MANAGEMENT'S DISCUSSION AND ANALYSIS

Results of Operations

Net Revenues
Net revenues in 1998 were $10,719,755, an increase of $3,354,375, or 46%, from
net revenues in 1997. The increase in revenues primarily reflects the Company's
emphasis on Everest laparoscopy product sales, the shipments of cardiovascular
bipolar products to Guidant Corporation and shipments to C.R. Bard of a version
of the Company's bipolar coagulating probe.

   Revenues of the Everest laparoscopy product line, a growth business for the
Company, increased 39% to $6,430,798 from 1997. This increase in revenues
primarily resulted from ongoing sales and marketing initiatives directed at
increasing this business. The 39% increase in revenues related primarily to the
BiCOAG(R) Bipolar Cutting Forceps. Revenues from this product increased 56% as
compared to 1997. The Company also experienced revenue increases of 30% and 54%
in 1998 from the BiCOAG Dissecting Forceps and the BiCOAG Classic Tip Forceps,
respectively. The Company expects revenues from the Everest-branded laparoscopic
product line to continue to grow as a result of improved sales management and
growing acceptance of the Company's bipolar product offering. The Company
believes bipolar electrosurgical instruments allow surgeons greater versatility
and cost savings when compared to alternative technologies.

   The other growth business for the Company is the cardiovascular business.
This segment achieved revenues in excess of $1,400,000 from the propriety
bipolar products supplied to Guidant Corporation. Guidant uses the Company's
products with their VasoView(R) Balloon Dissection System for minimally invasive
saphenous vein harvesting. The Company expects revenues from this product supply
agreement to increase in 1999 due to Guidant's increased marketing and
educational efforts.

   Revenues in 1998 from the Company's bipolar forceps sold to its OEM customers
in 1998 increased 48% as these customers continue to meet end-user demand. The
Company expects shipments of these bipolar forceps to decrease in 1999 as these
product lines are maturing. In addition, the Company has been informed that
Origin Medsystems, which represented 14% of OEM bipolar forceps sales in 1998,
will be discontinuing its offering of such products.

   Net revenues from gastrointestinal products increased 31% for the year due
primarily to C.R. Bard responding to a short-term market opportunity. The
Company does not expect this opportunity to continue in 1999. Offsetting this
revenue increase was a sharp decline in shipments of the Company's bipolar
polypectomy snare to the Company's Japanese distributor, due to an increased
presence of competitive products.

   Net revenues in 1997 were $7,365,380, an increase of $1,363,608, or 23%, over
net revenues in 1996. The increase in revenues resulted from a 46% increase in
sales of the Everest laparoscopy products and the commencement of shipments of
select propriety bipolar products to Guidant Corporation for use with their
balloon dissection system for minimally invasive saphenous vein harvesting.
Offsetting these revenue increases were declines in shipments of bipolar forceps
to the Company's OEM customers as they managed their inventory levels and a
decline in sales to the Company's Japanese distributor of its bipolar
polypectomy snare due to increased competition.

Gross Margin
Gross margin for 1998 was 48.7% of revenues, compared to 44.3% for 1997. This
improvement resulted from increased revenues from the Everest laparoscopy
product offerings and the increased sales to C.R. Bard. Also impacting the
improvement in gross margin was the large unit volume increase the Company
experienced which allowed for greater leverage of its overhead capacity. In
addition, the Company benefited from the cost savings of certain value
engineering projects completed in 1998. Lower gross margins from the
cardiovascular products sold to Guidant Corporation, compared to the Everest
laparoscopy products, offset the increase. The ramp up of production output to
meet the increased demand for all product lines resulted in production
inefficiencies which negatively impacted the gross margin. The Company expects
gross margin as a percent of revenues to increase in 1999 as the Company strives
to leverage its manufacturing overhead over a greater number of produced units
and as it reduces costs with additional value engineering projects.

   Gross margin for 1997 was 44.3% of sales, compared to 43.9% for 1996. This
improvement was a result of both increased sales from the Everest laparoscopy
product offerings and the recognition of licensing revenue in 1997 that
benefited gross margin by 2.5%.

Sales and Marketing
Sales and marketing expenses for 1998 were $2,680,409, an increase of $487,580,
or 22%, from 1997. This increase in expenses resulted primarily from payment of
increased commissions related to the revenue increase, marketing initiatives to
commercialize products for the emerging minimally invasive cardiovascular
surgery market, and expanding the sales and marketing staff in 1998 to meet
current and future needs and to support ongoing promotional and marketing
activities. The Company expects that sales and marketing expenses will increase
in 1999 in conjunction with the Company's anticipated increase in sales. The
Company continues to invest in its sales and marketing staff and other
initiatives aimed at the growing Everest laparoscopy product revenues.

   Sales and marketing expenses for 1997 were $2,192,829, an increase of
$661,553, or 43%, from 1996. This increase in expense resulted primarily from
increased commissions related to the revenue increase, marketing initiatives to
commercialize products for the emerging minimally invasive cardiovascular
surgery market and the rebuilding of the sales and marketing staff in 1997 to
meet the Company's sales objectives.

Research and Development
Research and development expenses for 1998 were $858,816, an increase of
$224,918, or 35%, from 1997. This expense increase resulted primarily from the
Company's successful efforts to obtain ISO 9001 certification and CE Mark
approval for its products, development costs associated with the minimally
invasive cardiovascular products, increased staffing costs necessary for the
Company to broaden its product offering and patent-related costs. The Company
expects research and development costs to increase in 1999 as the Company
increases its development efforts in the minimally invasive cardiovascular
arena, laparoscopy and other surgical specialties.

   Research and development expenses for 1997 were $633,898, an increase of
$26,928, or 4%, from 1996. This expense increase resulted, in part, from costs
related to the Company's efforts to obtain ISO 9001 certification and CE Mark
approval for its products, development costs associated with the minimally
invasive cardiovascular products and ongoing patent-related costs.

General and Administrative
General and administrative expenses for 1998 were $937,494, an increase of
$153,291, or 20%, over 1997. This increase was attributable to expenses related
to increases in executive compensation; higher insurance costs associated with
coverage enhancements and increased investor communication initiatives. The
Company expects that its general and administrative expenses will increase in
1999 due to the overall activity increases from the growth in the business.

   General and administrative expenses for 1997 were $784,203, an increase of
$44,250, or 6%, over 1996. This increase was attributable to expenses related to
obtaining the revolving line of credit secured by a private investor, increased
insurance costs and expenses related to investor communications.

Income Tax Expense
The Company has approximately $18 million of tax loss carryforwards available to
offset future taxable income. The Company can only utilize these tax attributes
to the extent of 90% of pre-tax income since the alternative minimum tax system
will result in tax liabilities at this point. The Company could also be limited
in the utilization of tax loss carryforwards by section 382 of the Internal
Revenue Code of 1986 as more fully discussed in the notes to the financial
statements. The Company recognized $10,000 of income tax expense for 1998.

Net Income (Loss)
The net income in 1998 was $660,316 compared to a net loss of $384,841 in 1997
and a net loss of $339,056 in 1996. The net income for 1998 was primarily a
result of sales increases, the increase in gross margin and effective control of
expenses. The net losses of 1997 and 1996 were primarily a result of continuing
efforts to shift the Company's revenue mix to the more profitable Everest
laparoscopy business, the strategic initiatives by the Company related to the
minimally invasive cardiovascular opportunity, and the ISO 9000 and CE Mark
certifications. Although there can be no assurance, the Company believes, that
it will maintain profitability in 1999 as it increases market share in its core
business of laparoscopy and as Guidant continues to increase its market share in
the minimally invasive cardiovascular surgery market.

Liquidity and Capital Resources

Cash and cash equivalents were $217,488 on December 31, 1998, compared to
$80,362 on December 31, 1997. The Company generated $400,433 of cash flow from
operating activities in 1998 compared to expending $788,237 on operating
activities in 1997. Operating activities in 1998 included income of $660,316, a
growth in accounts receivable due primarily to the increased sales volume, and
the growth in inventory as the Company expanded its product line with the
introduction of new products. In 1998, the Company expended $169,982 on capital
equipment. The Company received $727,202 from the sale of its common stock in
1998, including net proceeds of a stock sale to Guidant of $700,000. The Company
also reduced its borrowings $450,000 to $125,000 at December 31, 1998. The
Company met its obligations on its preferred stock dividends of $343,564.

   The Company's obligation to pay quarterly dividend payments to three
outstanding series of preferred stock, necessary capital expenditures, growth in
inventory as the Company expands its product offering and increased operating
expenses will challenge the Company to meet its capital needs for 1999. Based on
its existing operating plan, however, the Company believes its current bank
credit facility of $1,000,000 obtained in 1999 will be sufficient to meet its
working capital needs in 1999, provided there are no significant deviations from
such plan in 1999.

Year 2000

The Company has continued its detailed assessment of the Year 2000 issues
related to the Company's enterprise business applications. Although continuing
to seek written assurances, the Company has preliminarily concluded that it is
materially compliant with its accounting, resource planning and network systems
based on input from the third party software vendors. The Company intends to
fully test these systems over the next six months with the goal that these
applications will be capable of handling transactions with Year 2000 dates, but
no testing or remediation has been done to date.

   The Company also is organizing a task force to further assess its Year 2000
compliance issues with other functions including computer hardware, telephone
systems, and other manufacturing equipment. The Company's goal is to document
potential risks to the Company and plan necessary actions to meet the risks
associated with the Year 2000.

   The Company believes that given its reliance on outside software vendors and
its relatively simple information systems, it will achieve substantial
compliance with respect to Year 2000 issues before the end of 1999. Although the
Company is still in the process of assessment, it currently believes the costs
to meet this objective will not be material. The Company has not yet created a
contingency plan should the Year 2000 issues prove to present significant
unanticipated problems or if the Company is not ready in time. As the Company's
assessment process continues, it intends to revisit the risks of non-compliance
and how best to respond.

Forward-Looking Statements and Risks

Certain statements made in this Annual Report, which are summarized here, are
forward looking statements that involve risk and uncertainties, and actual
results may be materially different than those projected. Factors that could
cause actual results to differ include, but are not limited to those identified:

o    The expectation that revenues from the Everest laparoscopy product line
     will continue to grow in 1999 depends on market acceptance and demand,
     effectiveness of sales and marketing personnel, as well as other general
     market conditions and competitive conditions within this market, including
     the introduction of products by competitors.

o    The expectation of increased revenues under the Company's product supply
     agreement with Guidant Corporation depends upon successful marketing and
     education efforts of Guidant to increase market share in this emerging
     minimally invasive saphe-nous vein harvesting market.

o    The expectation that shipments of bipolar forceps will decrease in 1999
     depends primarily on the extent of the maturing of this product line for
     the Company's OEM customers.

o    The expectation that the Company's gross margin as a percent of revenues
     will increase in 1999 depends on the actual production of a greater number
     of units and the efficiency of the manufacturing process, so as to allow
     the Company to leverage its manufacturing overhead, in addition to
     receiving actual benefits from various value engineering projects completed
     in 1998 or currently in process.

o    The Company's ability to maintain profitability in 1999 depends on
     effective expense management and general market conditions and competitive
     conditions that may be encountered, including the Company's ability both
     (i) to increase its market share in its core business of laparoscopy given
     that the Company competes with larger, well capitalized companies who have
     the ability to enter into contract purchasing agreements with large
     institutions, and (ii) to establish a market presence in the minimally
     invasive cardiac surgery market.

o    The accuracy of the Company's belief that its current capital resources
     will be sufficient to fund current and anticipated business operations
     throughout 1999 depends, in part, on meeting anticipated revenue goals,
     operating efficiencies and effective expense management, in addition to
     general and competitive conditions.

o    The impact of Year 2000 issues on the Company's business depends on the
     accuracy, reliability and effectiveness of the Company's and its suppliers'
     and customers' assessment and remediation of Year 2000 issues.


<PAGE>
                            STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>

                                                                           Year ended December 31,
                                                                     1998           1997            1996
                                                                 -----------     -----------     -----------
<S>                                                              <C>             <C>             <C>         
Net revenues                                                     $10,719,755     $ 7,365,380     $ 6,001,772 
Cost of goods sold                                                 5,501,001       4,103,920       3,364,885 
                                                                 -----------     -----------     -----------
Gross margin                                                       5,218,754       3,261,460       2,636,887 

Operating expenses
  Sales and marketing                                              2,680,409       2,192,829       1,531,276 
  Research and development                                           858,816         633,898         606,970 
  General and administrative                                         937,494         784,203         739,953 
                                                                 -----------     -----------     -----------
Total operating expenses                                           4,476,719       3,610,930       2,878,199 

Interest income                                                       (8,018)        (16,775)        (62,702)
Interest expense                                                      79,737          52,146         160,446 
                                                                 -----------     -----------     -----------
Net income (loss) before income taxes                                670,316        (384,841)       (339,056)

Provision for income taxes                                            10,000               -               - 
                                                                 -----------     -----------     -----------
Net income (loss)                                                    660,316        (384,841)       (339,056)
Less preferred stock dividends                                       343,564         344,390         354,848 
                                                                 -----------     -----------     -----------
Net income (loss) applicable to common stock                     $   316,752     $  (729,231)    $  (693,904)
                                                                 ===========     ===========     ===========

Net income (loss) per common share-basic and dilutive            $       .04     $      (.10)    $      (.11)
                                                                 ===========     ===========     ===========
Weighted average number of shares
  outstanding during the period                                    7,364,982       7,017,635       6,349,775 
                                                                 ===========     ===========     ===========
</TABLE>

See accompanying notes to financial statements

<PAGE>
                                 BALANCE SHEETS
<TABLE>
<CAPTION>
                                                                                                     December 31,
                                                                                                 1998             1997
                                                                                            ------------     ------------
<S>                                                                                         <C>              <C>          
Assets
Current assets
  Cash and cash equivalents                                                                 $    217,489     $     80,362 
  Accounts receivable, less allowances (1998 - $61,750; 1997 - $46,750)                        1,745,512        1,563,066 
  Inventories                                                                                  1,751,946        1,055,811 
  Prepaid insurance and deposits                                                                  76,689           99,528 
                                                                                            ------------     ------------
     Total current assets                                                                      3,791,636        2,798,767 

Equipment
  Office and display equipment                                                                   414,315          387,919 
  Research and development equipment                                                             188,224          188,224 
  Production equipment                                                                         1,219,929        1,076,341 
  Equipment under capital lease                                                                  115,235          115,235 
                                                                                            ------------     ------------
                                                                                               1,937,703        1,767,719 
  Less allowance for depreciation                                                             (1,632,198)      (1,486,020)
                                                                                            ------------     ------------
                                                                                                 305,505          281,699 
Patents, net of amortization (1998 - $172,087; 1997 - $169,746)                                      250            2,591 
                                                                                            ------------     ------------

Total assets                                                                                $  4,097,391     $  3,083,057 
                                                                                            ============     ============

Liabilities and Shareholders' Equity
Current liabilities
  Customer advances                                                                         $     36,788     $     38,000 
  Accounts payable                                                                               582,110          340,378 
  Accrued compensation and related taxes                                                         314,174          202,915 
  Other accrued liabilities                                                                      189,875           93,777 
  Capital lease obligations, current portion                                                           -            2,496 
  Short-term debt                                                                                125,000                - 
                                                                                            ------------     ------------
Total current liabilities                                                                      1,247,947          677,566 

Long-term debt and other liabilities                                                                   -          600,000 


Shareholders' equity
  Convertible preferred stock series A, ($.01 par value, $2.50 liquidation value)
     1,400,000 authorized; outstanding: 1998 and 1997-632,937 shares                           1,551,717        1,551,717 
  Convertible preferred stock series B, ($.01 par value, $2.75 liquidation value)
     730,000 authorized, outstanding: 1998 and 1997-637,273 shares                             1,545,313        1,545,313 
  Convertible preferred stock series C, ($.01 par value, $2.75 liquidation value)
     authorized and outstanding: 1998 and 1997-410,906 shares                                  1,002,832        1,002,832 
  Convertible preferred stock series D, ($.01 par value, $2.875 liquidation value)
     authorized and outstanding: 1998 and 1997-471,500 shares                                  1,205,808        1,205,808 
  Common stock, ($.01 par value) 11,987,594 authorized; outstanding:
     1998-7,465,875; 1997-7,038,002                                                               74,659           70,380 
  Additional paid-in capital                                                                  16,420,828       16,041,470 
  Accumulated deficit                                                                        (18,951,713)     (19,612,029)
                                                                                            ------------     ------------
                                                                                               2,849,444        1,805,491 
                                                                                            ------------     ------------
  Total liabilities and shareholders' equity                                                $  4,097,391     $  3,083,057 
                                                                                            ============     ============
</TABLE>

See accompanying notes to financial statements.

<PAGE>
                 STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>

                                                                     Common  Additional
                                  Preferred      Common    Preferred    Stock-     Paid-in     Accumulated   
                                    Shares       Shares      Stock       Par       Capital       Deficit       Total
                                  ---------   ---------   ----------   -------   -----------   ------------   ----------
<S>                               <C>         <C>         <C>          <C>       <C>           <C>            <C>        
Balance January 1, 1996           2,702,616   5,806,700   $6,703,170   $58,067   $13,659,504   $(18,724,274)  $1,696,467 
                                  =========   =========   ==========   =======   ===========   ============   ==========
                                                                                                             
Common stock issued under                                                                                    
  stock purchase plan and stock                                                                              
  options less related costs                    107,219                  1,072      253,663                     254,735 
                                                                                                             
Common stock issued upon                                                                                     
  exercise of stock warrants                    325,993                  3,260      876,829        (163,858)    716,231 
                                                                                                             
Conversion of Series A                                                                                       
  preferred stock                  (456,000)    456,000   (1,140,000)    4,560    1,135,440                             
                                                                                                             
Conversion of Series B                                                                                       
  preferred stock                   (75,000)     75,000     (206,250)      750      205,500                             
                                                                                                             
Common stock issued upon                                                                                     
  conversion of convertible note                200,000                  2,000      498,000                     500,000 
Dividends on preferred stock                                                       (388,737)                   (388,737)
                                                                                                             
Net loss for the year                                                                              (339,056)   (339,056)
                                  ---------   ---------   ----------   -------   -----------   ------------   ----------
                                                                                                             
Balance December 31, 1996         2,171,616   6,970,912   5,356,920     69,709   16,240,199     (19,277,188)  2,439,640 
                                  ---------   ---------   ----------   -------   -----------   ------------   ----------
                                                                                                             
Common stock issued under                                                                                    
  stock purchase plan and                                                                                    
  stock options less related                                                                                 
  costs                                          40,818                    408       72,290                      72,698 
                                                                                                             
Common stock issued upon                                                                                     
  exercise of stock warrants                      7,272                     73       19,925                      19,998 
                                                                                                             
Conversion of Series A                                                                                       
  preferred stock                    (4,000)      4,000     (10,000)        40        9,960                             
                                                                                                             
Conversion of Series B                                                                                       
  preferred stock                   (15,000)     15,000     (41,250)       150       41,100                             
                                                                                                             
Issuance of warrants in                                                                                      
  connection with guarantee                                                                                  
  of bank line of credit                                                              2,386                       2,386 
                                                                                                             
Dividends on preferred stock                                                       (344,390)                   (344,390)
                                                                                                             
Net loss for the year                                                                              (384,841)   (384,841)
                                  ---------   ---------   ----------   -------   -----------   ------------   ----------
                                                                                                             
Balance December 31, 1997         2,152,616   7,038,002   5,305,670     70,380   16,041,470     (19,612,029)  1,805,491 
                                  ---------   ---------   ----------   -------   -----------   ------------   ----------
                                                                                                             
Common stock issued under                                                                                    
  stock purchase plan                            16,108                    161       23,464                      23,625 
                                                                                                             
Common stock issued in                                                                                       
  private transaction                           411,765                  4,118      695,882                     700,000 
                                                                                                             
Issuance of warrants in                                                                                      
  connection with guarantee of                                                                               
  bank line of credit                                                                 3,576                       3,576 
                                                                                                             
Dividends on preferred stock                                                       (343,564)                   (343,564)
                                                                                                             
Net income for the year                                                                             660,316     660,316 
                                  ---------   ---------   ----------   -------   -----------   ------------   ----------
                                                                                                             
Balance December 31, 1998         2,152,616   7,465,875   $5,305,670   $74,659   $16,420,828   $(18,951,713)  $2,849,444 
                                  =========   =========   ==========   =======   ===========   ============   ==========
</TABLE>                
                           
See accompanying notes to financial statements.         


<PAGE>
                            STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                                                    Year ended December 31,
                                                                                           1998             1997            1996 
                                                                                    -----------     ------------     -----------
<S>                                                                                 <C>             <C>              <C>         
OPERATING ACTIVITIES
Net income (loss)                                                                   $   660,316     $   (384,841)    $  (339,056)
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
  Depreciation and amortization                                                         148,516          168,086         171,910 
  Provision for losses on accounts receivable                                            15,000              750          30,000 
  Value of warrants granted in connection with guarantee of bank line                     3,576            2,386               - 
  Changes in operating assets and liabilities:
     Accounts receivable                                                               (197,446)        (428,271)       (249,204)
     Inventories                                                                       (696,135)        (275,682)       (121,375)
     Prepaid expenses                                                                    22,839           68,210        (126,273)
     Customer advances                                                                   (1,212)          20,000        (150,000)
     Accounts payable and accrued expenses                                              449,089           41,647         152,971 
                                                                                    -----------     ------------     -----------
Net cash provided by (used in) operating activities                                     404,543         (787,716)       (631,027)

INVESTING ACTIVITIES
Purchase of equipment                                                                  (169,981)        (187,629)       (121,640)
                                                                                    -----------     ------------     -----------
Net cash used in investing activities                                                  (169,982)        (187,629)       (121,641)

FINANCING ACTIVITIES
Dividends paid                                                                         (343,564)        (344,390)       (388,737)
Principal payments on debt and capital leases                                          (477,496)         (5,409)        (645,228)
Proceeds from issuance of debt                                                                -          600,000         500,000 
Net proceeds from sale of common stock                                                  723,625           92,696         970,966 
                                                                                    -----------     ------------     -----------
Net cash (used in) provided by financing activities                                     (97,434)         342,897         437,002 
                                                                                    -----------     ------------     -----------

Increase (decrease) in cash and cash equivalents                                        137,127         (632,448)       (315,666)
Cash and cash equivalents at beginning of period                                         80,362          712,810       1,028,476 
                                                                                    -----------     ------------     -----------
Cash and cash equivalents at end of period                                          $   217,489     $     80,362     $   712,810 
                                                                                    ===========     ============     ===========

Supplemental cash flow information:
  Conversion of Series A and B preferred stock into common stock                    $         -     $     51,250     $ 1,346,250 
  Conversion of convertible note into common stock                                  $         -     $          -     $   500,000 
                                                                                    -----------     ------------     -----------
</TABLE>

See accompanying notes to financial statements.
<PAGE>
   
                          NOTES TO FINANCIAL STATEMENTS
                           Everest Medical Corporation


1.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business Activity
Everest Medical Corporation (the Company) is engaged in the development,
manufacturing and marketing of bipolar electrosurgical instrumentation for the
minimally invasive surgery market. The Company operates as one segment.

Cash Equivalents
The Company considers all highly liquid investments with a maturity of less than
three months when purchased to be cash equivalents. The Company's cash
equivalents consist of money market accounts and Treasury Bills and are carried
at cost which approximates market value. The cost of Treasury Bills was $132,548
and $123,513 at December 31, 1998 and 1997, respectively.

Inventories
Inventories are valued at the lower of cost or market determined by the
first-in, first-out (FIFO) method.

Equipment and Fixtures
Equipment and fixtures are stated at cost. The Company provides for depreciation
on a straight-line basis over estimated useful lives from three to five years.
Maintenance, repairs and minor renewals are expensed as incurred.

Patents
Patents employed in current products are carried at cost (primarily patent legal
fees) and are amortized over 60 months. The Company reviews its patents
periodically to determine whether the patents have continuing value.
The expense of writing off patents is charged to research and development.

Income Taxes
The Company accounts for income taxes under the liability method.

Per Share Data
Basic earnings per share is computed using the weighted average number of common
shares outstanding. Diluted earnings per share is computed using the combination
of dilutive common share equivalents and the weighted average number of common
shares outstanding. The dilutive effect of options and warrants was not material
in 1998.

Impairment of Long-Lived Assets
The Company will record impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.

Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.

2.       INVENTORIES

Inventories consisted of:

                                                  December 31
                                       1998                      1997
                                       ----                      ----
         Raw materials           $      740,100            $       493,008
         Work in process                807,580                    462,290
         Finished goods                 204,266                    100,513
                                 --------------            ---------------
                                 $    1,751,946            $     1,055,811
                                 ==============            ===============

3.       DEBT

Debt consisted of:

<TABLE>
<CAPTION>
                                                                       December 31
                                                                1998                1997
                                                                ----                ----
<S>                                                         <C>                   <C>
         Line of credit, due March 1999. Interest 
          is payable monthly at the bank's reference 
          rate, which is currently 8.5%. Principal 
          is due in one payment on March 31, 1999. 
          The note is secured by a standby letter of 
          credit expiring on April 30, 1999.
                                                            $    125,000          $    600,000
         Capital    leases,     payable    in    monthly
         installments at various  interest rates through
         1999.                                                         -                 2,496
                                                            ------------          ------------
                                                                 125,000               602,496
         Less current portion                                    125,000                 2,496
                                                            ------------          ------------

                                                            $          -          $    600,000
                                                            ============          ============
</TABLE>

         In June 1997, the Company entered into a line of credit arrangement
with a bank. Under this agreement, the Company is able to borrow up to
$1,000,000. The line of credit bears interest at the bank's reference rate. The
line of credit expires March 1999. The line of credit is secured by a standby
letter of credit from a shareholder of the Company. As consideration for
securing the letter of credit, the Company paid the shareholder $50,000 per year
and issued a warrant to purchase 25,000 shares of common stock at an exercise
price of $2.50 per share. In addition, the shareholder holds a security interest
in all of the Company's assets, subordinated only to senior debt. The warrant
expires in May 2000. The warrant was deemed to have value of approximately
$6,900.
This amount is being expensed over the life of the line of credit.

         Interest paid by the Company in 1998, 1997 and 1996 was $76,161,
$49,760 and $160,446, respectively.

4.       OPERATING LEASE

The Company leases its office and manufacturing facility under an operating
lease that expires in 2004. Maintenance, utilities and real estate taxes are
paid by the Company. Total rent expense under this lease was $261,964, $165,368
and $173,067 for the years ended December 31, 1998, 1997 and 1996, respectively.

Minimum future obligations on the facility lease are as follows:

         1999                                           $      163,764
         2000                                                  164,255
         2001                                                  169,654
         2002                                                  170,144
         2003                                                  175,536
         Thereafter                                            160,908
                                                        --------------
                                                        $    1,004,261

5.       INCOME TAXES

At December 31, 1998, the Company had net operating losses for federal income
tax purposes of approximately $18,005,577, plus credits for research and
development costs of approximately $298,000 that are available to offset future
taxable income through the year 2013. These carryforwards are subject to the
limitations of Internal Revenue Code Section 382. This Section provides
limitations on the availability of net operating losses to offset current
taxable income when an ownership change has occurred for federal tax purposes.
The annual limitation on net operating losses is calculated by multiplying the
value of the corporation immediately prior to the ownership change by the
long-term federal tax exempt rate.

         As a result of the sale of Series A preferred stock in 1990, the
Company had a change of ownership under Section 382. The use of losses, incurred
through the change in ownership date, to offset future taxable income will be
limited to approximately $300,000 per year during the carryforward period. The
losses occurring after the change in ownership date are unaffected and can be
used to offset future taxable income without limit. The credits will also be
subject to limitations under these same rules.

         Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts used for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
Company's deferred tax assets are as follows:

                                                          December 31
                                                   1998               1997
                                                   ----               ----
         Net operating losses                 $ 6,842,000        $ 7,148,000
         Depreciation                              95,000             96,000
         Amortization                              36,000             35,000
         Reserve for bad debt                      23,000             18,000
         Reserve for obsolete inventory            27,000             28,000
         Research and development
           credit amount                          298,000            298,000
         Other                                     56,000             30,000
                                              -----------        -----------
         Total deferred tax asset               7,377,000          7,653,000
         Less valuation allowance               7,377,000          7,653,000
                                              -----------        -----------

         Net deferred tax asset               $         0        $         0
                                              ===========        ===========

6.       CONVERTIBLE PREFERRED STOCK

During 1995, the Company sold 471,500 shares of Series D Convertible Preferred
Stock for $1,205,808. The Series D Preferred Stock carries a coupon rate of 10%
with dividends payable quarterly. The conversion price is $2,875 per share.

         During 1994, the Company sold 410,906 units, each consisting of one
share of Series C Convertible Preferred Stock and a warrant to purchase one-half
share of Common Stock, for $1,002,832. The Series C Preferred Stock carries a
coupon rate of 6% with dividends payable quarterly. The conversion price is
$2.75 per share.

         The Company's Series B Convertible Preferred Stock carries a coupon
rate of 8% with dividends payable quarterly. The conversion price is $2.75 per
share. Each share of this Series was sold with a warrant attached to purchase
one share of Common Stock at $2.75. The warrants expired in 1998.

         The Series A Convertible Preferred Stock is convertible at $2.50 per
share. This Series is subject to automatic conversion concurrently with the
closing of a public offering of the Company's Common Stock with aggregate
minimum proceeds of $7,500,000 at a minimum price per share of $5.00.

         The Series A, B, C and D Preferred Stock are convertible into Common
Stock on a one-for-one basis at the option of the holders, and each holder has
voting rights on all matters submitted to shareholders on an as-if-converted
basis. The Series A Preferred Stock has anti-dilution rights for any sales of
Common Stock by the Company at less than its current conversion price, and the
conversion price for each Series of Preferred Stock is subject to adjustment for
stock dividends, stock splits and capital reorganizations.

7.       STOCK PURCHASE AND OPTION PLANS AND WARRANTS

The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation, but
applies Accounting Principles Board Opinion No. 25 and related interpretations
in accounting for its plans.

         The Company has a stock purchase plan, nonstatutory and incentive stock
option plans and compensatory stock options. Total shares reserved at December
31, 1998 for convertible preferred stock, future employee stock purchase plan
purchases and options and warrants were 4,360,639.

Stock Purchase Plan
The Company has an employee stock purchase plan under which the sale of 200,000
shares of its Common Stock has been authorized. The purchase price of the shares
under the plan is the lesser of 85% of the fair market value on the first or
last day of the offering period. Offering periods are six months each. Employees
may designate up to 10% of their compensation for the purchase of stock.

Stock Option Plans
In 1997, the Company adopted the 1997 Stock Option Plan under which 500,000
shares were reserved. Shares under this plan are generally exercisable beginning
one year from the date of grant in cumulative amounts of one-fourth to one-third
of the shares under option and expire seven years from the date of grant.
Incentive and nonstatutory options are granted at prices not less than market on
the date of grant.

         In 1992, the Company adopted the 1992 Stock Option Plan under which
500,000 shares were reserved. Shares under this plan are generally exercisable
beginning one year from the date of grant in cumulative amounts of one-fourth to
one-third of the shares under option and expire ten years from the date of
grant. Incentive and nonstatutory options are granted at prices not less than
market on the date of grant.

         In 1986, the Company adopted an Incentive Stock Option Plan under which
600,000 shares were reserved. Incentive options are generally exercisable
beginning one year from the date of grant in cumulative yearly amounts of
one-fourth and one-half of the shares under option and expire five to ten years
from the date of grant.

         Also, in 1986, the Company adopted a Nonstatutory Stock Option Plan
under which 300,000 shares were reserved. Shares under this plan are exercisable
beginning 18 months from the date of grant. Additionally, 55,000 shares were
reserved during the period from 1986 through 1989 for directors of the Company
through granting of individual non-qualified option agreements. Non-qualified
director options are exercisable beginning six months from the date of grant.
All non-qualified options expire after five years.

         Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of the
Statement. The fair value for these options was estimated at the date of the
grant using a Black-Scholes option pricing model with the following weighted
average assumptions for 1998, 1997 and 1996, respectively; risk free interest
rates of 5%, 5% and 5%; dividend yields of 0%, 0% and 0%; volatility factors of
the expected market price of the Company's stock of .582, .593 and .516; and a
weighted-average expected life of the option of seven, four and four years.

         The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different than those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

         For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:

<TABLE>
<CAPTION>

                                                                  1998          1997           1996
                                                                  ----          ----           ----
<S>                                                             <C>           <C>           <C>       
         Pro forma income (loss) applicable
           to common stock                                      $ 187,847     $(996,570)    $(780,840)
         Pro forma income (loss) per common share               $     .03     $    (.14)    $    (.12)
                                                                ---------     ----------    ----------
</TABLE>

The pro forma results may not be representative of the future impact of applying
Statement 123 due to the phase-in provisions of the Statement and actual vesting
experience.

A summary of the Company's stock option activity and related information for the
years ended December 31 follows:

<TABLE>
<CAPTION>
                                        1998                            1997                            1996
                                        ----                            ----                            ----
                                          Weighted-Average                Weighted-Average                Weighted-Average
                              Options      Exercise Price       Options    Exercise Price      Options     Exercise Price
                              ---------   ----------------      -------   ----------------     -------     --------------
<S>                           <C>               <C>            <C>             <C>            <C>              <C>  
Outstanding at            
beginning of year             1,170,154         $2.31           989,600         $2.31          1,070,000        $2.31
Granted                         146,500          1.99           346,554          2.23             44,500         3.14
Exercised                             -          -              (33,750)         1.70            (94,063)        2.42
Canceled                        (22,500)         2.30          (132,250)         2.28            (30,837)        3.08
Outstanding at end of year    1,294,154         $1.99         1,170,154         $2.31            989,600        $2.31
                              ---------         -----         ---------         -----            -------        -----
Exercisable at end of year    1,048,579                         944,064                          807,620
                              =========                         =======                          =======
Weighted average fair     
value of options          
granted during the        
year                                            $1.11                           $ .93                           $1.59
</TABLE>
                          
Exercise prices for options outstanding as of December 31, 1998 ranged from
$1.53 to $5.00. The weighted average remaining contractual life of those options
is five years.

         Shares reserved and available for grant at December 31, 1998 for the
option plans was 131,733.

Warrants
At December 31, 1998, the Company had outstanding total exercisable warrants to
purchase shares of its Common Stock as follows: 13,500 shares at $2.25 per
share; 25,000 shares at $2.50 per share; 360,440 shares at $2.75 per share;
247,150 shares at $2.875 per share. The warrants expire at various dates from
1999 through 2005.

8.       EMPLOYEE BENEFIT PLAN

In January 1989, the Company adopted a defined contribution plan for
substantially all employees. Each employee may elect to contribute from 1% to
20% of their compensation to the plan. Employees become 100% vested in Company
contributions after four years of service. There was no expense for this plan
for the years ended December 31, 1998, 1997 and 1996.

9.       EXPORT SALES AND MAJOR CUSTOMERS

Total sales to foreign customers were $1,267,653, $1,418,234 and $1,310,700 in
1998, 1997 and 1996, respectively.

         The Company had total sales to OEM customers of $3,791,058, $1,913,985
and $1,855,149 in 1998, 1997 and 1996, respectively. Sales to one OEM customer
amounted to $1,594,493 in 1998. Sales to another OEM customer amounted to
$685,553 in 1997. Accounts receivable at December 31, 1998 and 1997 included
$296,820 and $196,456, respectively, from these customers.

10.      CREDIT RISK

The Company is subject to credit risk on its accounts receivable which are
primarily with health care facilities, original equipment manufacturers and
medical products distributors. The Company performs credit investigations to
minimize credit risk. Certain distributors have the right to return unsold
product in the event the distributor's agreement is terminated for any cause.



<PAGE>


                         REPORT OF INDEPENDENT AUDITORS
                           Everest Medical Corporation

We have audited the accompanying balance sheets of Everest Medical Corporation
as of December 31, 1998 and 1997, and the related statements of operations,
changes in shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements 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 Everest Medical Corporation at
December 31, 1998 and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles.

                                                     /s/ Ernst & Young LLP

Minneapolis, Minnesota
January 13, 1999



                 PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
                           Everest Medical Corporation

The Company's Common Stock is quoted on the Nasdaq SmallCap Market, under the
symbol EVMD. The following table sets forth, for the periods indicated, the high
and low closing bid prices for the Common Stock as reported by Nasdaq. Such
quotations represent interdealer prices, without retail markup, markdown or
commission, and may not represent actual transactions.

         As of December 31, 1998, there were approximately 283 holders of record
of the Company's Common Stock, with approximately 2,600 beneficial holders. In
addition there were 7 holders of record of Series A Preferred Stock, 29 holders
of record of Series B Preferred Stock, 14 holders of Series C Preferred Stock
and 31 holders of record of Series D Preferred Stock.

         The Company has not declared or paid any cash dividends on its Common
Stock or its Series A Preferred Stock since inception. The Company has paid its
Series B Preferred Stockholders its current dividend of $0.22 per share per
annum (8% of the purchase price per share) plus its dividends in arrears
commencing in September 1994. Cash dividends paid on this Series B Preferred
Stock were $141,025 in 1998. The Series C Preferred Stock is entitled to
dividends of $0.165 per share per annum (6% of the purchase price per share)
plus its dividends in arrears commencing August 1995. Cash dividends paid on
this Series C Preferred Stock were $67,799 in 1998. The Series D Preferred Stock
is entitled to dividends of $0.2875 per share per annum (10% of the purchase
price per share) plus its dividends in arrears commencing September 1995. Cash
dividends paid on this Series D Preferred Stock were $135,566 in 1998.

         The Board of Directors presently intends to retain all other earnings
for use in the business for the foreseeable future. The Company is prohibited
from paying dividends on its common stock without consent of the holders of (a)
a majority of shares of Preferred Stock and (b) the Company's convertible
promissory notes and the warrants issued in connection therewith.

                                           HIGH              LOW
                  1998
                  First Quarter            $ 2 7/8           $ 1 5/16
                  Second Quarter             2 7/16            1 9/16
                  Third Quarter              2 3/8             1 1/4
                  Fourth Quarter             2 1/4             1 3/16

                  1997
                  First Quarter            $ 3               $ 1 7/8
                  Second Quarter             3 1/8             1 3/4
                  Third Quarter              3 1/8             1 7/8
                  Fourth Quarter             2 11/16           1 1/8


<PAGE>