDA and was
introduced in May 1996. The Company has installed several CRYOcare Systems in
North America, with over 500 patients treated to date. Early clinical data at
the CRYOcare Systems clinical sites are encouraging. In February 1999, HCFA
announced the decision to implement national Medicare coverage for cryosurgical
procedures as a primary treatment alternative for localized prostate cancer.
Endocare's CRYOcare System is the only temperature-monitored, cryosurgical
system specifically cleared by the FDA for the treatment of prostate cancer.



                                       5


<PAGE>   6
   The Company has received issued patents relating to the technology used to
create the freezing process and to precisely control the shape of the freeze
zone produced by the cryoprobes and covering the Company's CRYOprobe technology.
This also may allow for expanded therapeutic applications by tailoring the
cryoprobe performance to other anatomical targets, such as liver cancer and
gynecology applications.

OFFICE-BASED BPH THERAPY

   The goal of developing bloodless, anesthesia free, and pain free BPH
therapies has resulted in a category of new devices called thermotherapy
systems. In thermotherapy, a device is introduced into the prostate in the
gentlest manner possible and heat is delivered very slowly to thermally destroy
the enlarged tissue. The advantage of these thermotherapy systems is their
ability to destroy the obstruction without bleeding or anesthesia, thus allowing
the patient to be treated in the urologist's office. The less-invasive nature of
the therapy allows for faster and easier recovery periods.

   The disadvantage of thermotherapy based systems is the manner in which the
obstructive tissue is removed. The tissue temperature of the obstructive tissue
is slowly raised to the point the cells can no longer survive. The dead tissue
is left in place, in contrast to the traditional surgical techniques, in which
the obstructive tissue is removed immediately. The period it takes for the dead
cells to be completely cleared, and thus for the obstruction to be removed, can
be up to six months. Patients who are treated by thermotherapy typically recover
quickly, but need to be catheterized for up to one week post treatment to
maintain urine flow.

   Endocare is developing innovative products that will address BPH therapy to
include thermotherapy approaches. The development process will occur in two
discrete steps. The first step will deliver an immediate relief component to be
used with existing thermotherapy systems. The second step will offer a
combination device that will be able to provide immediate relief and long-term
removal of the obstructive tissue without bleeding or anesthesia.

   Horizon Stent(TM). Endocare has developed a new urological stent which has
been designed to provide immediate relief for BPH patients who undergo
thermotherapy. The Company's Horizon Stent is made of nitinol, a new titanium
metal alloy that employs a feature called shape memory. This shape memory
feature allows the Horizon Stent to be soft and flexible in its relaxed state,
allowing the device to be introduced in a relatively pain free manner using a
catheter. When the device is heated to its transition temperature, the device
self-expands to a pre-determined shape. In the case of the Horizon Stent, the
predetermined shape is that of a rigid tube, or stent. The catheter will be
inserted using a local anesthetic, and positioned in the prostatic urethra under
direct vision. The stent is activated by body heat, causing the shape memory to
open to its tube-like position. After approximately 30 days, the stent is
removed by the physician by flushing cool water through a flexible endoscope,
causing the stent to return to its soft, relaxed state. The stent will be
removed by retrieving it through the working channel of the flexible endoscope.

   Endocare has completed the early stage FDA clinical trials for the Horizon
Stent (TM) and is awaiting approval to expand the trial to the pivotal study,
which is the final study before clearance can be obtained for broader use.
Because the stent will be removed from the patients within 30 to 60 days, the
Company expects that the trials can be completed quickly and that the regulatory
process may be expedited. However, there can be no assurance that the FDA will
not require more time consuming and extensive clinical studies.

   ThermaStent(TM). Endocare's ThermaStent(TM) is expected to be the second
product developed for the Company's office-based therapy product line. The
ThermaStent(TM) is being designed to combine thermotherapy with the Company's
nitinol stent. The ThermaStent is currently in development and in pre-clinical
studies.

   The Company has secured a patent position on the ThermaStent(TM) device. In
April 1996, Endocare licensed from the Brigham and Women's Hospital ("BW") an
issued patent covering urological applications of the delivery of thermal energy
by a stent. The Company has also received a patent which describes the device
under development and its use to achieve temporary relief. In January 1999, the
Company licensed from Beth Israel Deaconess Medical Center ("BI") an issued
method patent covering treatment of obstructive portions of urinary passageway
via the placement of a temperature-activated nitinol stent.



                                       6


<PAGE>   7

SURGICAL DISPOSABLES

   Since its formation, Endocare has developed a line of surgical disposables
targeting improved treatment of BPH. The common element in the development of
each of the disposable devices is the ability to remove tissue in a near
bloodless manner.

   In 1995, Endocare developed a line of disposable electrodes that vaporize
prostate tissue while cutting. The combination of vaporization and cutting
results in near bloodless removal of the obstructed tissue. Endocare's Uroloop
and Vaporbar electrodes represent the next step in the evolution of near
bloodless, outpatient procedures for BPH.

PATENTS AND INTELLECTUAL PROPERTY

   The Company's policy is to secure and protect intellectual property rights
relating to its technology. While Endocare believes that the protection of
patents and licenses is important to its business, it also relies on trade
secrets, know-how and continuing technological innovation to maintain its
competitive position. The Company has received two issued patents from the U.S.
Patent and Trademark Office covering the Company's CRYOprobe technology. The
Company entered into worldwide licensing agreements relating to urological
applications of a patent from BW for the ThermaStent(TM) product and a method
patent covering treatment of obstructive portions of urinary passageways from BI
for the Horizon Stent product. The BW patent covers the concept of a variety of
methods to heat occluded body passageways by use of a stent. The BI issued
patent covers a method for the treatment of an obstructive portion of a urinary
passageway via the placement of a temperature-activated nitinol stent. The
Company has also received a patent which focuses on the use of a combination
therapy of a stent for short-term relief of the occlusion and thermotherapy for
long-term relief. Patent applications for some of the new products described
above under "Products" have been filed or are in the process of being filed.

   No assurance can be given that Endocare's processes or products will not
infringe patents or proprietary rights of others or that any license required
would be made available under any such patents or proprietary rights, on terms
acceptable to Endocare or at all. From time to time, the Company has received
correspondence alleging infringement of proprietary rights of third parties. No
assurance can be given that any relevant claims of third parties would not be
upheld as valid and enforceable, and therefore that the Company could be
prevented from practicing the subject matter claimed or would be required to
obtain licenses from the owners of any such proprietary rights to avoid
infringement.

   The Company seeks to preserve the confidentiality of its technology by
entering into confidentiality agreements with its employees, consultants,
customers and key vendors and by other means. No assurance can be given,
however, that these measures will prevent the unauthorized disclosure or use of
such technology.

SALES AND MARKETING

   In March 1999, the Company exercised an option to terminate its distribution
agreement with Boston Scientific Corporation ("BSC") which allowed BSC exclusive
worldwide distribution rights to market the CRYOcare System for urology, except
in Canada where it is distributed under a distribution agreement with Mentor
Medical Systems Canada. As a result of the termination of the BSC agreement,
future sales of the CRYOcare System, the Company's main current product, will
largely be dependent upon the marketing efforts of the Company and/or new
distributorship relationships which the Company may enter into.

   The Company derives a majority of its revenues from the sales of CRYOcare
Systems and expects that sales of CRYOcare Systems will continue to constitute
the majority of net sales for the foreseeable future. Accordingly, any factor
adversely affecting the sales of CRYOcare Systems would have a material adverse
effect on the Company's business, financial condition and results of its
operations. In February 1999, HFCA announced the decision to implement national
Medicare coverage for cryosurgical ablation of the prostate, one of the approved
uses of the Company's eight probe CRYOcare System. Although HFCA's decision has
been announced, reimbursement codes and corresponding rates are in the process
of being established. No assurance can be given that health care professionals
will adopt the technology or that reimbursement will be sufficient enough to
induce physicians to perform the procedure.

   Until March 1999, Endocare's CRYOcare System for urological applications was
distributed worldwide by BSC (other than in Canada). In Canada it is distributed
by Mentor Medical Systems Canada under a distribution agreement. For the years
ended December 31, 1996, 1997, and 1998, BSC accounted for 12%, 59%, and 41%,
respectively, of the Company's revenues. The Company is evaluating potential
distribution partners for its CRYOcare System for urological applications as an
alternative to expanding its own domestic sales force



                                       7



<PAGE>   8

to sell the product. The Company currently sells its products domestically
through its direct sales force which consists of four regional sales managers,
and internationally primarily through independent distributors. Overall,
international sales for urological applications represented approximately 50% of
revenue during 1996 and such sales were insignificant in 1997 and 1998. The
Company's distributor agreements typically provide the distributor with
exclusive selling rights to certain products in a particular territory, and are
terminable by either party on 180 days notice. Each party bears its own expenses
in performing under the agreement. The Company's ability to distribute its
products depends substantially on the capabilities of its distributors. There
can be no assurance that the Company will be able to maintain or expand its
relationships with its distributors or to replace a distributor in the event any
such relationships were terminated. In the event that the Company's
relationships with any of its distributors were terminated and the Company was
unable to replace the distribution capability, the Company's ability to
distribute its products could be materially adversely affected, which could have
a material adverse effect on the Company's business, financial condition and
results of operations. In addition, in such event, the Company's current sales
and marketing personnel and financial resources might not be sufficient to
enable the Company to establish its own distribution capability to market and
sell its products. See Note 11 to the Financial Statements.

BACKLOG

   At December 31, 1998, the Company maintained minimal backlog. Endocare's
policy is to stock enough inventory to be able to ship most orders within a few
days of receipt of order. Historically, most of the Company's orders have been
for shipment within 30 days of the placement of the order. Therefore, backlog
information as of the end of a particular period is not necessarily indicative
of future levels of the Company's revenue.

MANUFACTURING

   The Company uses internal manufacturing capacity in its manufacturing
efforts. Most of the Company's purchased components and processes are available
from more than one vendor. However, certain components and processes are
currently available from or performed by a single vendor. The ability of third
party manufacturing sources to deliver components or finished goods will affect
the Company's ability to commercialize its products, and the Company's
dependence on third party sources may adversely affect the Company's profit
margins. Further, although the Company is in the process of identifying
alternative vendors, the qualification of additional or replacement vendors for
certain components or services could be a lengthy process. Any supply
interruption from a single source vendor would have a material adverse effect on
the Company's ability to manufacture its products until a new source of supply
was qualified and, as a result, could have a material adverse effect on the
Company's business, financial condition and results of operations.

   Additionally, the Company's success will depend in part upon its ability to
manufacture its products in compliance with the FDA's current Good Manufacturing
Practices ("GMP") regulations and other regulatory requirements, in sufficient
quantities and on a timely basis, while maintaining product quality and
acceptable manufacturing costs. Failure to increase production volumes in a
timely or cost effective manner or to maintain compliance with current GMP or
other regulatory requirements could have a material adverse effect on the
Company's business, financial condition and results of operations. Endocare also
has obtained from the California Department of Health Services a license to
manufacture medical devices and is subject to periodic inspections and other
regulation by that agency.

   Further, the Company has limited experience in producing its products in
commercial quantities. Manufacturers often encounter difficulties in scaling up
production of new products, including problems involving production yields,
quality control and assurance, component supply and shortages of qualified
personnel. The Company's failure to overcome these manufacturing problems could
have a material adverse effect on the Company's business, financial condition
and results of operations.

GOVERNMENT REGULATION

   Governmental regulation in the United States and other countries is a
significant factor affecting the research and development, manufacture and
marketing of the Company's products. In the United States, the FDA has broad
authority under the Federal Food, Drug and Cosmetic Act and the Public Health
Service Act to regulate the distribution, manufacture and sale of medical
devices. Foreign sales of medical devices are subject to foreign governmental
regulation and restrictions which vary from country to country.

   Medical devices intended for human use in the United States are classified
into one of three categories, depending upon the degree of regulatory control to
which they will be subject. Such devices are classified by regulation into
either class I (general controls), class II (performance standards) or class III
(pre-market approval) depending upon the level of regulatory control required to
provide


                                       8




<PAGE>   9

reasonable assurance of the safety and effectiveness of the device. Good
Manufacturing Practices, labeling, maintenance of records and filings with the
FDA also apply to medical devices.

   A subset of medical devices categorized as class I or II devices that were
commercially distributed before March 28, 1976 or are substantially equivalent
to a device that was in commercial distribution before that date may be marketed
after the acceptance of the pre-market notification under a 510(k) exemption.
The 510(k) section of the Federal Food, Drug and Cosmetic Act allows an
exemption from the requirement of pre-market notification. Generally, devices
that have an existing history or track record are included in this category.

   The process of obtaining FDA and other required regulatory clearances or
approvals is lengthy and expensive. There can be no assurance that Endocare will
be able to obtain necessary clearances or approvals for clinical testing or for
manufacturing or marketing of its products. Failure to comply with applicable
regulatory approvals can, among other things, result in warning letters, fines,
suspensions of regulatory approvals, product recalls, operating restrictions and
criminal prosecution. In addition, governmental regulation may be established
which could prevent, delay, modify or rescind regulatory clearance or approval
of Endocare's products.

   Regulatory clearances or approvals, if granted, may include significant
limitations on the indicated uses for which the Company's products may be
marketed. In addition, to obtain such clearances or approvals, the FDA and
foreign regulatory authorities may impose numerous other requirements on the
Company. FDA enforcement policy strictly prohibits the marketing of approved
medical devices for unapproved uses. In addition, product approvals can be
withdrawn for failure to comply with regulatory standards or the occurrence of
unforeseen problems following initial marketing. There can be no assurance that
the Company will be able to obtain regulatory clearances or approvals for its
products on a timely basis or at all, and delays in receipt of or failure to
receive such approvals, the loss of previously obtained approvals, or failure to
comply with existing or future regulatory requirements would have a material
adverse effect on the Company's business, financial condition and results of
operations.

   Endocare's current surgical disposable products and its eight probe CRYOcare
System have received FDA clearance for sale in the United States for approved
urological uses. Endocare's previous manufacturing facility was subject to an
FDA audit in August 1996, and the Company received no notice that it did not
comply with the FDA's current GMP regulations. In addition, Endocare has
obtained from the California Department of Health Services a license to
manufacture medical devices, subject to periodic inspections and other
regulation by that agency.

COMPETITION

   Currently, the Company markets products in the following categories:
electrosurgical disposables and cryosurgical systems. Significant competitors
include Cryomedical Sciences, Inc., Urologix, Inc., VidaMed, Inc., EDAP/TMS,
S.A., C.R. Bard, Inc. and ACMI/Circon Corporation.

   Many of the Company's competitors are significantly larger than the Company
and have greater financial, technical, research, marketing, sales, distribution
and other resources than the Company. Additionally, the Company believes there
will be intense price competition for products developed in the Company's
market. There can be no assurance that the Company's competitors will not
succeed in developing or marketing technologies and products that are more
effective or commercially attractive than any that are being developed or
marketed by the Company, or that such competitors will not succeed in obtaining
regulatory approval, introducing or commercializing any such products prior to
the Company. Such developments could have a material adverse effect on the
Company's business, financial condition and results of operations. Further,
there can be no assurance that, even if the Company is able to compete
successfully, that it would do so in a profitable manner.

EMPLOYEES

   As of December 31, 1998, Endocare had a total of 39 employees. Of the 39
employees, 6 are engaged directly in research and development activities, 4 in
regulatory affairs/quality assurance, 10 in manufacturing, 13 in sales and
marketing, and 6 in general and administrative positions. The Company expects to
substantially increase employment in anticipation of a commercial launch of the
CRYOcare System and expanded research and development activities related to the
Horizon Stent(TM) and ThermaStent(TM) programs. The Company has never
experienced a work stoppage, none of its employees are represented by a labor
organization, and the Company considers its employee relations to be good.

   Although Endocare conducts most of its research and development using its own
employees, the Company occasionally has funded and plans to continue to fund
research using consultants. Consultants provide services under written
agreements and are paid



                                       9



<PAGE>   10

based on the amount of time spent on Company matters. Under their consulting
agreements, such consultants are required to disclose and assign to the Company
any ideas, discoveries and inventions developed by them in the course of
providing consulting services.

FACTORS THAT MAY AFFECT FUTURE RESULTS AND TRADING PRICE OF COMMON STOCK

   This report contains forward-looking statements that involve risks and
uncertainties, including those discussed below and in the section Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
the Notes to Financial Statements in this report. The actual results that the
Company achieves may differ materially from any forward-looking statements due
to such risks and uncertainties. All such factors should be considered carefully
by investors in the Company.

   Limited Operating History; History of Losses: The Company has a limited
history of operations as an independent operating entity. Since its inception,
the Company has engaged primarily in research and development, and the Company
has minimal experience in manufacturing, marketing and selling its products in
commercial quantities. Additionally, the Company has incurred annual operating
losses since its inception, and expects to continue to incur operating losses as
new products will require substantial development, clinical, regulatory,
manufacturing and other expenditures. For the fiscal years ended December 31,
1998, 1997 and 1996, the Company had net losses of $4,837,346, $3,899,860 and
$1,531,448, respectively. As of December 31, 1998, the Company's accumulated
deficit was approximately $10.3 million. There can be no assurance that the
Company will successfully develop or commercialize its current or future
products, that the Company will achieve significant revenues from sales, or that
the Company will achieve or sustain profitability in the future. Additionally,
successful completion of the Company's development program and its transition to
attaining profitable operations is dependent upon achieving a level of revenues
adequate to support the Company's cost structure and obtaining additional
financing adequate to fulfill its research and development activities to
continue refinement of existing products and to develop and commercialize new
products.

   Uncertain Market Acceptance of the Company's New Products: Certain of the
Company's products, including its CRYOcare Systems, which were introduced in the
second quarter of 1996, are in the early stages of development or market
introduction. There can be no assurance that any of the Company's products will
be accepted by potential customers. The Company's ability to successfully market
its CRYOcare System is dependent upon acceptance of cryosurgical procedures in
the United States and certain international markets. Although cryosurgery has
existed for many years, cryosurgery has not been widely accepted due to cost,
competing products and limited reimbursement by third party payers. Although
HCFA has announced the decision to implement national Medicare coverage for
cryosurgical ablation of the prostate, one of the approved uses of the Company's
eight probe CRYOcare System, reimbursement codes and corresponding rates are in
the process of being established. There is no assurance that reimbursement, once
established, will be sufficient to induce physicians to perform, and patients
elect, the procedure. The acceptance of cryosurgery by the general population
may be affected adversely by its price, concerns relating to its safety and
efficacy, the accepted effectiveness of alternative methods of correcting
urological disorders, level of reimbursement to be established by Medicare, and
lack of reimbursement from other third party payers. In addition, any future
reported adverse events or other unfavorable publicity involving patient
outcomes from the use of cryosurgery, whether from the Company's products or the
products of the Company's competitors, could adversely affect acceptance and
reimbursement for cryosurgery. Emerging new technologies and procedures to treat
cancer, prostate enlargement and other prostate disorders also may adversely
affect the market acceptance of cryosurgery. There can be no assurance that the
Company's CRYOcare Systems will gain any significant degree of market acceptance
among physicians, patients and health care payers.

   Uncertainty of Product Development; Risks Related to Clinical Trials: The
Company's growth is substantially dependent upon its continued ability to
successfully develop, commercialize and market new products. Several of the
Company's products are in varying stages of development. There can be no
assurance that the Company will be successful in developing and commercializing
new products that achieve market acceptance or that the Company will not
experience difficulties that could delay or prevent the successful development,
introduction and marketing of new products. There can be no assurance that the
Company's products in development will prove to be safe and effective in
clinical trials under applicable regulatory guidelines, and clinical trials may
identify significant technical or other obstacles that must be overcome prior to
obtaining necessary regulatory or reimbursement approvals. Even if a product
overcomes these obstacles, the Company's products will not be used unless they
present an attractive alternative to other treatments and the clinical benefits
to the patient and cost savings achieved through use of the Company's products
outweigh the cost of such products. The Company believes that recommendations
and endorsements of physicians and patients and reimbursement by health care
payers will be essential for market acceptance of its products, and there can be
no assurance that any such recommendations, endorsements or reimbursements will
be obtained. Failure of the Company to successfully develop, commercialize and
market new products or the failure of the Company's products to achieve
significant market acceptance would have a material adverse effect on the
Company's business, financial condition and results of operations.



                                       10



<PAGE>   11
   Limited Sales and Marketing Experience: The Company has only limited
experience marketing and selling its products, and does not have experience
marketing and selling its products in commercial quantities. In March 1999, the
Company exercised its right to terminate its exclusive worldwide distribution
agreement with BSC pursuant to which BSC had agreed to market and distribute the
Company's CRYOcare Systems for urology worldwide, except Canada. As a result,
future sales of the CRYOcare System, the Company's main product, will be
dependent on the marketing efforts of the Company. The Company derives a
majority of its revenues from the sales of CRYOcare Systems and expects that
sales of CRYOcare Systems will continue to constitute the majority of net sales
for the foreseeable future. Accordingly, any factor adversely affecting the
sales of CRYOcare Systems would have a material adverse effect on the Company's
business, financial condition and results of its operations.

   The Company believes that to become and remain competitive, it will need to
continue to develop third party international distribution channels and a direct
sales force for its new and other products. In lieu of expanding its domestic
sales force, the Company is evaluating potential domestic partners for
distribution of its products. Establishing marketing and sales capabilities
sufficient to support sales in commercial quantities will require significant
resources, and there can be no assurance that the Company will be able to
recruit and retain direct sales personnel, or that the Company will succeed in
establishing and maintaining any third party distribution channels, or that the
Company's future sales and marketing efforts will succeed at all.

   Need for Additional Long Term Financing: The Company believes that its
existing cash resources and anticipated cash flow from future operations will
provide sufficient resources to meet present and reasonably foreseeable working
capital requirements and other cash needs through the end of 1999. The Company
has a $1,000,000 unused bank line of credit which expires on April 30, 1999. The
Company anticipates either renewing the existing line or entering into a new
debt facility with another bank in April 1999; however, there is no assurance
the Company will be able to obtain another debt facility on favorable terms, or
at all. If the Company elects to undertake or accelerate significant research
and development projects for new products or pursue corporate acquisitions, it
may require additional outside financing prior to such time. The Company
expects, even if it does obtain a new debt facility, that to meet its long-term
needs it will need to raise substantial additional funds through the sale of its
equity securities, the incurrence of indebtedness or through funds derived
through entering into collaborative arrangements with third parties. Any
additional equity financing may be dilutive to shareholders, and debt financing,
if available, may involve restrictive covenants. Collaborative arrangements, if
necessary to raise additional funds, may require the Company to relinquish
rights to certain of its technologies, products or marketing territories. The
failure of the Company to raise capital when needed could have a material
adverse effect on the Company's business, financial condition and results of
operations.

   Competition; Rapid Technological and Industry Change: The Company competes in
an established field of surgical device manufacturers, and the competition in
this field is intense. Many of the Company's competitors are significantly
larger than the Company and have greater financial, technical, research,
marketing, sales, distribution and other resources than the Company.
Additionally, the Company believes there will be intense price competition for
products developed in the Company's markets. There can be no assurance that the
Company's competitors will not succeed in developing or marketing technologies
and products, including drug-based treatments, that are more effective or
commercially attractive than any that are being developed or marketed by the
Company, or that such competitors will not succeed in obtaining regulatory
approval, introducing or commercializing any such products prior to the Company.
Such developments could have a material adverse effect on the Company's
business, financial condition and results of operations. Further, there can be
no assurance that, even if the Company is able to compete successfully, it would
do so in a profitable manner. The medical device industry generally, and the
urological disease treatment market in particular, are characterized by rapid
technological change, changing customer needs, and frequent new product
introductions. The Company's future success will depend upon its ability to
develop and introduce new cost effective products in a timely manner. There can
be no assurance that the Company's products will not be rendered obsolete as a
result of future innovations.

   Limited Manufacturing Experience: The Company has limited experience in
producing its products in commercial quantities. Manufacturers often encounter
difficulties in scaling up production of new products, including problems
involving production yields, quality control and assurance, component supply and
shortages of qualified personnel. The Company's failure to overcome these
manufacturing problems could materially adversely affect the Company's business,
financial condition and results of operations. The Company uses internal
manufacturing capacity in its manufacturing efforts. Most of the Company's
purchased components and processes are available from more than one vendor.
However, certain components and processes are currently available from or
performed by a single vendor. Any supply interruption from a single source
vendor would have a material adverse effect on the Company's ability to
manufacture its products until a new source of supply was qualified and, as a
result, could have a material adverse effect on the Company's business,
financial condition and results of operations. Further, the ability of third
party manufacturing sources to deliver components will affect the Company's
ability to commercialize its products, and the Company's dependence on third
party sources may adversely affect the Company's profit margins. Additionally,
the Company's success will depend in part upon its ability to manufacture its
products in compliance with the FDA's Good Manufacturing Practices ("GMP")
regulations and other regulatory requirements, in sufficient quantities and on a
timely basis, while maintaining product quality and


                                       11
<PAGE>   12
acceptable manufacturing costs. Failure to increase production volumes in a
timely or cost effective manner or to maintain compliance with GMP or other
regulatory requirements could have a material adverse effect on the Company's
business, financial condition and results of operations.

   Dependence Upon Key Personnel: The Company's future success depends to a
significant degree upon the continued service of key technical and senior
management personnel, including Paul W. Mikus, the President of the Company,
none of whom is bound by an employment agreement or covered by an insurance
policy of which the Company is the beneficiary. The Company's future success
also depends on its continuing ability to attract, retain and motivate highly
qualified technical, managerial and sales personnel. The inability to retain or
attract qualified personnel could have a material adverse effect upon the
Company's business, financial condition and results of operations.

   Government Regulation: Governmental regulations in the United States and
other countries are a significant factor affecting the research and development,
manufacture and marketing of the Company's products. In the United States, the
FDA has broad authority under the Federal Food, Drug and Cosmetic Act and the
Public Health Service Act to regulate the distribution, manufacture and sale of
medical devices. Foreign sales of drugs and medical devices are subject to
foreign governmental regulation and restrictions which vary from country to
country. The process of obtaining FDA and other required regulatory approvals is
lengthy and expensive. There can be no assurance that the Company will be able
to obtain necessary approvals for clinical testing or for manufacturing or
marketing of its products. Failure to comply with applicable regulatory
approvals can, among other things, result in fines, suspension of regulatory
approvals, product recalls, operating restrictions and criminal prosecution. In
addition, governmental regulation may be established which could prevent, delay,
modify or rescind regulatory approval of the Company's products. There can be no
assurance that any such position by the FDA, or change of position by the FDA,
would not adversely impact the Company's business, financial condition or
results of operations. Regulatory approvals, if granted, may include significant
limitations on the indicated uses for which the Company's products may be
marketed. In addition, to obtain such approvals, the FDA and foreign regulatory
authorities may impose numerous other requirements on the Company. FDA
enforcement policy strictly prohibits the marketing of approved medical devices
for unapproved uses. In addition, product approvals can be withdrawn for failure
to comply with regulatory standards or the occurrence of unforeseen problems
following initial marketing. There can be no assurance that the Company will be
able to obtain regulatory approvals for its products on a timely basis or at
all, and delays in receipt of or failure to receive such approvals, the loss of
previously obtained approvals, or failure to comply with existing or future
regulatory requirements would have a material adverse effect on the Company's
business, financial condition and results of operations.

   Uncertainty Relating to Third Party Reimbursement: In the United States,
health care providers, such as hospitals and physicians, that purchase medical
devices such as the Company's products, generally rely on third party payers,
principally Federal Medicare, state Medicaid and private health insurance plans,
to reimburse all or part of the cost of medical procedures involving the
Company's products. In February 1999, HCFA announced its decision to implement
national Medicare coverage for cryosurgical ablation of the prostate, one of the
approved uses of the Company's eight probe CRYOcare System; however,
reimbursement codes and corresponding rates are in the process of being
established. Without adequate reimbursement, market acceptance and use of the
product will be limited and may adversely affect the Company's revenues from
sales of the product. There can be no assurance that the cost of medical
procedures involving the Company's products will be adequately reimbursed by
Medicare or other governmental, insurance or third party payers. In addition,
the Company anticipates that in a prospective payment system, such as the DRG
system utilized by Medicare, and in many managed care systems used by private
health care payers, the cost of the Company's products will be incorporated into
the overall cost of the procedure and that there will be no separate, additional
reimbursement for the Company's products. Separate reimbursement for the
Company's products is not expected to be available in the United States and
there can be no assurance that reimbursement for the Company's products will be
available in international markets under either governmental or private
reimbursement systems. Furthermore, the Company could be adversely affected by
changes in reimbursement policies of governmental or private health care payers,
particularly to the extent any such changes affect reimbursement for procedures
in which the Company's products are used. Failure by physicians, hospitals and
other users of the Company's products to obtain sufficient reimbursement from
health care payers for procedures involving the Company's products, or adverse
changes in governmental and private third party payers' policies toward
reimbursement for such procedures, could have a material adverse effect on the
Company's business, financial condition and results of operations.

   Risks Related to Acquisitions: As part of its strategy to develop and market
its products, the Company may acquire a business or businesses that the Company
believes might enhance and speed up the development of its products through
clinical trials, such as a surgical center or related company that would use the
Company's products in clinical applications. There is no assurance, however,
that the Company will be able to identify suitable acquisition candidates, or,
if it identifies such candidates, that it would be able to consummate the
acquisition of such candidates. Furthermore, there is no assurance that if the
Company acquires a suitable acquisition candidate, the Company will be able to
effectively integrate the operations of the company acquired into the operations
of the

                                       12

<PAGE>   13

Company, or effectively utilize the company acquired to develop and market the
Company's products. The failure to integrate an acquired company into the
operations of the Company may cause a drain on the financial and managerial
resources of the Company, and thereby materially adversely effect the financial
results of operations of the Company.

   Product Liability and Recall Risks: The manufacture and sale of medical
products entails significant risk of product liability claims or product
recalls. There can be no assurance that the Company's existing insurance
coverage limits are adequate to protect the Company from any liabilities it
might incur in connection with the clinical trials or sales of its products. In
addition, the Company may require increased product liability coverage as its
products are commercialized. Such insurance is expensive and in the future may
not be available on acceptable terms, if at all. A successful product liability
claim or series of claims brought against the Company in excess of its insurance
coverage, or a recall of the Company's products, could have a material adverse
effect on the Company's business, financial condition and results of operations.

   Uncertainty Related to Health Care Reform: Political, economic and regulatory
influences are subjecting the health care industry in the United States to
fundamental change. The Company anticipates that Congress, state legislatures
and the private sector will continue to review and assess alternative health
care delivery and payment systems. Potential approaches that have been
considered include mandated basic health care benefits, controls on health care
spending through limitations on the growth of private purchasing groups, price
controls and other fundamental changes to the health care delivery system.
Legislative debate is expected to continue in the future, and market forces are
expected to demand reduced costs. The Company cannot predict what impact the
adoption of any Federal or state health care reform measures, future private
sector reform or market forces may have on its business.

   Dependence on Patent and Proprietary Rights: The Company's success will
depend in part on its ability to secure and protect intellectual property rights
relating to its technology. While the Company believes that the protection of
patents or licenses is important to its business, it also relies on trade
secrets, know-how and continuing technological innovation to maintain its
competitive position. No assurance can be given that the Company's patent
applications will be approved, that the Company will develop any additional
proprietary products that are patentable and/or that any issued patents will
provide the Company with a competitive edge or will not be challenged by any
third parties. No assurance can be given that the Company's processes or
products will not infringe patents or proprietary rights of others or that any
license required would be made available under any such patents or proprietary
rights, on terms acceptable to the Company or at all. From time to time, the
Company has received correspondence alleging infringement of proprietary rights
of third parties. No assurance can be given that any relevant claims of third
parties would not be upheld as valid and enforceable, and therefore that the
Company could be prevented from practicing the subject matter claimed or would
be required to obtain licenses from the owners of any such proprietary rights to
avoid infringement. The Company seeks to preserve the confidentiality of its
technology by entering into confidentiality agreements with its employees,
consultants, customers, and key vendors and by other means. No assurance can be
given, however, that these measures will prevent the unauthorized disclosure or
use of such technology.

   Limited Market for Common Stock: The Company Common Stock began trading on
the Nasdaq SmallCap Market on February 28, 1997. Between February 20, 1996 and
February 28, 1997, the Common Stock traded on the Nasdaq electronic bulletin
board. As a result, the Common Stock has a limited trading history. If the
Company is unable to maintain the standards for quotation on the Nasdaq Small
Cap Market, the ability of investors to resell their shares after registration
with the Securities and Exchange Commission may be limited. In addition, the
Company's securities may be subjected to so-called "penny stock" rules that
impose additional sales practice and market making requirements on
broker-dealers who sell and/or make a market in such securities. This could
affect the ability or willingness of broker-dealers to sell and/or make a market
in the Company's securities and the ability of holders of the Company's
securities to sell their securities in the secondary market. There can be no
assurance regarding the price at which the Company Common Stock will trade. The
market prices for securities of emerging companies have historically been highly
volatile. Future announcements concerning the Company or its competitors,
including the Company's operating results, technological innovations or new
commercial products, corporate collaborations, government regulations,
developments concerning proprietary rights, litigation or public concern as to
safety of the Company's products, as well as investor perception of the Company
and industry and general economic and market conditions, may have a significant
impact on the market price of the Company's Common Stock. In addition, the stock
market is subject to price and volume fluctuations that affect the market prices
for companies in general and small capitalization, high technology companies in
particular, and are often unrelated to their operating performance.

   Shares Eligible for Future Sale; Dilution: Future sales of Common Stock
(including shares issued upon the exercise of outstanding options and warrants)
could materially adversely affect the market price of the Common Stock. Such
sales also might make it more difficult for the Company to sell equity
securities or equity-related securities in the future at a time and price that
the Company would deem appropriate. As of March 18, 1999, the Company had
10,477,290 shares of Common Stock outstanding, all of which may be freely traded
(unless held by an affiliate of the Company). In addition, as of March 18, 1999
warrants to purchase 392,497 shares of



                                       13



<PAGE>   14

Common Stock were outstanding. Also, as of March 18, 1999, stock options to
purchase 3,105,416 shares of Common Stock had been granted under the Company's
stock option plans, subject to various vesting schedules. Stock options to
purchase an additional 233,520 shares of Common Stock may be issued by the
Company from time to time under such option plans and up to 250,000 shares of
Common Stock may be purchased under the Company's Employee Stock Purchase Plan.
An aggregate of 3,000,000 shares of Common Stock may be issued under the
Company's 1995 Stock Plan subject to an automatic annual increase, beginning
with the 1999 calendar year, of 3% of the total number of shares outstanding on
the last trading day of the immediately preceding calendar year, up to a maximum
increase of 500,000 shares per year. Additionally, 300,000 shares of Common
Stock may be issued under the Company's 1995 Director Option Plan and up to
250,000 shares of Common Stock may be issued under the Company's Employee Stock
Purchase Plan. Exercise of these options or warrants may result in substantial
dilution to investors. The Company has also granted certain shareholders and
warrantholders piggyback registration rights with respect to 357,497 shares of
Common Stock to enable them to freely trade such stock in certain circumstances.

   Anti-Takeover Effect of Certain Provision: Possible Negative Effect on Stock
Price: Certain provisions of the Company's Certificate of Incorporation and the
Bylaws may have the effect of making it more difficult for a third party to
acquire, or of discouraging a third party from attempting to acquire, control of
the Company. In March 1999, the Company's Board of Directors adopted a
Stockholder Rights Plan in which preferred stock purchase rights will be
distributed as a dividend. The rights are designed to guard against partial
tender offers and other abusive and coercive tactics that may be used in an
attempt to gain control of the Company. Such provisions could limit the price
that certain investors might be willing to pay in the future for shares of the
Company's Common Stock. These provisions may make it more difficult for
shareholders to take certain corporate actions and may have the effect of
delaying or preventing a change in control of the Company.

   Year 2000: Many existing computer systems and applications, and other control
devices, use only two digits to identify a year in the date field, without
considering the impact of the upcoming change in the century. As a result, such
systems and applications could fail or create erroneous results unless corrected
so that they can process data related to the year 2000 and beyond. The Company
relies on its systems, applications and devices in operating and monitoring all
major aspects of its business, including financial systems (such as general
ledger, accounts receivable, accounts payable and payroll modules), customer
services, infrastructure, networks and telecommunications equipment, and end
products. The Company has initially assessed how it may be impacted by the Year
2000 and has commenced a plan to address the following aspects of the Year 2000
problem: information systems, non-information systems, products, suppliers and
customers. The plan as it relates to information systems, involves a combination
of upgrades and replacement. The Company has begun remediation of its critical
information systems, and the target date for remediation of the critical
information systems and remainder of its information systems is March 31, 1999.
The Company has completed the assessment and development of remediation plans
with respect to substantially all of the Company's non-information systems and
expects remediation to be complete by June 30, 1999. The Company has completed
an assessment of its products and has determined its products do not contain
specific calendar year functions. However, there can be no assurance that
unforeseen problems will not be encountered when the Company's products are used
in conjunction with equipment which is non-Year 2000 compliant. The Company is
currently assessing Year 2000 issues with respect to major suppliers and
customers and expects this process to be completed by June 30, 1999; however,
the Company can provide no assurance that Year 2000 compliance plans will be
successfully completed by suppliers and customers in a timely manner. If the
Company is not successful in implementing its Year 2000 compliance plan, there
may be a material adverse impact on the Company's results of operations and
financial condition. 

ITEM 2.   PROPERTIES

   The Company currently occupies approximately 16,000 square feet of office,
manufacturing, engineering, warehouse, and research and development laboratories
in Irvine, California. The property is leased through February, 2002. The
Company had subleased its previously occupied facility and the original lease
and sublease expired in August, 1998.

ITEM 3.   LEGAL PROCEEDINGS

   On November 27, 1996, Cryomedical Sciences, Inc., ("CMS") filed a complaint
in the Circuit Court for Montgomery County, Maryland against the Company and Dr.
ZhaoHua Chang, a former employee of CMS whom the Company retained as a
consultant, and, subsequently, as Vice President of Research and Development.
The suit alleged that, by entering into his consulting and employment
relationship with the Company, Dr. Chang breached his employment contract with
CMS (which included a post-termination non-solicitation/non-competition clause),
violated the Maryland Uniform Trade Secrets Act ("MUTSA"), engaged in unfair
competition, conspired with the Company to injure CMS and committed a breach of
fiduciary duty under Maryland law. CMS further alleged that, by hiring Dr.
Chang, the Company tortiously interfered with the employment contract and CMS's
prospective business relations, violated the MUTSA, engaged in unfair
competition, and conspired with Dr. Chang to injure CMS. CMS sought injunctive
relief, compensatory damages of $10,000,000 and punitive damages of $20,000,000
jointly and severally against the Company and Dr. Chang. On March 26, 1999 the
lawsuit was dismissed by stipulation of the parties and order of the court.

   From time to time, the Company has received correspondence alleging
infringement of proprietary rights of third parties. No assurance can be given
that any relevant claims of third parties would not be upheld as valid and
enforceable, and therefore that the Company could be prevented from practicing
the subject matter claimed or would be required to obtain licenses from the
owners of any such proprietary rights to avoid infringement. Management does not
expect any material adverse effect on financial condition or the results of
operations because of such actions.

   The Company, in the normal course of business, is subject to various other
legal matters. While the results of litigation and claims cannot be predicted
with certainty, the Company believes that the final outcome of these other
matters will not have a material adverse effect on the Company's results of
operations or financial condition.

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

   No matters were submitted to a vote of security holders of the Company during
the fourth quarter of 1999, as required to be disclosed in this item.




                                       14


<PAGE>   15

                                     PART II

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

   Endocare's common stock began trading on the NASDAQ SmallCap Market on
February 28, 1997 and between February 20, 1996 and February 27, 1997, trading
was conducted in the over-the-counter market on the NASDAQ Electronic Bulletin
Board under the symbol "ENDO." The following table sets forth the high and low
bid prices for Endocare's common stock during the periods indicated as quoted on
the NASDAQ SmallCap Market or NASDAQ Electronic Bulletin Board. Figures reflect 
inter-dealer prices, without mark-ups, mark-down or commission, and may not 
necessarily represent actual transactions:

<TABLE>
<CAPTION>

                                        FISCAL YEAR ENDED DECEMBER 31,
                                        ------------------------------
                                1996                 1997              1998
                           ---------------     ---------------    ----------------
                            HIGH       LOW      HIGH       LOW      HIGH      LOW
                           -----     -----     -----     -----    -----      -----
 <S>                       <C>       <C>       <C>       <C>      <C>        <C>
 Fourth quarter            $6.38     $3.38     $3.63     $3.50    $3.25      $1.63


 Third quarter              5.00      2.25      3.88      3.69    $3.63      $1.81

 Second quarter             5.88      1.88      3.88      3.69    $4.13      $2.75

 First quarter
 (from February 20, 1996)   3.00      0.38      4.63      3.94    $3.94      $2.75
</TABLE>


   Endocare's common stock first traded publicly on February 20, 1996, at a
price of $0.375 per share. As of March 18, 1999, the closing price of the
Company's common stock was $4.625. Also, as of that date, Endocare had
approximately 370 shareholders of record. On March 18, 1999, there were
10,477,290 shares of Endocare common stock issued and outstanding.

   In March 1999, the Company's Board of Directors adopted a Stockholder Rights
Plan ("Plan") in which preferred stock purchase rights will be distributed as a
dividend at the rate of one Right for each share of Common Stock held as of the
close of business on April 15, 1999. The Rights are designed to guard against
partial tender offers and other abusive and coercive tactics that might be used
in an attempt to gain control of the Company or to deprive Stockholders of their
interest in the long-term value of the Company. The Rights will be exerciseable
only if a person or group acquires 15% or more of the Company's Common Stock
(subject to certain exceptions stated in the Plan) or announces a tender offer
the consummation of which would result in ownership by a person or group of 15%
or more of the Company's Common Stock. Each Right will entitle stockholders to
buy one one-thousandth of a share of new series of junior participating
preferred stock at an exercise price of $25 upon certain events. If a person or
group acquires 15% or more of the Company's outstanding Common Stock (subject to
certain exceptions stated in the Plan), or a holder of 15% or more of the
Company's Common Stock engages in certain self-dealing transactions or a merger
transaction in which the Company is the surviving corporation and its Common
Stock remains outstanding, then each Right not owned by such person or certain
related parties will entitle its holder to purchase, at the Right's then-current
exercise price, units of the Company's Series A Preferred Stock (or, in certain
circumstances, Company Common Stock, cash, property or other securities of the
Company) having a market value equal to twice the then-current exercise price.
In addition, if, after the Rights become exerciseable, Endocare is acquired in a
merger or other business combination transaction, or sells 50% or more of its
assets or earnings power, each Right will entitle its holder to purchase, at the
Right's then-current price, a number of the acquiring company's common shares
having a market value at the time of twice the Right's exercise price. At any
time on or prior to the close of business on the first date of a public
announcement that a person or group has acquired beneficial ownership of 15% or
more of the Company's Common Stock (subject to certain exceptions stated in the
Plan), the Rights are redeemable for one cent per Right at the option of the
Board of Directors. The Rights are intended to enable all stockholders to
realize the long-term value of their investment in the Company. The Rights will
not prevent a takeover attempt, but should encourage anyone seeking to acquire
the Company to negotiate with the Board prior to attempting to a takeover. The
dividend distribution will be made on April 15, 1999 payable to stockholders of
record on that date. The Rights will expire on April 15, 2009.

   Endocare has not paid any cash dividends on its common stock and does not
intend to pay any cash dividends in the foreseeable future.




                                       15

<PAGE>   16

ITEM 6.   SELECTED FINANCIAL DATA

   The following table presents selected financial data of Endocare for the
years ended December 31, 1996, 1997 and 1998 and for its predecessor, Endocare
Division of Medstone, for previous years. Prior to 1996, Endocare was not an
independent company with publicly traded shares. Hence, no earnings per share
data is presented for those years.

<TABLE>
<CAPTION>
                                                             YEARS ENDED DECEMBER 31,
                                       ----------------------------------------------------------------
                                        1994         1995         1996          1997           1998
                                       ------    ------------------------------------------------------
                                                (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                    <C>       <C>          <C>           <C>            <C>
Statement of Operations Data:
Revenues:
  Net product sales ...........        $2,283       $  951    $     1,878    $     1,918    $     1,476
  Revenue from collaborative
    agreements ................            --           --            250             83            642
  Research revenue from related
    party .....................           379          377              1             --             --
                                       ------       ------    -----------    -----------    -----------
    Total revenues ............         2,662        1,328          2,129          2,001          2,118
Costs and expenses:
  Cost of product sales .......           638          380            994          1,271          1,049
  Research and development ....           911          852          1,023          1,596          1,920
  Selling, general and
    administrative ............         1,376          673          1,285          3,233          4,323
  Impairment loss on long-lived              
    assets ....................            --           --            325             --             --
                                       ------       ------    -----------    -----------    -----------
    Total costs and expenses ..         2,925        1,905          3,627          6,100          7,292
                                       ------       ------    -----------    -----------    -----------
Loss from operations ..........          (263)        (577)        (1,498)        (4,099)        (5,174)
Other income (expense), net ...            --           --            (33)           199            337
                                       ------       ------    -----------    -----------    -----------
Net loss ......................        $ (263)      $ (577)   $    (1,531)   $    (3,900)   $    (4,837)
                                       ======       ======    ===========    ===========    ===========
Net loss per share ............                               $      (.27)   $      (.48)   $      (.49)
                                                              ===========    ===========    ===========
Weighted average shares
    outstanding ...............                                 5,635,000      8,047,000      9,802,000
                                                              ===========    ===========    ===========
</TABLE>

<TABLE>
<CAPTION>

                                                            BALANCES AT DECEMBER 31,
                                            ---------------------------------------------------
                                            1994        1995       1996        1997        1998
                                            ----        ----       ----        ----        ----
                                                              (IN THOUSANDS)
     <S>                                    <C>         <C>       <C>        <C>         <C>
     Balance Sheet Data:
     -------------------
     Working capital.................       $295        $328      $  519      $3,735      $5,422
     Total assets....................        972         806       1,751       5,543       7,797
     Long-term debt..................         --          --         750          --          --
     Total shareholders'/division
       equity (deficiency)...........        864         803        (149)      3,933       6,049
</TABLE>



ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS

GENERAL

   Endocare designs, manufactures, and markets an array of innovative,
temperature-based surgical devices and technologies to treat prostate diseases,
including prostate cancer and prostate enlargement. Endocare began marketing
disposable surgical devices in 1993 with the introduction of the Prolase laser
catheter. In late 1995, Endocare began marketing two new disposable product
families, the Uroloop and Vaporbar electrosurgical cutting elements. In May
1996, the Company introduced its new CRYOcare cryosurgical system for the
treatment of prostate cancer.

   Endocare currently is developing additional, innovative therapies for
prostate enlargement. The Company does not expect to be profitable in the near
future because of increased operating expenses associated with product launches
and from expanded research and development efforts and support of clinical
trials for products currently under development.

   Since its formation in 1990, Endocare operated first as a research and
development department, then later as a division of Medstone International, Inc.
In this form, Endocare shared facilities and certain personnel with its parent.
Effective January 1, 1996, Endocare began operating as an independent
corporation.




                                       16




<PAGE>   17

RESULTS OF OPERATIONS

   The following table sets forth, for the periods indicated, certain financial
   data as a percentage of total revenues.

<TABLE>
<CAPTION>
                                                                  YEARS ENDED DECEMBER 31,
                                                                  ------------------------
                                                                   1996     1997     1998
                                                                   ----     ----     ----
<S>                                                                <C>      <C>      <C>
Revenues:
  Net product sales ............................................     88%      96%      70%
  Revenue from collaborative agreements ........................     12        4       30
  Research revenue from related party ..........................     --       --       --
                                                                   ----     ----     ----
    Total revenues .............................................    100%     100%     100%

Costs and expenses:
  Cost of product sales ........................................     47       64       50
  Research and development .....................................     48       80       91
  Selling, general and administrative ..........................     60      162      204
  Impairment loss on long-lived assets .........................     15       --       --
                                                                   ----     ----     ----
    Total costs and expenses ...................................    170      306      344
                                                                   ----     ----     ----
 Loss from operations ..........................................    (70)    (205)    (244)
 Net loss ......................................................    (72)%   (195)%   (228)%
                                                                   ====     ====     ====
</TABLE>


   Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

   Revenue from product sales for the year ended December 31, 1998 decreased to
$1,476,000 compared to $1,918,000 for the year ended December 31, 1997. The
decline in product sales is due primarily to reduced purchases of CRYOcare
surgical systems for urological applications by Boston Scientific Corporation
("BSC") in exchange for higher licensing payments as discussed below. The
majority of product sales in 1998 resulted from direct sales by the Company.

   Revenue from collaborative agreements was $642,000 for the year ended
December 31, 1998 compared to $83,000 for the year ended December 31, 1997. The
increase in 1998 revenue from collaborative agreements reflects $475,000 in
non-refundable BSC licensing payments as discussed above and recognition of the
remaining deferred revenue associated with a BSC milestone payment upon
fulfilling corresponding obligations. The 1997 revenue from collaborative
agreements represents one year's amortization of the lump-sum milestone payment
from BSC to Endocare associated with a distribution agreement giving BSC
exclusive worldwide marketing rights for the CRYOcare system in urological
applications. The distribution agreement with BSC was terminated by Endocare in
March 1999.

   Gross margins on product sales were 29% in 1998 compared to 34% in 1997. This
difference was caused by a change in Endocare's revenue mix along with
additional infrastructure and personnel costs associated with the Company's
manufacturing facility.

   Research and development expense increased 20% to $1,920,000 in 1998 from
$1,596,000 in 1997. The increase resulted primarily from additional personnel
and costs to support the further development of the CRYOcare systems, including
one and four probe platforms, development of the Horizon Stent(TM) and other new
products.

   Selling, general and administrative expense increased 34% to $4,323,000 in
1998 from $3,233,000 in 1997. This increase reflects the increased sales and
marketing effort associated with the Company's CRYOcare products, in addition to
the increases in personnel and operating costs as the Company continues to build
its infrastructure to support its product lines.

   Other income, net of expenses, was $337,000 in 1998 and $199,000 in 1997. The
increase in 1998 was due to increased interest income on a higher balance of
cash and cash equivalents.

   Endocare's net loss increased to $4,837,000 in 1998 from $3,900,000 in 1997.
This increase was primarily due to lower gross margins and the increase in
research and development costs and selling, general and administrative expenses
described above.

   Year Ended December 31, 1997 Compared to Year Ended December 31, 1996

   Revenue from product sales for the year ended December 31, 1997 increased
slightly to $1,918,000 compared to $1,878,000 for the year ended December 31,
1996. In 1997 product sales consisted almost entirely of CRYOcare surgical
systems while the volumes of surgical disposables declined considerably during
the year.



                                       17



<PAGE>   18

   Revenue from collaborative agreements was $83,000 for the year ended December
31, 1997 compared to $250,000 for the year ended December 31, 1996. The 1997
amount represents one year's amortization of a lump-sum milestone payment from
BSC to Endocare associated with the distribution agreement entered in to in
1996. The $250,000 in 1996 was a non-refundable, lump-sum payment from BSC to
Endocare upon signing of the original distribution agreement.

   Gross margins on product sales were 34% in 1997 compared to 47% in 1996. This
difference was caused by a change in Endocare's product revenue mix along with
additional infrastructure and personnel costs associated with the Company's new
manufacturing facility. In 1996 Endocare's revenue product mix consisted of more
higher margin surgical disposables along with the mid-year introduction of
CRYOcare systems, including early units shipped with lower, introductory prices.
The majority of the CRYOcare systems revenue in 1997 consisted of units also
shipped with lower introductory prices, primarily to BSC.

   Research and development expense increased 56% to $1,596,000 in 1997 from
$1,023,000 in 1996. The increase resulted primarily from additional personnel
and costs to support the further development of the CRYOcare systems, including
one and four probe platforms, and development of other new products.

   Selling, general and administrative expense increased 151% to $3,233,000 in
1997 from $1,285,000 in 1996. This increase reflects the increased sales and
marketing effort associated with the Company's CRYOcare products and
relationship with BSC, in addition to the increases in personnel and operating
costs as the Company continued to build its infrastructure to support its
product lines.

   Other income (expense), net, was $199,000 in 1997 and ($33,000) in 1996. The
increase in 1997 was due to increased interest income on a higher balance of
cash and cash equivalents. The 1996 balance reflects interest expense on a
convertible note payable.

   Endocare's net loss increased to $3,900,000 in 1997 from $1,531,000 in 1996.
This increase was primarily due to lower gross margins and the increase in
research and development costs and selling, general and administrative expenses
described above.

LIQUIDITY AND CAPITAL RESOURCES

   At December 31, 1998, Endocare's cash balance was $6,289,000, compared to
$3,896,000 at December 31, 1997. This cash increase was provided primarily by
the 1998 financing transaction discussed below offset by cash used in operating
activities.

   Working capital has been used as Endocare's operations have increased in
1998. Although revenue levels remained relatively consistent, net accounts
receivable decreased to $269,000 at December 31, 1998, compared to $376,000 at
December 31, 1997. The decrease resulted primarily from accelerated customer
payments associated with fourth quarter 1998 sales. Inventory decreased to
$543,000 at December 31, 1998, compared to $926,000 at the beginning of the
year. Fixed asset additions during 1998 were approximately $224,000. Working
capital was provided as accounts payable and other current liabilities grew to
approximately $1,748,000 compared to $1,527,000 at December 31, 1997 due to an
increase in operating activities.

   At December 31, 1998, Endocare's net working capital was $5,422,000, and the
ratio of current assets to current liabilities was 4.1 to 1.

   In April 1998, Endocare sold 2 million shares of common stock at a price of
$3.50 per share in a private placement. After deducting expenses of the sale,
this offering added approximately $6.9 million cash to Endocare's capital base.

   As described in Note 14 to the financial statements, the Company has a
$1,000,000 bank line of credit which is available for working capital purposes.
The line of credit is secured by the Company's assets, excluding intellectual
property, and is subject to certain financial and other covenants. The line of
credit expires April 30, 1999 and, prior to that time, the Company anticipates
either renewing the existing line of credit or entering into a new debt facility
with another bank. There is no assurance the Company will be able to obtain 
another debt facility on favorable terms, or at all.

   The Company believes that its existing cash resources and anticipated cash
flow from future operations will provide sufficient resources to meet present
and reasonably foreseeable working capital requirements and other cash needs
through the end of 1999. If the Company elects to undertake or accelerate
significant research and development projects for new products or pursue
corporate acquisitions, it may require additional outside financing prior to
such time. The Company expects that to meet its long-term needs it will need to
raise substantial additional funds through the sale of its equity securities,
the incurrence of indebtedness or through funds derived through entering into
collaborative arrangements with third parties.




                                       18



<PAGE>   19

   This document contains forward looking statements. The Company's business and
results of operations are subject to risk and uncertainties including, but not
limited to, those discussed under the caption "Factors That May Effect Future
Results and Trading Price of Common Stock" included elsewhere in this report,
and in risk factors contained in other periodic reports filed with the
Securities and Exchange Commission. Such risk factors include, but are not
limited to, limited operating history of the Company with a history of losses;
fluctuations in the Company's order levels; uncertainty regarding market
acceptance of the Company's new products; uncertainty of product development and
the associated risks related to clinical trials; the rapid pace of technological
change in the Company's industry; the Company's limited sales, marketing and
manufacturing experience; uncertainty regarding the impact Year 2000 system
failures may have if experienced by the Company, its suppliers and customers;
the ability to convince health care professionals and third party payers of the
medical and economic benefits of the Company's CRYOcare System, and uncertainty
as to whether payers will reimburse health care providers who perform prostate
cancer cryosurgical procedures or that reimbursement, if provided, will be
adequate. The actual results that the Company achieves may differ materially
from any forward looking statements due to such risks and uncertainties.

OTHER MATTERS

   ACCOUNTING PRINCIPLES

   The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" (SFAS 130), and Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information" (SFAS 131), in 1998. Implementation of both standards
required minimal financial statement disclosure and did not have a material
effect on the Company's financial position or results of operations. SFAS 130
establishes standards for the reporting and display of comprehensive income.
Components of comprehensive income include items such as net earnings, foreign
currency translation adjustments and changes in value of available-for-sale
securities. SFAS 131 changes the way companies report segment information and
requires segments to be determined and reported based on how management measures
performance and makes decisions about allocating resources.

   YEAR 2000

   Many existing computer systems and applications, and other control devices,
use only two digits to identify a year in the date field, without considering
the impact of the upcoming change in the century. As a result, such systems and
applications could fail or create erroneous results unless corrected so that
they can process data related to the year 2000 and beyond. The Company relies on
its systems, applications and devices in operating and monitoring all major
aspects of its business, including financial systems (such as general ledger,
accounts receivable, accounts payable and payroll modules), customer services,
infrastructure, networks and telecommunications equipment, and end products. The
Company has initially assessed how it may be impacted by the Year 2000 and has
commenced a plan to address the following aspects of the Year 2000 problem:
information systems, non-information systems, products, suppliers and customers.

   The plan as it relates to information systems, involves a combination of
upgrades and replacement. The Company has begun remediation of its critical
information systems, and the target date for remediation of the critical
information systems and remainder of its information systems is March 31, 1999.
The Company has completed the assessment and development of remediation plans
with respect to substantially all of the Company's non-information systems and
expects remediation to be complete by June 30, 1999. The Company has completed
an assessment of its products and has determined its products do not contain
specific calendar year functions. However, there can be no assurance that
unforeseen problems will not be encountered when the Company's products are used
in conjunction with equipment which is non-Year 2000 compliant. The Company is
currently assessing Year 2000 issues with respect to major suppliers and
customers and expects this process to be completed by June 30, 1999; however,
the Company can provide no assurance that Year 2000 compliance plans will be
successfully completed by suppliers and customers in a timely manner.

   The Company currently estimates that the costs associated with the Year 2000
issues will not have a material effect on the results of operations or financial
position of the Company in any given year. Historical amounts spent on
assessment and remediation have not been material to the results of operations.

   If the Company is not successful in implementing its Year 2000 compliance
plan, there may be a material adverse impact on the Company's results of
operations and financial condition. The Company believes its greatest risks
related to the Year 2000 issue involve interrupted product flow from suppliers
and a possible redirection or interruption of purchasing activities from key
customers due to their potential failure to fully address their own Year 2000
issues. Due to the importance of addressing these risks, and the need for the
Company to focus attention to remediation efforts, the Company expects to
develop contingency plans to address those Year


                                       19




<PAGE>   20

2000 problems which may not be corrected by implementation of the Company's Year
2000 compliance plan. Contingency plans are expected to be complete by June 30,
1999.

   OTHER

   The Company is not aware of any issues related to environmental concerns that
have or are expected to materially effect its business.


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   Not applicable.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

   See Item 14, "Exhibits, Financial Statement Schedules, and Reports on Form
8-K."

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

   Not applicable.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT *

ITEM 11. EXECUTIVE COMPENSATION *

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT *

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS *

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


   *The information called for by items 10, 11, 12 and 13 is omitted from this
Report and is incorporated by reference to the definitive Proxy Statement to be
filed by the Company no later than 120 days after December 31, 1998, the close
of its fiscal year.




                                     PART IV

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

(a) DOCUMENTS FILED AS A PART OF THIS REPORT

(1) Index to Financial Statements

        Independent Auditors' Reports

        Statements of Operations for the years ended
        December 31, 1996, 1997 and 1998

        Balance Sheets at December 31, 1997 and 1998

        Statements of Shareholders' Equity (Deficiency)
        for the years ended December 31, 1996, 1997 and 1998



                                       20



<PAGE>   21

        Statements of Cash Flows for the years ended
        December 31, 1996, 1997 and  1998

        Notes to Financial Statements

(2) Financial Statement Schedules
        Schedule II--Valuation and Qualifying Accounts

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



(3) Exhibits

 2.1    Distribution Agreement between the Registrant and Medstone
        International, Inc., dated October 31, 1995(1)

 3.1    Certificate of Incorporation of the Company(2)

 3.2    Amended and Restated Bylaws of the Company(9)

 4.1    Specimen Certificate of the Company's Common Stock(3)

 10.1   Facility Lease on 18 Technology Drive(2)

 10.2   Contribution Agreement between Medstone International, Inc. and the
        Company, dated October 31, 1995(1)

 10.3   Research and Development Services Agreement between Medstone
        International, Inc. and the Company, dated October 31, 1995(1)

 10.4   Form of Indemnification Agreement(2)

 10.5   1995 Stock Plan(1)

 10.6   1995 Director Option Plan(1)

 10.7   Patent License Agreement between the Company and Brigham and Women's
        Hospital, Inc., dated April 17, 1996(4)

 10.8   Form of Convertible Secured Promissory Note due August 26, 1998, issued
        by Endocare, Inc. in an aggregate principal amount of $1,500,000, dated
        August 26, 1996(5)

 10.9   Form of Warrant to purchase an aggregate of 150,000 shares of common
        stock, dated August 26, 1996(5)

 10.10  Distributorship Agreement between the Company and Boston Scientific
        Corporation, dated November 18, 1996(6)

 10.11  Common Stock Purchase Agreement by and among the Company and the persons
        listed on the Schedule of Investors attached thereto as Exhibit A, dated
        January 21, 1997(7)

 10.12  Facility Lease dated January 31, 1997 for 7 Studebaker(9)

 10.13  Sublease dated May 19, 1997 for 18 Technology Drive(9)

 10.14  Common Stock Purchase Agreements by and among the Company and the
        persons indicated therein, dated April 15 and April 22, 1998(10)

 23.1   Consent of KPMG LLP*



                                       21



<PAGE>   22

 27.1   Financial Data Schedule*

 29.1   Endocare, Inc. Information Statement distributed to shareholders of
        Medstone International, Inc., dated February 6, 1996(8)

----------

(1) Previously filed with the Company's Application for Registration on Form
    10-SB under the Securities Exchange Act of 1934, filed on November 14, 1995,
    and incorporated herein by reference. Each such exhibit had the same exhibit
    number in that filing, except that the 1995 Stock Plan was exhibit number
    10.6 and the 1995 Director Option Plan was exhibit 10.7.

(2) Previously filed with Amendment number 1 to Company's Application for
    Registration on Form 10-SB, filed on December 21, 1995, and incorporated
    herein by reference.

(3) Previously filed with the Company's Annual Report on Form 10-K for the year
    ended December 31, 1995, and incorporated herein by reference.

(4) Previously filed with the Company's Current Report on Form 8-K, as amended,
    dated April 25, 1996 as filed with the Securities and Exchange Commission on
    April 26, 1996, and incorporated herein by reference.

(5) Previously filed with the Company's Current Report on Form 8-K dated August
    26, 1996 as filed with the Securities and Exchange Commission on September
    10, 1996, and incorporated herein by reference.

(6) Previously filed with the Company's Current Report on Form 8-K dated
    November 18, 1996 as filed with the Securities and Exchange Commission on
    December 3, 1996, and incorporated herein by reference.

(7) Previously filed with the Company's Current Report on Form 8-K dated January
    27, 1997 as filed with the Securities and Exchange Commission on January 31,
    1997, and incorporated herein by reference.

(8) Previously filed on February 9, 1996 by Medstone International, Inc. under
    Section 14(c) of the Securities Exchange Act of 1934, and incorporated
    herein by reference.

(9) Previously filed with the Company's Annual Report on Form 10-K/A (Amendment
    No. 3) for the year ended December 31, 1996, and incorporated herein by
    reference.

(10) Previously filed with the Company's current report on Form 8-K dated April
     15, 1998 as filed with the Securities and Exchange Commission on April 23,
     1998, and incorporated herein by reference.

*   Filed herewith.

(b) REPORTS ON FORM 8-K

    None




                                       22



<PAGE>   23

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors
Endocare, Inc.:

We have audited the accompanying financial statements of Endocare, Inc. (the
Company) as listed in the accompanying index. In connection with our audits of
the financial statements, we also have audited the financial statement schedule
as listed in the accompanying index. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Endocare, Inc. as of December
31, 1997 and 1998, and the results of its operations and its cash flows for each
of the years in the three year period ended December 31, 1998, in conformity
with generally accepted accounting principles. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.

                                                  KPMG LLP

Orange County, California 
February 15, 1999, except 
  as to the second paragraph
  of Note 7, the fourth paragraph 
  of Note 8, and Note 15,
  which are as of
  March 10, 1999, March 26, 1999
  and March 5, 1999, respectively.




                                       23



<PAGE>   24

                                 ENDOCARE, INC.
                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>

                                                        FOR THE YEARS ENDED DECEMBER 31,
                                                    ---------------------------------------
                                                       1996          1997           1998
                                                    ----------    ----------     ----------
     <S>                                            <C>          <C>            <C>
     Revenues:
       Net product sales                           $ 1,877,678    $1,917,707     $1,476,112
       Revenue from collaborative agreements           250,000        83,328        641,672
       Research revenue from related party               1,600            --             --
                                                   -----------   -----------    -----------
         Total revenues                              2,129,278     2,001,035      2,117,784
                                                   -----------   -----------    -----------
     Costs and expenses:
       Cost of product sales                           994,374     1,270,838      1,049,308
       Research and development                      1,023,172     1,596,242      1,919,527
       Selling, general and administrative           1,285,295     3,232,782      4,322,888
       Impairment loss on long-lived assets            324,878            --             --
                                                   -----------   -----------    -----------
         Total costs and expenses                    3,627,719     6,099,862      7,291,723
                                                   -----------   -----------    -----------
     Loss from operations                           (1,498,441)   (4,098,827)    (5,173,939)
     Other income (expense), net                       (33,007)      198,967        336,593
                                                   -----------   -----------    -----------
     Net loss                                      $(1,531,448)  $(3,899,860)   $(4,837,346)
                                                   ===========   ===========    ===========
     Net loss per share of common stock -
       basic and diluted                           $      (.27)  $      (.48)   $      (.49)
                                                   ===========   ===========    ===========
     Weighted average shares of
       common stock outstanding                      5,635,000     8,047,000      9,802,000
                                                   ===========   ===========    ===========

</TABLE>



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



                                       24



<PAGE>   25

                                 ENDOCARE, INC.
                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                        DECEMBER 31
                                                                          --------------------------------------
                                                                              1997                       1998
                                                                          -----------                -----------
<S>                                                                      <C>                         <C>
                        ASSETS
                        ------
Current assets:
   Cash and cash equivalents                                              $ 3,896,316                $ 6,288,567
   Accounts receivable, less allowances of $192,000
       and $86,000 at December 31, 1997 and 1998,
       respectively                                                           376,141                    269,207
   Inventories                                                                925,592                    542,610
   Prepaid expenses and other current assets                                   64,237                     69,653
                                                                          -----------                -----------
       Total current assets                                                 5,262,286                  7,170,037
Property and equipment, net                                                   238,192                    321,956
Other assets                                                                   42,566                    305,206
                                                                          -----------                -----------
          Total assets                                                    $ 5,543,044                $ 7,797,199
                                                                          ===========                ===========

      LIABILITIES AND SHAREHOLDERS' EQUITY
      ------------------------------------

Current liabilities:
   Accounts payable                                                       $   745,771                $   632,948
   Accrued compensation                                                       266,756                    594,301
   Other accrued liabilities                                                  430,918                    521,204
   Deferred revenue                                                            83,333                         --
                                                                          -----------                -----------
       Total current liabilities                                            1,526,778                  1,748,453

Deferred revenue                                                               83,339                         --

Shareholders' equity:
   Preferred stock, $.001 par value; 1,000,000 shares
       authorized; none issued and outstanding                                     --                         --
   Common stock, $.001 par value; 20,000,000 shares
       authorized; 8,378,354 and 10,438,354 issued and
       outstanding at December 31, 1997 and 1998, respectively                  8,378                     10,438
   Additional paid-in capital                                               9,355,857                 16,306,962
   Accumulated deficit                                                     (5,431,308)               (10,268,654)
                                                                          -----------                -----------
       Total shareholders' equity                                           3,932,927                  6,048,746
                                                                          -----------                -----------
Commitments and contingencies
Subsequent events (Notes 7, 8 and 15)
       Total liabilities and shareholders' equity                         $ 5,543,044                $ 7,797,199
                                                                          ===========                ===========

</TABLE>




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




                                       25

<PAGE>   26

                                 ENDOCARE, INC.
             STATEMENT OF SHAREHOLDERS'/DIVISION EQUITY (DEFICIENCY)

<TABLE>
<CAPTION>
                                                                                                               TOTAL
                                                                                                            SHAREHOLDERS'/
                                         COMMON STOCK           ADDITIONAL    ADVANCES                        DIVISION
                                  ------------------------       PAID-IN        FROM         ACCUMULATED       EQUITY
                                  SHARES            AMOUNT       CAPITAL      MEDSTONE         DEFICIT      (DEFICIENCY)
                                  ------            ------      ----------    --------       -----------    --------------
<S>                               <C>              <C>         <C>          <C>             <C>             <C>

BALANCE AT DECEMBER 31, 1995             --       $     --   $         --   $  2,831,364    $ (2,028,231)   $    803,133

Common stock issued in
   Medstone Distribution          5,616,528          5,617      1,297,516     (2,831,364)      2,028,231         500,000
Other common stock issued            28,611             28         59,868             --              --          59,896
Equity provided by
   warrant amortization                  --             --         18,970             --              --          18,970
Net loss                                 --             --             --             --      (1,531,448)     (1,531,448)
                               ------------       --------   ------------   ------------    ------------    ------------
BALANCE AT DECEMBER 31, 1996      5,645,139          5,645      1,376,354             --      (1,531,448)       (149,449)

Common stock issued in
   private placement and
   and note conversion, net       2,550,714          2,551      7,868,600             --              --       7,871,151
Stock options exercised             182,501            182         32,668             --              --          32,850
Equity provided by
   warrant amortization                  --             --         78,235             --              --          78,235
Net loss                                 --             --             --             --      (3,899,860)     (3,899,860)
                               ------------       --------   ------------   ------------    ------------    ------------
BALANCE AT DECEMBER 31, 1997      8,378,354          8,378      9,355,857             --      (5,431,308)      3,932,927

Common stock issued in
   private placement, net         2,000,000          2,000      6,861,320             --              --       6,863,320
Stock options exercised              60,000             60         10,741             --                          10,801
Equity provided by
   warrant amortization                  --             --         79,044             --                          79,044
Net loss                                 --             --             --             --      (4,837,346)     (4,837,346)
                               ------------       --------   ------------   ------------    ------------    ------------
BALANCE AT DECEMBER 31, 1998     10,438,354         10,438     16,306,962             --    $(10,268,654)   $  6,048,746
                               ============       ========   ============   ============    ============    ============

</TABLE>




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



                                       26



<PAGE>   27


                                 ENDOCARE, INC.
                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                       FOR THE YEARS ENDED DECEMBER 31,
                                                  -----------------------------------------
                                                     1996            1997           1998
                                                  -----------    -----------    ------------
<S>                                               <C>            <C>            <C>
Cash flows from operating activities:
-------------------------------------
   Net loss                                       $(1,531,448)   $(3,899,860)   $(4,837,346)
   Adjustments to reconcile net loss to net
     cash used in operating activities:
       Depreciation and amortization                   38,325        142,286        139,739
       Amortization of warrant value                   18,970         78,235         79,044
       Common stock issued for services                59,896             --             --
   Impairment loss on long-lived assets               324,878             --             --
   Changes in operating assets and liabilities:
       Accounts receivable                           (485,529)       211,804        106,934
       Inventories                                   (177,427)      (528,867)       382,982
       Prepaid expenses and other current
          assets                                      (34,063)       (22,839)        (5,416)
       Other assets                                   (53,284)        26,625        (91,227)
       Accounts payable                               668,761         77,010       (112,823)
       Accrued compensation                            53,190        213,566        327,545
       Other accrued liabilities                      143,399        287,519         90,286
       Deferred revenue                               283,372       (118,328)      (166,672)
       Customer deposits                                 (932)            --             --
                                                  -----------    -----------    -----------
Net cash used in operating activities                (691,892)    (3,532,849)    (4,086,954)
                                                  -----------    -----------    -----------
Cash flows from investing activities:
-------------------------------------
   Purchases of property and equipment               (110,569)      (201,690)      (223,504)
   Proceeds from sale of property and
     equipment                                         27,374             --             --
   Advances to AMP                                         --             --       (171,412)
                                                  -----------    -----------    -----------
Net cash used in investing activities                 (83,195)      (201,690)      (394,916)
                                                  -----------    -----------    -----------
Cash flows from financing activities:
-------------------------------------
   Advances from Medstone                                  --             --             --
   Issuance of common stock, Medstone
     Distribution                                     500,000             --             --
   Issuance of common stock, other                         --      7,154,001      6,874,121
   Borrowing on convertible note payable              750,000             --             --
                                                  -----------    -----------    -----------
Net cash provided by financing activities           1,250,000      7,154,001      6,874,121
                                                  -----------    -----------    -----------
Net increase in cash and cash equivalents             474,913      3,419,462      2,392,251
Cash and cash equivalents, beginning of year            1,941        476,854      3,896,316
                                                  -----------    -----------    -----------
Cash and cash equivalents, end of year            $   476,854    $ 3,896,316    $ 6,288,567
                                                  ===========    ===========    ===========
Non-cash activities:
--------------------
   Book value of net assets contributed by
      Medstone at time of spin-out and
      initial capitalization of Endocare,
      Inc                                         $   803,133    $       --     $        --
   Conversion of note payable and accrued
     interest to common stock, net of
     origination fees paid by issuance
     of common stock                                       --        820,250             --
                                                  -----------    -----------    -----------
          Total non-cash activities               $   803,133    $   820,250    $        --
                                                  ===========    ===========    ===========

</TABLE>


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



                                       27


<PAGE>   28


                                 ENDOCARE, INC.
                          NOTES TO FINANCIAL STATEMENTS

1. ORGANIZATION AND OPERATIONS OF THE COMPANY

   Endocare, Inc. (the "Company") designs, manufactures, and markets an array of
   innovative, temperature-based surgical devices and technologies primarily to
   treat prostate diseases, including prostate cancer and prostate enlargement.
   Since its formation in 1990, Endocare operated first as a research and
   development department, then later as a division of Medstone International,
   Inc. ("Medstone"). Effective January 1, 1996, Endocare became a totally
   independent, publicly-owned corporation.


2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

   Cash and Cash Equivalents: All highly liquid investments purchased with an
   original maturity of three months or less are considered to be cash
   equivalents.

   Inventories: Inventories are stated at the lower of actual cost (first-in,
   first-out) or net realizable value.

   Property and Equipment: Property and equipment are stated at cost and are
   depreciated on a straight-line basis over the estimated useful lives of the
   respective assets, which range from two to five years. Leasehold improvements
   are amortized over the shorter of the estimated useful lives of the assets or
   the related lease term.

   Long-Lived Assets: The Company reviews property, equipment, and intangible
   assets for possible impairment whenever events or circumstances indicate that
   the carrying amounts may not be recoverable. If the sum of the expected
   future undiscounted cash flows is less than the carrying amount of an asset,
   an impairment loss is recognized. See Note 4 for impairment adjustments in
   1996.

   Revenue Recognition: Endocare recognizes product revenue upon the shipment of
   its products and records reserves for estimated returns. Research revenue and
   revenue from collaborative agreements are recognized as the related
   activities are performed or milestones are met. Realizability of accounts
   receivable is determined based upon an understanding of the financial
   condition of, and prior history with, the buyer and overall historical
   experience.

   Warranty Costs: Certain of the Company's products are covered by warranties
   against defects in material and workmanship for periods of up to twelve
   months. The estimated warranty cost is recorded at the time of sale and is
   adjusted periodically to reflect actual experience.

   Research and Development: Research and development costs relate to both
   present and future products and are expensed immediately as incurred.

   Stock-Based Compensation: In October 1995, the Financial Accounting Standards
   Board issued Statement of Financial Accounting Standards ("SFAS") No. 123,
   "Accounting for Stock-Based Compensation." In 1996, Endocare adopted this
   pronouncement to account for stock options and warrants. Under this
   standard's "fair value" method, compensation cost is measured based on the
   fair value of the award computed as of the grant date and is recognized over
   the service period of the award, which usually is the vesting period. In
   accordance with this standard, the Company has elected to follow the guidance
   of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued
   to Employees," and disclosing the effect of using the fair value method in
   Note 10.

   Earnings (Loss) Per Share: The Company has adopted SFAS No. 128, "Earnings
   Per Share." SFAS 128 simplifies the computation of earnings per share ("EPS")
   previously required in Accounting Principles Board (APB) Opinion No. 15,
   "Earnings Per Share," by replacing primary and fully diluted EPS with basic
   and diluted EPS. Under SFAS 128, basic EPS is calculated by dividing net
   earnings (loss) by the weighted-average common shares outstanding during the
   period. Diluted EPS reflects the potential dilution to basic EPS that could
   occur upon conversion or exercise of securities, options, or other such
   items, to common shares using the treasury stock method based upon the
   weighted-average fair value of the Company's common shares during the period.
   In accordance with SFAS 128, the loss (numerator), shares (denominator) and
   per-share amount for fiscal 1996 are $(1,531,448), 5,635,000 and $(0.27),
   respectively. The loss (numerator), shares (denominator) and per-share amount
   for fiscal 1997 are $(3,899,860), 8,047,000 and $(0.48), respectively, and
   the loss (numerator), shares (denominator) and per-share


                                       28


<PAGE>   29
   amount for fiscal 1998 are $(4,837,346), 9,802,000 and $(0.49), respectively.
   As the Company has been in a net loss position for the fiscal years 1996,
   1997 and 1998, common share equivalents of 1,036,000 and 1,087,000 and
   911,000 in fiscal years 1996, 1997 and 1998, respectively, were not used to
   compute diluted loss per share as the effect was antidilutive. Consequently,
   diluted EPS equals basic EPS.

   Fair Value of Financial Instruments: The carrying amount of cash and cash
   equivalents approximates fair value for all periods presented because of the
   short-term maturity of these financial instruments. The carrying amounts of
   all other financial instruments on the balance sheet approximate their fair
   values.

   Comprehensive Income: In 1998, the Company adopted SFAS NO. 130 ("SFAS 130"),
   "Reporting Comprehensive Income." This statement establishes rules for the
   reporting of comprehensive income and its components. The adoption of SFAS
   130 did not impact the Company's financial statements or related disclosures
   as the Company does not have any components of other comprehensive income
   other than net loss. Therefore, comprehensive income (loss) equaled net 
   income (loss) for all periods presented.

   Segment Disclosures: In 1998, the Company adopted SFAS No. 131 ("SFAS 131"),
   "Disclosure about Segments of an Enterprise and Related Information." SFAS
   131 establishes standards for reporting information about operating segments.
   The Company operates in one industry segment - the design, manufacture and
   marketing of surgical devices to treat prostate diseases.

   Use of Estimates: Company management has made a number of estimates and
   assumptions relating to the reporting of assets and liabilities, revenues and
   expenses, and contingent assets and liabilities in conformity with generally
   accepted accounting principles. Actual results could differ from these
   estimates.

3. SUPPLEMENTAL FINANCIAL STATEMENT DATA

                                                    DECEMBER 31,
                                               ----------------------
                                                 1997          1998
                                               --------      --------
   Inventories:
     Raw materials                             $628,466      $260,222
     Work in process                             56,306        86,375
     Finished goods                             240,820       196,013
                                               --------      --------
          Total inventories                    $925,592      $542,610
                                               ========      ========


                                                     DECEMBER 31,
                                               ----------------------
                                                  1997         1998
                                               ---------    ---------
   Property and Equipment:
     Production equipment                      $ 219,154    $ 313,127
     Furniture and fixtures                      148,810      275,371
     Leasehold improvements                       79,771       82,740
     Assets held for disposal (net 
       of reserves) (see note 4)                 167,947      167,947
                                               ---------    ---------
         Total property and equipment, 
           at cost                               615,682      839,185
     Accumulated depreciation and 
       amortization                             (377,490)    (517,229)
                                               ---------    ---------
         Net property and equipment            $ 238,192    $ 321,956
                                               =========    =========

4. LONG-LIVED ASSETS

   Effective January 1, 1996, Endocare adopted Statement of Financial Accounting
   Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and
   for Long-Lived Assets to Be Disposed Of" ("SFAS 121"). In accordance with
   this standard, the Company reviewed the cash flows being generated by certain
   assets which were not expected to be utilized fully in the Company's
   operations after its spin-out from Medstone. Based upon this review,
   effective January 1, 1996, Endocare reduced the value of certain property and
   equipment by $264,047 and intangible organizational costs by $60,831 to their
   estimated fair market values. The identification and measurement of these
   impaired assets was primarily a result of the post spin-out business
   operations of the Company, not solely the adoption of SFAS 121. However, the
   provisions of SFAS 121 were utilized in determining the amount of the
   impairment charge. The majority of the property and equipment adjustment
   pertained to laser machines which were no longer generating sales of the
   Company's ProLase laser catheters. Prior to 1998, the net book value of these
   assets were fully reserved and are included in assets held for disposal.



                                       29

<PAGE>   30

5. INTANGIBLE ASSETS

   At the end of 1995, Medstone incurred significant legal, accounting, and
   other professional expenses in connection with the distribution of Endocare
   to its existing Medstone shareholders. Medstone elected to capitalize these
   expenses as deferred organizational costs on its balance sheet. Effective
   January 1, 1996, in accordance with the new accounting standard described in
   Note 4 above, Endocare wrote off these amounts entirely.

6. CONVERTIBLE LOAN PAYABLE

   On August 26, 1996, Endocare obtained a two-year $1,500,000 borrowing
   facility from four partnerships (the "Partnerships") managed by Technology
   Funding Inc., a venture capital firm. Peter F. Bernardoni is an officer of
   Technology Funding Inc. and has served as a member of Endocare's Board of
   Directors since November 1995. At December 31, 1996, $750,000 was outstanding
   under this loan.

   In connection with entering into this loan, Endocare issued to the four
   partnerships 10,000 shares of common stock as an origination fee and warrants
   to purchase an aggregate of up to 150,000 shares of Endocare common stock.
   The warrants are exercisable at any time between August 26, 1996 and August
   26, 2001, at an exercise price of $3.00 per share, subject to adjustment.

   The loan accrued interest at the rate of 16% per year, which was due and
   payable in arrears on the maturity date. The outstanding principal and
   interest under the loan was convertible into common stock of Endocare at a
   conversion price of $2.50 per share, subject to certain conditions. All of
   the obligations under the loan were secured by a security interest in all
   present and after acquired personal property of Endocare.

   On January 27, 1997, the Partnerships converted their $750,000 principal
   amount and accrued interest of $50,000 into 320,000 shares of common stock.
   Also, 12,000 additional shares of common stock were issued to the
   partnerships as an inducement to convert at that time which were valued at
   fair value of $50,250. The Convertible Loan, which provided an additional
   $750,000 in borrowing capacity, was cancelled as of the conversion. In
   conjunction with the conversion, approximately $30,000 in unamortized note
   origination fees were reclassified against additional paid-in capital.

7. COLLABORATIVE AGREEMENTS

   Brigham: On April 17, 1996, Endocare entered into a patent license agreement
   with Brigham and Women's Hospital, Inc., ("Brigham") an affiliate of Harvard
   University. This agreement gives Endocare the worldwide exclusive right to
   use Brigham's patented thermal radiation technology in the Company's planned
   ThermaStent(TM) product. In return, Brigham received a warrant to purchase up
   to 10,000 shares of Endocare common stock at a price of $2.875 per share. The
   warrants are exercisable at any time between April 17, 1996 and April 17,
   2001. In addition, if Endocare successfully brings the product to market,
   Brigham may receive royalties on ThermaStent(TM) product sales. No royalties
   have been earned or paid through December 31, 1998.

   Boston Scientific: On March 10, 1999, Endocare exercised its right to
   terminate a distribution agreement with and purchase rights held by Boston
   Scientific Corporation ("BSC"), which was originally entered into in November
   1996. This agreement granted BSC exclusive worldwide marketing rights for
   Endocare's CRYOcare system for urology and a purchase right on the
   technology. Under the original distribution agreement, BSC guaranteed
   Endocare certain minimum purchases of CRYOcare Systems over a five-year
   period, subject to certain conditions and renegotiations. In addition, BSC
   committed to pay Endocare four payments of $250,000 each, based upon meeting
   certain specified milestones. The first milestone payment, based upon
   contract signing, was received in November 1996, and revenue was recognized
   in the fourth quarter of 1996. Due to continuing obligations of the Company
   to BSC, cash related to the second milestone of $250,000 received in December
   1996 was being recognized as earned. The remaining obligations relating to
   this second milestone were fulfilled in 1998 and the remaining deferred
   revenue of $166,672 recognized. In 1998, BSC paid additional nonrefundable
   licensing payments of $475,000 to Endocare.

8. COMMITMENTS AND CONTINGENCIES

   Commitments

   In September 1995, Endocare moved from Medstone's facility to its own
   facility in Irvine, California. Gross rent expense was $51,391, $40,872 and
   $30,654 in 1996, 1997 and 1998, respectively. This facility lease, and a
   related sublease, expired on August 31, 1998. In 

                                       30

<PAGE>   31

   February 1997, Endocare signed a new five-year lease for a larger 16,100
   square foot facility in Irvine, California. Rent expense on this lease was
   $119,383 in 1997 and $153,046 in 1998. Future minimum commitments on this
   operating lease are $157,727 in 1999, $161,953 in 2000, $165,460 in 2001, and
   $34,983 in 2002.

   Endocare also leases various office equipment under operating leases, with
   lease commitments totaling $20,237 in 1999, $17,658 in 2000, and $3,075 in
   2002.

   As of December 31, 1998, Endocare has no other facility leases, capital
   leases, or other long-term commitments.

   Contingencies

   On November 27, 1996, Cryomedical Sciences, Inc., ("CMS") filed a complaint
   in the Circuit Court for Montgomery County, Maryland against the Company and
   Dr. ZhaoHua Chang, a former employee of CMS whom the Company retained as a
   consultant, and, subsequently, as Vice President of Research and Development.
   The suit alleged, that by entering into his consulting and employment
   relationship with the Company, Dr. Chang breached his employment contract
   with CMS (which included a post-termination non-solicitation/non-competition
   clause), violated the Maryland Uniform Trade Secrets Act ("MUTSA"), engaged
   in unfair competition, conspired with the Company to injure CMS and committed
   a breach of fiduciary duty under Maryland law. CMS further alleged that, by
   hiring Dr. Chang, the Company tortiously interfered with the employment
   contract and CMS's prospective business relations, violated the MUTSA,
   engaged in unfair competition, and conspired with Dr. Chang to injure CMS.
   CMS sought injunctive relief, compensatory damages of $10,000,000 and
   punitive damages of $20,000,000 jointly and severally against the Company and
   Dr. Chang. On March 26, 1999, the lawsuit was dismissed by stipulation of the
   parties and order of the court.

   From time to time, the Company has received correspondence alleging
   infringement of proprietary rights of third parties. No assurance can be
   given that any relevant claims of third parties would not be upheld as valid
   and enforceable, and therefore that the Company could be prevented from
   practicing the subject matter claimed or would be required to obtain licenses
   from the owners of any such proprietary rights to avoid infringement.
   Management does not expect any material adverse effect on financial condition
   or the results of operations because of such actions.

   The Company, in the normal course of business, is subject to various other
   legal matters. While the results of litigation and claims cannot be predicted
   with certainty, the Company believes that the final outcome of these other
   matters will not have a material adverse effect on the Company's results of
   operations or financial condition.

9. INCOME TAXES

   Income tax expense, which is included in other income (expense), consisted
   of:

                                            YEARS ENDED DECEMBER 31,
                                            ------------------------
                                             1997            1998
                                            ------          -------
   Current:     Federal                     $   --          $    --
                State and local              5,000            3,400
   Deferred:    Federal                         --               --
                State and local                 --               --
                                            ------          -------
                      Total                 $5,000          $ 3,400
                                            ======          =======


   The following table summarizes the tax effects of temporary differences which
   give rise to significant portions of the deferred tax assets:

                                                   DECEMBER 31,
                                        -------------------------------
                                            1997                1998
                                        ------------        -----------
   Deferred tax assets:
     Product and other reserves
        established for book purposes   $    12,000         $    19,000
     Property and equipment reserve          81,000              84,000
     Inventory obsolescence reserve          69,000              80,000
     Accounts receivable reserve             76,000              16,000
     Recognition of deferred revenue         66,000                  --
     Net operating loss carryforwards     1,778,000           3,738,000
     Other                                   66,000             203,000
                                        -----------         -----------
         Gross deferred tax assets        2,148,000           4,140,000
     Valuation allowance                 (2,148,000)         (4,140,000)
                                        -----------         -----------
         Net deferred tax assets        $        --         $        --
                                        ===========         ===========




                                       31
<PAGE>   32
   The valuation allowance increased by $1,797,000 and $1,992,000 during the
   years ended December 31, 1997 and 1998, respectively.

   Actual income tax expense differs from amounts computed by applying the U.S.
   federal income tax rate of 34% to pretax loss as a result of the following:

<TABLE>
<CAPTION>
                                                        YEARS ENDED DECEMBER 31,
                                               -----------------------------------------
                                                   1996           1997           1998
                                               -----------    -----------    -----------
   <S>                                         <C>            <C>            <C>
   Computed expected tax benefit               $  (519,000)   $(1,326,000)   $(1,644,000)
   State income taxes (benefit) net of 
      federal benefit                                2,000       (214,000)      (282,000)
   Nondeductible expenses                            3,000          6,000         13,000
   Change in valuation allowance                   351,000      1,797,000      1,992,000
   Change in tax rate with respect to
      net operating loss                           165,000       (259,000)            --
   Other                                             3,000          1,000        (75,600)
                                               -----------    -----------    -----------
               Actual tax expense              $     5,000    $     5,000    $     3,400
                                               ===========    ===========    ===========
</TABLE>


   As of December 31, 1998, the Company has net operating loss carryforwards for
   federal income tax purposes of approximately $9,393,000 which are available
   to offset future federal taxable income, if any, through the year 2018. As of
   December 31, 1998, the Company has tax credit carryforwards for federal
   income tax purposes of approximately $81,000 which are available to offset
   future federal tax, if any, through the year 2018. For state income tax
   purposes, the Company has net operating losses of approximately $9,393,000
   which are available to offset future state taxable income, if any, through
   the year 2013.

   In accordance with Internal Revenue Code Section 382, the annual utilization
   of net operating loss carryforwards and credits existing prior to a change in
   control may be limited.

10. STOCK OPTIONS AND WARRANTS

   At December 31, 1998, Endocare had two stock-based compensation plans, as
   described below. Per FASB Statement No. 123, the Company has elected to apply
   APB Opinion No. 25 and related Interpretations in accounting for its plans.
   Accordingly, no compensation expense has been recognized for grants to
   employees under these plans in the Statements of Operations.

   The 1995 Stock Plan authorizes the Board or one or more committees which the
   Board may appoint from among its members (the "Committee") to grant options
   and rights to purchase common stock to employees and certain consultants and
   distributors. Options granted under the 1995 Stock Plan may be either
   "incentive stock options" as defined in Section 422 of the Internal Revenue
   Code of 1986, as amended, or nonstatutory stock options, as determined by the
   Board or the Committee. The exercise price of options granted under the 1995
   Stock Plan is equal to the fair market value of Endocare common stock on the
   date of grant. Options generally vest 25% on the one year anniversary date,
   with the remaining 75% vesting monthly over the following three years.
   Options are exercisable for ten years. A total of 3,000,000 shares of common
   stock have been reserved for issuance under the 1995 Stock Plan, subject to
   an automatic annual share increase to which the number of shares available
   for issuance under the plan will automatically increase on the first trading
   day of each calendar year, beginning with 1999, by 3% of the total number of
   shares of the Company's common stock outstanding at the end of the preceding
   calendar year, to a maximum of 500,000 shares each year. As of December 31,
   1998, options to purchase a total of 2,850,054 shares of the Company's common
   stock have been granted under the 1995 Stock Plan.

   The 1995 Director Option Plan (the "Director Plan") was adopted by the Board
   of Directors (the "Board") in October 1995 and approved by the shareholders
   in November 1995. It provides automatic, nondiscretionary grants of options
   to Endocare's non-employee directors ("Outside Directors"). The Director Plan
   provides that each Outside Director is granted an option to purchase 20,000
   shares of Endocare common stock vested over a two-year period upon his or her
   initial election or appointment as an Outside Director. Subsequently, each
   Outside Director who has served for at least six months will be granted an
   additional option to purchase 5,000 shares of Endocare common stock, which
   vests in one year, on January 1 of each year so long as he or she remains an
   Outside Director. The exercise price of options granted to Outside Directors
   must be the fair market value of Endocare common stock on the date of grant.
   Options granted to Outside Directors have ten-year terms, subject to an
   Outside Director's continued service as a director. The Subsequent Options
   granted to the Outside Directors become fully exercisable on the first
   anniversary of the date of grant. A total of 300,000 shares of common stock
   has been reserved for issuance under the Director Plan. As of December 31,
   1998, options to purchase a total of 50,000 shares of the Company's common
   stock have been granted under the Director Plan.




                                       32


<PAGE>   33

   The following tables summarize Endocare's option activity under both plans:

<TABLE>
<CAPTION>
                                     1996                           1997                            1998
                          ---------------------------    ----------------------------  -----------------------------
                                                                        WEIGHTED AVG.                  WEIGHTED AVG.
                                      WEIGHTED AVG.                     EXERCISE                       EXERCISE
                           NUMBER OF  EXERCISE PRICE      NUMBER OF     PRICE          NUMBER OF       PRICE
                           OPTIONS    PER OPTION          OPTIONS       PER OPTION     OPTIONS         PER OPTION
                           ---------  --------------      ---------     -------------  ---------       -------------
<S>                        <C>        <C>                 <C>           <C>            <C>             <C>
Outstanding,               
beginning of year            980,000      $0.18            1,506,000       $0.84        1,499,916         $1.36
Granted during year          626,000      $2.07              363,500       $3.25        1,463,000         $2.70
Cancelled during year       (100,000)     $2.09             (187,083)      $2.05         (245,363)        $2.84
Exercised                         --         --             (182,501)      $0.18          (60,000)        $0.18
                          ----------      -----           ----------       -----        ---------         -----
Outstanding, end of year   1,506,000      $0.84            1,499,916       $1.36        2,657,553         $1.96
                          ==========      =====           ==========       =====        =========         =====
</TABLE>

<TABLE>
<CAPTION>

                                    OPTIONS OUTSTANDING                 OPTIONS EXERCISABLE
                                    -------------------                 -------------------
                                 NUMBER                               NUMBER
                               OUTSTANDING      WEIGHTED-AVG.       EXERCISABLE
             EXERCISE PRICES       AT             REMAINING             AT            WEIGHTED-AVG.
             --------------- DECEMBER 31, 1998  CONTRACTUAL LIFE   DECEMBER 31, 1998  EXERCISE PRICE
                             ------------------ ----------------   -----------------  --------------
             <S>             <C>                <C>                <C>                <C>
              $      0.18         871,355           6.9 years         633,438             $ 0.18
              $      1.88          11,000           8.4 years           4,000             $ 1.88
              $      1.94          43,000          10.0 years              --             $ 1.94
              $      2.00         130,000           9.7 years              --             $ 2.00
              $      2.06          50,000           9.8 years              --             $ 2.06
              $      2.13          80,000           9.6 years              --             $ 2.13
              $      2.31          10,000           9.9 years              --             $ 2.31
              $      2.50          20,000           9.6 years              --             $ 2.50
              $      2.75         672,500           9.5 years              --             $ 2.75
              $      2.81         170,000           8.6 years          70,000             $ 2.81
              $      2.88          20,000           9.3 years              --             $ 2.88
              $      3.00         150,000           9.1 years              --             $ 3.00
              $      3.25          15,000           8.3 years           6,250             $ 3.25
              $      3.38         202,500           8.9 years          29,167             $ 3.38
              $      3.50          23,000           8.2 years          11,229             $ 3.50
              $      3.63          75,000           7.3 years          50,000             $ 3.63
              $      3.69          10,000           8.8 years           2,917             $ 3.69
              $      3.75          96,198           7.9 years          52,292             $ 3.75
              $      4.00           5,000           8.7 years           1,563             $ 4.00
              $      4.50           3,000           8.8 years             875             $ 4.50
                                ---------                             -------             ------
              $0.18 to $4.50    2,657,553                             911,730             $ 1.08
                                =========                             =======             ======
</TABLE>


   The following table presents pro forma information as if Endocare recorded
   compensation cost using the fair value of the issued stock options using the
   Black-Scholes valuation model:

<TABLE>
<CAPTION>
                                             1996           1997            1998
                                          -----------    -----------    -----------
<S>                                       <C>            <C>            <C>
Net loss:
---------
      As reported                         $(1,531,448)   $(3,899,860)   $(4,837,346)
      Assumed stock compensation cost        (107,000)      (157,000)      (363,000)
                                          -----------    -----------    -----------
      Pro forma, adjusted                 $(1,638,448)   $(4,056,860)   $(5,200,346)
                                          ===========    ===========    ===========
Net loss per share - basic and diluted:
---------------------------------------
      As reported                         $     (0.27)   $     (0.48)   $     (0.49)
      Pro forma, adjusted                 $     (0.29)   $     (0.50)   $     (0.53)
</TABLE>

   The weighted average fair value of the Company's options at the grant date
   was approximately $.50 in 1996, $1.01 in 1997, and $1.35 in 1998. The fair
   value of each option grant is estimated on the date of grant using the
   Black-Scholes option pricing model, with the following assumptions:

                                          1996       1997          1998
                                        --------   --------      -------
       Stock volatility                       .3         .1            .1
       Risk-free interest rate              8.00%      6.00%         6.00%
       Option term in years             10 years   10 years      10 years
       Stock dividend yield                   --         --            --

   Endocare issued warrants to purchase 160,000, 222,497, and 5,000 shares of
   the Company's common stock in 1996, 1997 and 1998, respectively (see note
   13). The Company amortizes the fair values of these warrants to expense over
   the service period of the related warrants. No warrants were issued in 1995
   or earlier.





                                       33

<PAGE>   34

11. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

   The Company currently operates in one industry segment - the design,
   manufacture and marketing of surgical devices to treat prostate diseases. The
   Company sells its devices worldwide to distributors of medical devices and
   directly to hospitals and other medical professional organizations. Until the
   Company exercised its right to terminate the distribution agreement with BSC
   in March 1999 (see Note 7), Endocare's CRYOcare system was distributed
   exclusively by BSC for that product's original market, urological
   applications.

   Customer credit may be extended based upon evaluation of the customer's
   financial condition. The Company maintains reserves for credit losses, and
   Company management considers such reserves to be adequate based upon
   historical experience. International shipments are billed and collected by
   the Company in U.S. dollars.

   During the year ended December 31, 1998, 9 customers accounted for 40% of the
   Company's total revenues. During the year ended December 31, 1998, BSC
   accounted for an additional 41% of the Company's revenues. As of December 31,
   1998, four customers accounted for approximately 98% of net accounts
   receivable. The Company derived 8% of its total revenues from foreign
   customers during the year ended December 31, 1998.

   During the year ended December 31, 1997, BSC accounted for 59% of total
   revenues. As of December 31, 1997, one customer and BSC accounted for
   approximately 44% and 48%, respectively, of net accounts receivable. The
   Company derived approximately 5% of its total revenues from foreign customers
   during the year ended December 31, 1997.

   During the year ended December 31, 1996, two customers accounted for over 10%
   of the Company's revenues. A Canadian distributor accounted for 14% of total
   revenues, and BSC accounted for 12%. At December 31, 1996, four customers
   accounted for over 10% of gross accounts receivable. An Australian
   distributor accounted for 19%, a Michigan medical group accounted for 16%, a
   Texas distributor accounted for 17% and a San Diego distributor accounted for
   11%. The Company derived 50% of its total revenues from foreign customers
   during the year ended December 31, 1996.

12. RELATED PARTY TRANSACTIONS

   Relationship with AMP

   Included in other assets at December 31, 1998 are advances totaling $171,412
   to Advanced Medical Procedures LLC ("AMP"). The advances bear interest at
   prime plus 1% and are repayable beginning September 30, 2000 in equal monthly
   installments of principal and interest over a twelve month period. The
   advances are secured by the assets of AMP and Robert F. Byrnes, a shareholder
   in AMP and a member of Endocare's Board of Directors. AMP is a cryosurgical
   service provider.

   Loan to Officers

   Included in other assets at December 31, 1998 are loans and interest due from
   officers totaling $104,228. The loans accrue interest at 5.41% and all
   interest and principal are payable on August 25, 2000.

13. PRIVATE PLACEMENTS

   In January 1997, Endocare sold 2,218,714 shares of common stock at a price of
   $3.50 per share in a private placement, with Oppenheimer & Co., Inc.
   ("Oppenheimer") acting as placement agent. After expenses, the net
   contribution to the Company's capital was approximately $7,050,000. Expenses
   deducted from the proceeds include a commission to Oppenheimer of
   approximately $540,000 and legal, accounting, and other professional expenses
   of approximately $172,000. In addition, Oppenheimer received a warrant to
   purchase 177,497 shares of Endocare common stock for a period of five years
   at a price of $4.20 per share. The warrants are exercisable at any time
   through January 27, 2002.

   In April 1998, Endocare sold 2,000,000 shares of common stock at a price of
   $3.50 per share in a direct private placement. After legal, accounting,
   filing fees and other associated offering expenses of approximately $150,000
   and miscellaneous stock repurchases, the net contribution reflected in the
   Company's additional paid-in capital in 1998 was $6,861,320.



                                       34



<PAGE>   35

14. BANK LINE OF CREDIT

   The Company has a $1,000,000 line of credit with a bank which bears interest
   at prime plus 1%. The line of credit is secured by the Company's assets,
   excluding intellectual property, and is subject to certain financial and
   other covenants. The Company anticipates either renewing the existing line of
   credit or entering into a new debt facility with another bank prior to the
   expiration of the line on April 30, 1999.

15. SUBSEQUENT EVENT - STOCKHOLDER RIGHTS PLAN

   On March 5, 1999, the Company's Board of Directors adopted a Stockholder
   Rights Plan ("Plan") in which preferred stock purchase rights will be
   distributed as a dividend at the rate of one Right for each share of Common
   Stock held as of the close of business on April 15, 1999. Each Right will
   entitle Stockholders to buy one one-thousandth of a share of Series A
   Preferred Stock of the Company at an Exercise Price of $25. The Rights are
   designed to guard against partial tender offers and other abusive and
   coercive tactics that might be used in an attempt to gain control of the
   Company or to deprive Stockholders of their interest in the long-term value
   of the Company. The Rights will be exerciseable only if a person or group
   acquires 15% or more of the Company's Common Stock (subject to certain
   exceptions stated in the Plan) or announces a tender offer, the consummation
   of which would result in ownership by a person or group of 15% or more of the
   Company's Common Stock. Each Right will entitle stockholders to buy one
   one-thousandth of a share of new series of junior participating preferred
   stock at an exercise price of $25 upon certain events. If a person or group
   acquires 15% or more of the Company's outstanding Common Stock (subject to
   certain exceptions stated in the Plan), or a holder of 15% or more of the
   Company's Common Stock engages in certain self-dealing transactions or a
   merger transaction in which the Company is the surviving corporation and its
   Common Stock remains outstanding, then each Right not owned by such person or
   certain related parties will entitle its holder to purchase, at the Right's
   then-current exercise price, units of the Company's Series A Preferred Stock
   (or, in certain circumstances, Company Common Stock, cash, property or other
   securities of the Company) having a market value equal to twice the
   then-current exercise price. In addition, if, after the Rights become
   exerciseable, Endocare, Inc. is acquired in a merger or other business
   combination transaction, or sells 50% or more of its assets or earnings
   power, each Right will entitle its holder to purchase, at the Right's
   then-current price, a number of the acquiring company's common shares having
   a market value at the time of twice the Right's exercise price. At any time
   on or prior to the close of business on the first date of a public
   announcement that a person or group has acquired beneficial ownership of 15%
   or more of the Company's Common Stock (subject to certain exceptions stated
   in the Plan), the Rights are redeemable for one cent per Right at the option
   of the Board of Directors. The Rights are intended to enable all stockholders
   to realize the long-term value of their investment in the Company. The Rights
   will not prevail a takeover attempt, but should encourage anyone seeking to
   acquire the Company to negotiate with the Board prior to attempting to a
   takeover. The dividend distribution will be made on April 15, 1999 payable to
   stockholders of record on that date. The Rights will expire on April 15,
   2009.

16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

<TABLE>
<CAPTION>

                                                   TOTAL                                    NET LOSS
                                                  REVENUE          NET LOSS                 PER SHARE
                                                  -------          --------                 ---------
      <S>                                         <C>            <C>                        <C>
      Quarter Ended:
         December 31, 1998                        $505,852       $(1,425,573)                $(0.14)
         September 30, 1998                        551,282        (1,122,024)                 (0.11)
         June 30, 1998                             649,749        (1,228,988)                 (0.12)
         March 31, 1998                            410,901        (1,061,661)                 (0.13)

         December 31,1997                         $515,429       $(1,010,404)                $(0.12)
         September 30, 1997                        555,941        (1,090,176)                 (0.13)
         June 30, 1997                             249,997        (1,059,826)                 (0.13)
         March 31, 1997                            679,668          (739,454)                 (0.10)

         December 31, 1996                         839,764          (192,245)                 (0.03)
         September 30, 1996                        499,073          (367,062)                 (0.07)
         June 30, 1996                             419,785          (394,557)                 (0.07)
         March 31, 1996                            370,656          (577,584)                 (0.10)
</TABLE>


                                       35



<PAGE>   36

                                 ENDOCARE, INC.
                 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                   ALLOWANCE FOR              RESERVE FOR
                               DOUBTFUL RECEIVABLES     INVENTORY OBSOLESCENCE
                                 AND SALES RETURNS     AND NET REALIZABLE VALUE
                               --------------------    ------------------------
<S>                                <C>                      <C>
Balance at December 31, 1995          46,948                        --
   Changes to operations              22,687                        --
   Deductions                        (11,496)                       --
   Other                                  --                        --
                                   ---------                 ---------
Balance at December 31, 1996          58,139                    77,236
   Changes to operations             249,983                    62,764
   Deductions                       (116,122)                       --
   Other                                  --                        --
                                   ---------                 ---------
Balance at December 31, 1997         192,000                   140,000
   Changes to operations              34,736                    87,000
   Deductions                       (140,736)                  (25,000)
   Other                                  --                        --
                                   ---------                 ---------
Balance at December 31, 1998       $  86,000                 $ 202,000
                                   =========                 =========

</TABLE>









                                       36





<PAGE>   37

                                   SIGNATURES

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

                                          ENDOCARE, INC.

                                          By: /s/ PAUL W. MIKUS
                                              ----------------------------------
                                              Paul W. Mikus
                                              Chief Executive Officer and
                                              President

Dated:  March 30, 1999

   Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 30, 1999.

        SIGNATURE                                    TITLE


/s/     PAUL W. MIKUS                  Chief Executive Officer, President,
------------------------------------        and Chairman of the Board
        Paul W. Mikus                       

/s/     WILLIAM R. HUGHES                  Senior Vice President and
------------------------------------        Chief Financial Officer
        William R. Hughes                   (Principal Financial and
                                              Accounting Officer)

/s/     PETER F. BERNARDONI
------------------------------------
        Peter F. Bernardoni                        Director


/s/     ROBERT F. BYRNES
------------------------------------
        Robert F. Byrnes                           Director


/s/     BENJAMIN GERSON, M.D.
------------------------------------
        Benjamin Gerson, M.D.                      Director





                                       37

<PAGE>   38

                                 ENDOCARE, INC.
                                INDEX TO EXHIBITS

 2.1    Distribution Agreement between the Registrant and Medstone
        International, Inc., dated October 31, 1995(1)

 3.1    Certificate of Incorporation of the Company(2)

 3.2    Amended and Restated Bylaws of the Company(9)

 4.1    Specimen Certificate of the Company's Common Stock(3)

 10.1   Facility Lease on 18 Technology Drive(2)

 10.2   Contribution Agreement between Medstone International, Inc. and the
        Company, dated October 31, 1995(1)

 10.3   Research and Development Services Agreement between Medstone
        International, Inc. and the Company, dated October 31, 1995(1)

 10.4   Form of Indemnification Agreement(2)

 10.5   1995 Stock Plan(1)

 10.6   1995 Director Option Plan(1)

 10.7   Patent License Agreement between the Company and Brigham and Women's
        Hospital, Inc., dated April 17, 1996(4)

 10.8   Form of Convertible Secured Promissory Note due August 26, 1998, issued
        by Endocare, Inc. in an aggregate principal amount of $1,500,000, dated
        August 26, 1996(5)

 10.9   Form of Warrant to purchase an aggregate of 150,000 shares of common
        stock, dated August 26, 1996(5)

 10.10  Distributorship Agreement between the Company and Boston Scientific
        Corporation, dated November 18, 1996(6)

 10.11  Common Stock Purchase Agreement by and among the Company and the persons
        listed on the Schedule of Investors attached thereto as Exhibit A, dated
        January 21, 1997(7)

 10.12  Facility Lease dated January 31, 1997 for 7 Studebaker(9)

 10.13  Sublease dated May 19, 1997 for 18 Technology Drive(9)

 10.14  Common Stock Purchase Agreements by and among the Company and the
        persons indicated therein, dated April 15 and April 22, 1998(10)

 23.1   Consent of KPMG LLP*

 27.1   Financial Data Schedule*

 29.1   Endocare, Inc. Information Statement distributed to shareholders of
        Medstone International, Inc., dated February 6, 1996(8)

----------

(1) Previously filed with the Company's Application for Registration on Form
    10-SB under the Securities Exchange Act of 1934, filed on November 14, 1995,
    and incorporated herein by reference. Each such exhibit had the same exhibit
    number in that filing, except that the 1995 Stock Plan was exhibit number
    10.6 and the 1995 Director Option Plan was exhibit 10.7.



                                       38



<PAGE>   39

(2) Previously filed with Amendment number 1 to Company's Application for
    Registration on Form 10-SB, filed on December 21, 1995, and incorporated
    herein by reference.

(3) Previously filed with the Company's Annual Report on Form 10-K for the year
    ended December 31, 1995, and incorporated herein by reference.

(4) Previously filed with the Company's Current Report on Form 8-K, as amended,
    dated April 25, 1996 as filed with the Securities and Exchange Commission on
    April 26, 1996, and incorporated herein by reference.

(5) Previously filed with the Company's Current Report on Form 8-K dated August
    26, 1996 as filed with the Securities and Exchange Commission on September
    10, 1996, and incorporated herein by reference.

(6) Previously filed with the Company's Current Report on Form 8-K dated
    November 18, 1996 as filed with the Securities and Exchange Commission on
    December 3, 1996, and incorporated herein by reference.

(7) Previously filed with the Company's Current Report on Form 8-K dated January
    27, 1997 as filed with the Securities and Exchange Commission on January 31,
    1997, and incorporated herein by reference.

(8) Previously filed on February 9, 1996 by Medstone International, Inc. under
    Section 14(c) of the Securities Exchange Act of 1934, and incorporated
    herein by reference.

(9) Previously filed with the Company's Annual Report on Form 10-K/A (Amendment
    No. 3) for the year ended December 31, 1996, and incorporated herein by
    reference.

(10)Previously filed with the Company's current report on Form 8-K dated April
    15, 1998 as filed with the Securities and Exchange Commission on April 23,
    1998, and incorporated herein by reference.

*   Filed herewith.





                                       39